In this guide
- What is IR35?
- What are the ‘Off Payroll Working’ rules?
- Who do the new rules apply to?
- Do the Off Payroll Working rules apply to those working via a payroll umbrella company?
- Do the Off Payroll Working rules apply to those working as a sole trader?
- Is working via a payroll umbrella company more tax-efficient than working inside IR35 via a PSC?
- What will change for contractors working via PSCs who are found to be inside IR35?
- Will I need to adjust my daily rate for payments made after 6th April 2020?
- What determines whether or not my contract falls inside IR35?
- Whose responsibility is it to determine a contract’s IR35 status?
- Who is liable for any unpaid tax and NI under the new rules?
- What are the consequences of a contract being wrongly designated outside IR35?
- Should I retain my PSC?
- Where to find advice
What is IR35?
Disguised employment is where the working practices and wording of a contract are similar to that of an employee, but where the contractor enjoys the tax benefits of working through an intermediary, such as a limited company, also known as a personal service company (PSC). When a contractor is seen to be in disguised employment, they are deemed to be ‘inside’ or ‘caught by’ IR35.
The 2000 IR35 rules state that if your contract is inside IR35, then 95% of the fees you earn (less certain allowable expenses of employment, which include pension premiums) must be paid as salary to the contractor who has carried out the work.
For contractors working in the Public Sector, and for larger end-users (referred to here as end-client) in the Private Sector, the new ‘Off-Payroll Working’ rules now apply.
What are the ‘Off Payroll Working’ rules?
If the contractor is found to be inside IR35, they must either:
- Go on to the payroll of their end-client
- Work via a payroll umbrella company
- Use a PSC but be taxed according to new regulations
There is new legislation written for the Private Sector (sitting in draft form in the Finance Bill 2019/2020 and currently under review by the Treasury), on track to be introduced in April 2020. Therefore, contractors working in the Private Sector need to be sure whether their contracts are likely to be caught by IR35, and if they are, must weigh up their options.
If you do not wish to go on the payroll of your end-client, you can either switch to working via a payroll umbrella company such as Competex Pro (recommended) or continue to work through your PSC (which is becoming more costly and difficult as explained further below).
Who will the new rules apply to?
The small business exemption
Small end-client businesses in the Private Sector are exempt from applying the legislation. A business is classed as ‘small’ if they meet two or more of the following:
- The turnover is under £10.2 million
- The ‘Gross asset total’ is under £5.1 million
- The number of employees is under 50
Small subsidiaries of large parent companies do not count as small businesses, and non-corporates are treated slightly differently (i.e. the rules are simplified).
NB Contractors working for small end-clients will still need to assess their contracts for IR35 status and if caught, will have to apply old IR35 rules, i.e. 95% of income must be used as salary.
Do the Off Payroll Working rules apply to those working via a payroll umbrella company?
It is however, extremely important that the IR35 status of the contract is determined and communicated to all parties in the supply chain, as the status will determine whether HMRC will allow tax relief on certain expenses (such as commuting). Therefore, if a contractor is working via a payroll umbrella company but is outside IR35, then commuting expenses are allowable for tax relief, which is not the case if the contractor is inside IR35.
If we are found to be reclaiming expenses incorrectly on your behalf whilst you are working on assignment under IR35, then HRMC advise that the expenses will be reclassified as income, and tax and NI will be due on the income. Furthermore, they could at the same time instigate an unwelcome investigation.
Do the Off Payroll Working rules apply to those working as a sole trader?
We therefore think it is unlikely that many clients will wish to engage with contractors in this way.
Is working via a payroll umbrella company as tax-efficient as working inside IR35 via a PSC?
Competex Pro, launched in 2017, has proven to be a professional, simple, easy and tax-efficient way of working under these rules, and draws on our 20+ years of accounting experience in the consultant, interim and contractor market. We will ensure that expenses you recharge to your client are taxed correctly and that any allowable expenses are deducted before calculating tax and NI due.
