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?
- How does a payroll umbrella company compare with working via a PSC if I am inside IR35?
- What will change for PSC workers who are found to be inside IR35?
- Will I need to adjust my daily rate for payments made after 6th April 2021?
- 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?
IR35, also known as the Intermediaries Legislation, was introduced in the year 2000 and was designed to collect additional tax and NI from independent professionals (referred to in this guide as ‘workers’) who HMRC believed to be working in ‘disguised employment’.
Disguised employment is where the working practices and wording of a contract are similar to that of an employee, but where the worker enjoys the tax benefits of working through an intermediary, such as a limited company, also known as a personal service company (PSC). When a worker 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 worker.
For independent professionals in the Public Sector, and as of April 2021, for those working for larger end-users (referred to here as end-clients) in the Private Sector, the new ‘Off-Payroll Working’ rules apply.
What are the ‘Off Payroll Working’ rules?
The ‘Off-Payroll Working’ rules (first introduced into the Public Sector in April 2017), state that the end-client is now responsible for determining the IR35 status of the contract, rather than the worker as was the case in the 2000 legislation.
If the worker 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 Off Payroll Working legislation written for the Private Sector which is on track to be introduced in April 2021. By this date, independent professionals 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 are not required 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 you can continue to work through your PSC (which will become more costly and difficult after April 2021).
Who will the new rules apply to?
The small business exemption
Small end-client businesses in the Private Sector will be exempt from applying the Off Payroll Working rules when they come into force. 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 Workers whose end-clients are classed as ‘small’ will still need to assess their contracts for IR35 status and if caught, will have to apply the original 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?
Not with regard to taxation as it is the payroll umbrella company that deducts tax and NI, rather than the fee payer (agency or end-client).
It is however, still paramount that the IR35 status of the contract is determined and communicated to all parties in the supply chain, even if the worker is using a payroll umbrella company. The status will determine whether HMRC will allow tax relief on certain expenses (such as commuting). If a worker is using a payroll umbrella company but is outside IR35, then commuting expenses, and any associated hotel expenses, are allowable for tax relief, which is not the case if the worker is inside IR35.
If Competex Pro is 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 end-clients will wish to engage with you in this way.
How does a payroll umbrella company compare with working via a PSC if I am inside IR35?
Working through a payroll umbrella company is appropriate for you if your assignment falls inside IR35 and working through your own personal service company is no longer viable. It is also a useful way to work if this is a short first contract and it doesn’t seem economic to incorporate your own personal service company.
Even if you have come to us for one of the above reasons, we believe that you will find Competex Pro to be a professional, simple, easy and tax-efficient way of working under these rules.
Competex Pro draws on Competex’s 20+ years of specialist accounting experience in the contractor market. We will ensure that expenses you recharge to your end-client are taxed correctly in your hands, 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 PSC workers who are found to be inside IR35?
PSC workers will be taxed in a different way under the new rules. If the PSC worker is caught by IR35, then the ‘fee payer’ (agency or end-client) is required to deduct tax and Employee’s National Insurance on the worker’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. The worker should therefore be prepared to pay additional tax if appropriate after submitting their annual self-assessment tax return.
- The 5% allowance for business expenses will be removed. This means that 100% of the fee income paid to the worker’s PSC by the fee payer is treated as taxable income, rather than 95% as in the original IR35 legislation. The worker will still need to pay for the costs of running their PSC (such as accounting fees, IT, communications and marketing costs), and will have to do so out of taxed income (meaning they lose money).
- There is no provision in the 2021 legislation for fee-payers to contribute to Off Payroll Workers’ pensions if working via a PSC. Therefore, PSC workers would need to make contributions out of taxed earnings.
As such, the new regulations make it very difficult and uneconomic to work through a PSC if your work is inside IR35.
Once the new rules are introduced, if a large or medium-sized Private Sector end-client deems a PSC worker 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 worker’s working arrangements in such a way that the worker would no longer be inside IR35. It is as yet unclear whether PSC workers 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 2021?
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 end-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 ‘supervision, direction and control’ (SDC) test
This test focuses on the level of autonomy given to the worker. HMRC considers consultants, for example, 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 can however depend on the individual’s skill and expertise, as a highly skilled employee is likely to enjoy a greater degree of autonomy than a less experienced consultant.
The ‘supervision, direction and control’ (SDC) test asks the following questions of the working practices and the wording of the contract itself:
- Supervision: is the worker supervised while they carry out their work?
- Direction: is the worker told how to do the job at hand?
- Control: does the engaging organisation have control over aspects of the working practices, such as the worker’s schedule?
If the answer to any of these questions is “yes”, then there’s a chance that the worker 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 work in the event of the worker being unavailable. If the engaging organisation would not be prepared to do this and would only accept the personal service of that particular worker, 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 regular 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, non-employees 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 the 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 contract’s IR35 status
HMRC doesn’t just consider the outcome of the three employment tests when assessing a contract’s IR35 status. It looks at a wide range of factors that might indicate that the worker is “part and parcel of the organisation” and that a traditional employment relationship might, therefore, be in place. These factors include:
- The worker having an email address at the engaging organisation
- The worker having permission to use company equipment
- The worker receiving the same company ‘perks’ as their employed colleagues
- The worker 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 worker 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 worker 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 worker is not caught.
Whose responsibility is it to determine a contract’s IR35 status?
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 end-client, the end-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 worker, 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 worker 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 worker 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 2021 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 worker’s 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 worker 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 workers, 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 workers and the companies who engage them to check whether a contract and the 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
IR35 is a matter of employment law and we are not authorised to give anything other than broad advice on this matter. If required, an IR35 contract review can be obtained from an employment law specialist such as Croner Taxwise or Bauer and Cottrell.
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 workers 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.