HMRC introduced IR35 (or the “off-payroll working rules”) in 2000 to tackle what they call “disguised” employment. By disguised employment HRMC means an instance where an individual is working as a contractor – usually through their limited company, also called a Personal Services Company or PSC – and enjoys the subsequent tax benefits, when actually their relationship with their client is closer to an employer/employee relationship.
As of now, the hirer is responsible for assessing whether a contractor falls within IR35 only if the hirer operates within the public sector, otherwise the responsibility falls onto the contractor.
However, starting in April 2020, some private businesses will be required to operate under the same rules as public sector companies for what concern IR35 regulations.
This applies to companies where at least two of the following conditions are met:
- Annual turnover is over £10.2 million.
- Balance sheet total is over £5.1 million.
- Total number of employees is more than 50.
Where the company determines that the IR35 applies, the company will be responsible for deducting income tax and employee’s national insurance contributions (NICs) from fees paid and ensuring the contractor is paid correctly under the legislation.
With the new legislation kicking in in a few months’ time, it is important for the businesses and individuals affected to become familiar with IR35 regulations and prepare themselves to be compliant.
Who falls within IR35?
There is still a lot of uncertainty on how HMRC will effectively action the new rules. The goal of the legislation is to make sure that agreements between a hirer and a contractor involve the supply of services, rather than employment.
The following are the three main criteria that HMRC evaluates when assessing whether a contractor falls within IR35.
- Supervision, direction, control – this indicates the degree of freedom the contractor has in relation to the work contracted. For example, if most of their working hours are set, that implies employment.
- Substitution – if the contractor has an obligation to complete the job personally, without involving a substitute if needed, then they are likely to fall within IR35.
- Mutuality of obligation (MOO) – is there an obligation on the hirer’s end to offer work, or on the contractor’s end to accept it? This is called mutuality of obligation, and if it exists, the contract will fall within IR35.
Other criteria often used to prove whether or not a contract falls within IR35 are:
- Equipment – if this is provided by the client, then the contract will likely fall into IR35.
- Financial risk – As self-employed, contractors usually take a degree of financial risk, like any business would. Responsibility for errors and being required to fix possible mistakes in their own time is a typical characteristic of contractors that do not fall within IR35.
- Payment terms – Contractors are usually paid on a project or milestone basis, hourly/daily/weekly/monthly rates independent of the amount of work being completed could be seen as a “disguised salary” by HMRC.
- ‘Part and parcel’ of the organisation – if contractors become part of a company’s structure, with people reporting to them for example, this points to employment rather than self-employment.
- Exclusivity – Contractors are usually free to work for different clients at the same time. If they are not allowed to and are bound to be exclusive to a client, the relative contract might fall within IR35.
- Intentions of the parties – If necessary, HMRC will investigate the actual relationship between the contractor and the hirer. If they find that it is more like an employee/employer relationship, HMRC will ignore the contract.
- Business ‘on your own account’ – Self-employed contractors should run their business as such, with a company website, a dedicated office space and possibly even their own employees. None of these are necessary but they are all factors that point towards self-employment rather than employment.
How to prepare
If your company frequently employs PSC contractors, then you should probably start preparing for the new legislation kicking in next April. While this is not too much work, it can save loads of time in the event that an IR35 enquiry from HMRC arises.
Basic preparation simply involves gathering documents – like contracts between your company and its contractors – showing that:
- The contractor has the right to provide a substitute;
- They do not work under the direct control of the company;
- They are not obligated to carry out the work; and
- They are not “part and parcel” of the company’s organisation.
It is also worth having documentation in place which outlines that each party in the supply chain confirms the contractor falls outside of the IR35 status. This can be key when providing evidence to the HMRC should an IR35 enquiry arise. The agreement should outline the specific reasons that your working arrangement belongs outside IR35.
If current contracts do not offer sufficient evidence that contractors fall outside of IR35, then those contracts should be re-drafted and signed by all parties involved.
Implement processes and procedures
- Companies will want to consider who in their organisation will be responsible for determining the status of contractors they engage with and how payments will be made to them.
- Companies might need to consider whether they have suitable payroll systems to facilitate and process invoices correctly, considering whether tax and NICs apply.
- Companies should consider investing in their IT programs/equipment and ensure that those responsible for operating them are trained and ready when the new legislation kicks in.
Under the new rules, companies will also be obliged to have in place a dispute resolution procedure which meets minimum criteria set by Government, to allow for determinations to be challenged and for contractors to exercise their rights to seek written reasons for their status determination.