Competex Pro is set up in a way that allows you to:
- Claim bona fide costs of employment for your current contract, tax free
- Pay contributions into your chosen pension scheme, tax free (within your allowances)
- Be fully covered with Professional Indemnity and Public Liability insurance, at no extra cost to you
- Keep running your limited company and easily switch between IR35 and non-IR35 assignments, knowing your accountant and personal tax adviser are being kept in the loop
- Gain access to tools and resources to help you navigate the new legislation (e.g. calculating your take-home pay and setting your daily rate)
- Gain access to advice and support from our specialist accounting team
- Have peace of mind knowing everything is being run smoothly and efficiently with your agency or end-client and any issues are being responded to
- Project a professional image to your agency and end-client.
What will change for contractors working via PSCs who are found to be inside IR35?
PSC contractors will be taxed in a different way under the new rules. If the contract is caught by IR35 and the contractor is working via a PSC, then the ‘fee payer’ (agency or end-client) is required to deduct tax and Employee’s National Insurance on the contractor’s earnings, and to pay this to HMRC together with Employer’s National Insurance, before paying the net amount to the PSC.
There are also the following issues:
- Fees are normally taxed at the 20% basic rate unless the fee payer is advised to do otherwise by HMRC. Contractors should therefore be prepared to pay additional tax if appropriate after submitting their annual self-assessment tax return.
- The 5% allowance for business expenses has been removed. This means that 100% of the fee income paid to the PSC by the fee payer is treated as taxable income, rather than 95% as in the original IR35 legislation. The contractor would still need to pay for the costs of running their PSC (such as accounting fees, IT, communications and marketing costs), and would have to do so out of taxed income (meaning they lose money).
- There is no provision in the 2020 draft legislation for fee-payers to contribute to Off Payroll Workers’ pensions if working via a PSC. Therefore, PSC contractors would need to make contributions out of taxed earnings.
All the above issues can be avoided by working via a payroll umbrella company such as Competex Pro, which we recommend if your contract is inside IR35.
Once the new rules are introduced, if a large or medium-sized Private Sector end-client deems a contractor who is working through a PSC to be inside IR35, the end-client will have a decision to make.
It could either terminate the contract and re-issue it to reflect the new status, or it could change the contractor’s working arrangements in such a way that the contractor would no longer be inside IR35. It is as yet unclear whether PSC contractors who are currently outside IR35, will be caught by IR35 if they are on the same assignment once the rules come in.
There is a danger of blanket status determinations being made by large organisations, as we saw with HSBC in 2019. In 2017 we saw many contracts in the Public Sector defaulting to IR35 status without the proper checks being made. This was largely due to a lack of information supplied by HMRC and a flawed CEST (Check Employment Status for Tax) tool, which was then revised in November 2019.
Will I need to adjust my daily rate for payments made after 6th April 2020?
You should be clear when negotiating the rate whether it is before or after employment costs such as Employer’s NI, auto enrolment and apprenticeship levy. These costs mean that as a minimum your rate would need to increase by at least 13.8%.
Also, be aware that your client may offer you two different rates – a lower rate for being paid through their payroll and a higher rate for being paid via a payroll umbrella company. In the one case, the client is paying Employer’s NI and other employment costs in addition to the taxable fee. In the other case these costs of employment are paid by the payroll umbrella company.
If you switch to working via a payroll umbrella company such as Competex Pro, you may be able to claim certain expenses out of pre-tax fee income, which could also affect how your daily rate should be adjusted. Our take home pay calculator allows you to compare the different options and convert your projected annual earnings into a daily rate.
What determines whether or not my contract falls inside IR35?
The employment tests
The “direction, supervision and control” test
This test focuses on the level of autonomy given to the contractor. HMRC considers contractors to have more autonomy when it comes to choosing the work that they do, while employees are more likely to be assigned tasks by their employer. This does depend on the individual’s skill and expertise, however, as a highly skilled employee is likely to enjoy a greater degree of autonomy than a less experienced contractor.
The “direction, supervision and control” test asks the following questions of a contractor’s working practices and the wording of the contract itself:
- Direction: is the contractor told how to do the job at hand?
- Supervision: is the contractor supervised while they carry out their work?
