The Definitive Guide for UK Companies
In 2017, BBC presenter Christa Ackroyd made headlines when she lost an appeal with HMRC and had to fork out a huge £419,151 in uncollected Income Tax.
The reason? Christa was not an employee of the BBC, but a freelancer working through a limited liability company (LLC).
Changes to the IR35 legislation, which governs how ‘off-payroll’ workers are taxed, meant that she was found to be a ‘deemed employee’ — and thus liable for taxes and National Insurance Contributions (NICs) at the same rate as an employee. Since she wasn’t aware of this, she was left with a bill for seven years’ worth of unpaid taxes.
The changes to the IR35 legislation were brought in in 2017 for public sector companies employing independent contractors.
And as of April 2021, they’ve been expanded to affect all public institutions, as well as all medium and large private sector businesses.
Back in 2018, when the new IR35 rules only applied to public bodies, research by IPSE and the CIPD revealed that 51% of public sector hiring managers had lost skilled contractors because of the changes to the legislation, and 71% said they were struggling to retain contractors.
For medium and large enterprises that work with independent contractors, these figures are worrying.
Companies that engage independent workers need to be aware of the changes to the rules and what they mean — otherwise, both they and their contractors could be hit with hefty tax bills.
But don’t panic: this article will cover everything you need to know about the IR35 legislation, who it affects, and what the 2021 changes mean for companies that engage contingent workers.
Let’s get started.
What is IR35?
The off-payroll working rules (IR35) are a set of tax laws that govern how off-payroll workers are taxed. This means that they affect people who work for an organisation but are not its employees.
Instead, they work through an intermediary like an LLC. The original rules came into force more than twenty years ago, in 2000.
The legislation takes its name from the initials of the Inland Revenue (now HM Revenue and Customs, or HMRC), and the number of the press release announcing the rules: 35. There have since been two important updates to the legislation, in 2017 and 2021.
Why were the changes introduced?
The changes to the IR35 rules were brought in to close a tax loophole. Previously, many professionals were providing services to clients through an intermediary. This is usually their own personal services company (an LLC or other business structure with them as the director and sole employee), but it could also be:
- A partnership
- Another personal services company
- An individual
Because these workers were not working for their client companies directly, they didn’t have the same tax obligations as employees — even when they were performing the same work.
Which companies are affected by the changes to the IR35 legislation?
As of April 2021, the IR35 legislation affects all public sector organisations and all medium and large enterprises in the private sector. These organisations are responsible for determining the ‘IR35 status’ of any contractors that they engage.
Which companies are not affected by the changes to IR35?
Small companies are currently exempt from the rules, as their limited resources make it difficult for them to perform the necessary worker classification checks. According to HMRC, a business is ‘small’ if at least two of the following apply:
- It has an annual turnover of £10.2 million or less
- It has £5.1 million or less on their balance sheet
- It has 50 or fewer employees
How does IR35 affect organisations that employ contractors?
Under the new rules, people who work through a limited company (or another intermediary) but would be classed as employees if they worked for their client company directly, are deemed to be employees in tax law.
These contractors are sometimes referred to as ‘deemed employees’, ‘disguised employees’ or ‘statutory employees’.
They are therefore required to pay Income Tax and NICs at the same rate as employees who fall into the same tax bracket as them.
The company they work for must also pay employer NICs and the apprenticeship levy at the same rate they do for other employees.
Crucially, the responsibility for determining the correct status of each contractor falls on the company that engages them. This means that if your company engages independent contractors, you must determine whether each contractor falls inside or outside of IR35.
This should be done on a case-by-case basis, since some companies may have contractors who fall within the rules and others who don’t.
Companies that misclassify workers as contractors when they are really deemed employees could face a sizable bill for the tax due, and even receive penalties from HMRC for misclassifying workers.
What does ‘inside IR35’ mean?
If a contractor is ‘inside IR35’, this means that they are effectively an employee, and need to comply with the rules for off-payroll workers.
What does ‘outside IR35’ mean?
Contractors who are ‘outside IR35’ are genuine independent contractors or freelancers who are self-employed and operate their own business independently. They are not deemed to be employees by HMRC.
Determining IR35 status: what companies need to consider
Medium and large enterprises, as well as all public sector organisations, are now responsible for determining the IR35 status of any independent contractor they engage. HMRC can examine a contractor’s status at any time, and you could be fined for incorrectly classifying someone as outside IR35.
In making these determinations, HMRC doesn’t just consider the agreement or contract you have in place with your contractors. Instead, they look at various factors related to the actual nature of their work, to establish whether you have an employer-employee relationship with them.
Control, substitution and mutual obligation
The main criteria for determining whether someone is inside or outside IR35 are:
- Control: HMRC will consider how much control you have over how, when, and where the contractor’s services are carried out. The more control you have, the more likely it is that the contractor is inside IR35.
- Substitution: Genuine contractors have the right to substitution: they can send someone else to complete the tasks they’ve been engaged for if they’re unavailable. If your contractors have this right, they are likely outside IR35.
- Mutual obligation: This principle means that the employer is obliged to provide work for the contractor and that the contractor is obliged to accept it. If there is mutual obligation, it’s likely that the contractor is a ‘deemed employee’ — and thus inside IR35.
HMRC also consider other factors when making their determinations, such as:
- Whether the contractor provides their own equipment
- If there is any financial risk to the contractor
- The type of contract or agreement in place
- The contractor’s role within the organisation
What happens if a contractor is inside IR35?
If an independent contractor is found to be inside IR35, they must be treated as an employee in tax law.
Income Tax and NICs
‘Deemed employees’ have the same tax obligations as actual employees who fall into the same pay band. In this case, the fee you pay to the contractor is referred to as the ‘direct deemed payment’ and is effectively treated like an employee’s salary. As their effective employer, you need to deduct PAYE Income Tax and National Insurance from this fee.
Employer NICs and the apprenticeship levy
If you employ a worker inside IR35, you have to pay Employer National Insurance contributions (usually 15.05% of their annual salary) and the apprenticeship levy (usually 0.5% of their annual salary), as if they were an employee. You must pay these on top of the fees you usually pay to the contractor — you can’t deduct it from their fee.
How to avoid problems with IR35?
The IR35 legislation affects all medium and large enterprises that engage contractors who work through an intermediary.
Both contractors and the companies that employ them should be wary of schemes that claim to help contractors to get around IR35 rules and increase their take-home pay. These schemes are considered to be a form of tax avoidance, and if you are found to have used one, you’re likely to receive a bill for any tax owed and a penalty from HMRC.
As a business owner, there are certain things you can do to avoid running into problems caused by IR35:
1. Hire fixed-term employees instead
Some companies choose to avoid the risks associated with IR35 entirely by not working with contractors, and hiring short-term workers on fixed-term employment contracts instead. However, this is not really a solution, as it means you’ll have to pay the fees and employment taxes associated with hiring employees. Your employees will also have to pay Income Tax and NICs.
2. Consult with an expert in worker classification
If you don’t have the resources or know-how to determine the status of each worker you engage in-house, there are companies that can help you. By enlisting an expert to help you with your IR35 determinations, you can avoid the risk of mistakenly classing someone as outside IR35 — and facing fines from HMRC.
Ensure compliance with CXC Comply
Our workforce compliance solution, CXC Comply, can help you to confidently and compliantly engage contingent workers. We’ll help you to determine the correct classification for each contractor you engage. We’ll also perform background screening and right to work checks on your behalf — and you can manage everything through our intuitive online platform.
Interested? Contact a contingent workforce expert to learn more about how CXC could help your organisation.