- Control: does the engaging organisation have control over aspects of the contractor’s working practices, such as their work schedule?
If the answer to any of these questions is “yes”, then there’s a chance that the contractor might be inside IR35.
The “substitution” test
The test of substitution considers whether the engaging organisation would be prepared to accept someone else to do the contractor’s work in the event of the contractor being unavailable. If the engaging organisation would not be prepared to do this and would only accept the personal service of that particular contractor, it would suggest that a traditional employment relationship might be in place and that the contract could therefore be inside IR35.
The “mutuality of obligation” test
In the context of employment, mutuality of obligation (MOO) means that one party – the employer – is obliged to provide work and the other party – the employee – is obliged to accept it.
However, unlike employees, contractors have no obligation to accept work and unlike employers, the companies that engage them have no obligation to provide it.
Therefore, as MOO is a feature of an employment relationship, if it is present in a contract, it suggests that the contract might be inside IR35.
When assessing a contractor’s working practices and contract, there are certain factors that would indicate that MOO isn’t present and that an employment relationship, therefore, doesn’t exist. These include:
- the use of specific projects with set end dates
- the ability for either party to stop the work with very little notice
Additional factors that might affect a contractor’s IR35 status
HMRC doesn’t just consider the outcome of the three employment tests when assessing a contractor’s IR35 status. It looks at a wide range of factors that might indicate that the contractor is “part and parcel of the organisation” and that a traditional employment relationship might, therefore, be in place. These factors include:
- the contractor having an email address at the engaging organisation
- the contractor having permission to use company equipment
- the contractor receiving the same company ‘perks’ as their employed colleagues
- the contractor being line managed in the same way as their employed colleagues
Common IR35 myths
If I fail on one test, then my contract will be caught.
This is not true – all three tests should be applied and all factors considered.
If I word my contract in a certain way, I can be seen to be outside of IR35
The wording of the contract should always reflect the working practices. In the event of a tribunal, it will be the working practices that will take precedence over the wording of the contract.
If my engagement is long, then I will be caught
The length of the contract doesn’t affect the status, but if the working practices change over the course of the assignment to reflect more of an employment scenario, then it could end up being under IR35. There is currently no provision for statuses changing part-way through a contract in the draft legislation, so this could create complications and we are waiting for further information on this.
If an agency substitutes another contractor in my absence, I am not caught
This could equally happen in an employment scenario and is not what is meant by substitution. It is the contractor who must have the right to substitute, not the agency, to contribute to an outside IR35 determination.
If I have more than one end-client, I am not caught
This can be an indicator of being in business in one’s own right and can contribute to an outside IR35 determination, but the combination of the other factors would also need to reflect that the contractor is not caught.
Whose responsibility is it to determine a contract’s IR35 status?
In the Private Sector, it’s currently the contractor’s responsibility to determine if they are inside or outside IR35. However, the 2020 draft legislation puts the onus on the engaging organisation to make this assessment.
If the end-client is outside the UK
If both the fee-payer (typically the employment agency) and the end client are outside of the UK, the fee-payer will remain liable with regard to the IR35 determination of the contract. The consultation document would also suggest that should the contract be directly with an overseas client, the client will then become the fee-payer and be responsible for the contractor’s status. Here is a useful article about this from QDOS.
It is important to understand that if you are a UK resident for tax, then IR35 and the new rules will apply to any work you undertake, even if that work is carried out overseas or for a client based overseas. It would therefore be prudent to have your contract reviewed and to obtain either a Statement of Working Practices or some type of Confirmation of Arrangements letter signed by your end client. One of the specialist legal firms can advise you further on what you might need (see see ‘Where to Find Advice’).
Who is liable for any unpaid tax and NI under the new rules?
The end-client must however take ‘reasonable care’ (see below) to communicate the IR35 status determination statement (SDS) and reasons, to all parties in the supply chain, down to the contractor, otherwise the end-client remains liable for any tax and NI not deducted. This must be communicated before the first payment is made.
The following rules also apply:
- If the supply chain is lengthy, then the end-client must inform the fee payer and contractor directly of the IR35 status and reasons for the status determination, short-circuiting the chain
- Liability moves down the chain as each party fulfils their obligations, resting with each party until it has passed down the required information
- Where the agency or third party that would be the fee-payer is offshore, the liability moves to the next party above them in the contractual chain which is in the UK. If only the end-client is in the UK then they will be the liable party. Where a party in the contractual chain, including the end-client is outside the UK but the contractor performs services in the UK, fee-payers must still deduct tax and NICs.
- If the lower part of the supply chain (i.e. the PSC) is unable to pay the unpaid tax, then the liability will transfer back up to the end-client even if they followed the rules.
This way of dealing with liability is intended to give an incentive for all parties to comply. This is new to the 2020 rules, and was not addressed in the 2017 version of the rules. It has been stated that if this method is successful then this will be adopted in the public sector too.
What does ‘reasonable care’ mean?
- The draft legislation provides that if the end-client does not take reasonable care in reaching the decision for the SDS, then they become responsible (and liable) for deducting the contractors tax and NI, and employers NI. It could be argued that clients who make blanket decisions and fail to carry out an assessment on an individual basis, could be at risk of failing to take reasonable care.
- The end-client must do all they can to communicate with all parties in the supply chain and make sure that the IR35 status, and reasons for the status determination, are known and understood by all parties
- The end-client must respond to any disagreements about the status determination and reasons for determination within 45 days. If they do not, they become liable for any unpaid tax and NI.
If you consider that your role is not a typical IR35 role (and perhaps is currently outside of IR35), but you receive an SDS that says you are, you have a right to challenge the decision. In such cases, we recommend obtaining your own independent status check from a specialist such as Bauer & Cottrell (see ‘Where to Find Advice’).
Critics of the legislation have pointed out that HMRC is delegating their role to the business community, as there is no third party available that the contractor can go to in the event of a disagreement. We will see how this plays out in practice. Further guidelines are expected to be issued at the end of February, following HMRC’s review of practices, and we hope that these will cover these issues in more depth.
What are the consequences of a contract being wrongly designated outside IR35?
Should I retain my PSC?
If in the foreseeable future you expect to be working for large organisations who are likely to issue an IR35 status to their contractors, you may wish to consider closing your company. Please be aware that if your company has reserves on closure of more than £25k you would need to apply for a voluntary liquidation of the assets so that the reserves may be taken as a capital distribution (on which lower tax is generally payable) rather than as revenue.
For further information on closures, please ask your accountant for a copy of our handout.
Where to find advice
The CEST Tool
HMRC developed the Check Employment Status for Tax (CEST) tool to help contractors and the companies who engage them to check whether a contract and the contractor’s working practices fall inside or outside IR35. However, some questions were raised relating to the initial version of the tool and its exclusion of the mutuality of obligation test. An updated version of the CEST tool was released in November 2019. We cannot endorse its accuracy, however, and we always recommend that you seek an independent contract review from a trusted provider such as Croner Taxwise or Bauer and Cottrell.
IR35 Contract Reviews
An independent contract review highlights each relevant clause within your contract and details why it is a pass or a fail for the IR35 legislation. Remember, however, that your working practices are paramount, so they will be scrutinised and individual methods of working will also be judged to be either a pass or a fail. If appropriate, guidance and suggestions will be provided as to how to make your contract and working practices more robust.
Be aware that it is now the end-client who is responsible for determining the IR35 status of a contract, and so you would only seek a contract and working practices review in the event of a disagreement or to get an idea of what to expect and help you plan accordingly. However, if you were to be subject to an HMRC IR35 enquiry for any reason, it would then demonstrate that you have taken ‘reasonable steps’ to ascertain your status.
Letters from HMRC
Some PSC contractors on contract with large end-clients have already received letters from HMRC, stating that they should expect to be caught by IR35. If you have received such a letter, it is important to take independent advice before responding to HMRC, as an incorrect response could invalidate your PI insurance.
Subscribers to the Competex Tax Investigation Protection Scheme with Croner Taxwise receive free support and advice about how to respond, as part of their cover. However, even if you do not subscribe to the Scheme, please contact your accountant if you have received such a letter.