Are you ready for the new IR35 rules?

DUE TO THE COVID-19 PANDEMIC, THESE RULES WERE PREVIOUSLY POSTPONED BUT WILL BE COMING INTO EFFECT FROM APRIL 2021

IR35 is here to stay!

There have been lots of changes to IR35 in the past few years and it is indeed here to stay. IR35 is also known as the off-payroll working rules, and although IR35 in itself is nothing new and has always been applicable to contractors, the new rules that come into force from April 2021 will affect many freelancers.

IR35 originally came in as anti-avoidance legislation back in April 2000 and was used to counter the avoidance of tax and NIC for individuals providing their own services via a Personal Services Company, (known as a PSC), which is simply a limited company used for the purpose of providing individual personal services.

Ultimately IR35 is used to determine the relationship between the end client and the worker to determine if there is actually an ‘employer’ and ‘employee’ relationship, and therefore if the PSC wasn’t there, would the worker be employed or self-employed? It is each contract and ‘hypothetical relationship’ that is reviewed for IR35 purposes and not the company in its entirety, and it can apply to any contract, whether written or not.

Up until now, the Personal Service Company would have been responsible for determining whether IR35 applied and if applicable, be responsible for applying PAYE tax and NIC on the applicable contract, which would then negate the ability and benefit of utilising a low salary and high dividend remuneration arrangement for tax purposes.

However, HMRC have estimated that only a small percentage (10%) of PSCs have applied IR35 properly, hence their need to get this right.

What’s new and who is affected?

From 6 April 2021 (postponed from 6 April 2020) the responsibility for making IR35 decisions will now be put on the end-client, rather than the PSC providing the worker, and now applies to all private sector organisations, unless the end client is deemed as small. A small business would therefore be excluded and is one that meets two or more of the following conditions;

• Has less than £10.2m in turnover per year

• Has balance sheet assets before liabilities less than £5.1m

• Has 50 employees or less

If the business is small, the existing rules will continue to apply.

So for the purpose of this article, we are not referring to small entities who are the end client but we discuss the implications for those who are affected, such as contract workers.

It is worth noting that it applies to work related to the period after 6 April 2021, and it is important to note that ultimately the legislation hasn’t changed, it is only the obligation and responsibility that has. PSCs working for a small business should still be reviewing their IR35 status on an ongoing basis.

The cost of IR35

Fundamentally the new rules state that if the end client determines that IR35 is applicable, it will be their obligation to apply PAYE and NIC as if the worker is employed by them, rather than by the PSC (the company providing the worker). Most of the time the ‘end client’ is the ‘fee-payer’ and thus has the responsibility, but in some cases an agency could be involved and could be the ‘fee-payer’ and so they would be required to follow the IR35 procedures also. It is the ultimate responsibility of the fee-payer (ie whoever pays the worker), to apply the PAYE and NIC and run the payroll. It would then mean that the payments made under the terms of the contract would be subject to PAYE and NIC like any other ordinary employment calculation. This means that the worker will get payslips, a P45 and P60 in the same way as if they were an employee, but VAT, if applicable, would still continue to be charged as normal as the contract remains within the PSC. It is possible to claim some small amounts of expenses against the employment income personally provided they are incurred wholly, exclusively and necessarily for the purpose of the employment and would have been contractually required under an equivalent employment contract, but we are not covering this in detail here. The PSC would invoice in the same way as they would a non IR35 contract and the fee-payer would take into account the VAT and apply PAYE and NIC, paying the net difference to the PSC.

Although the above does not seem to differ much to an employment arrangement, it is very important to note that the employment rights and contract terms that would usually apply to an employment, do not apply where IR35 is in place. This means no benefits, employment rights or pension entitlements, and thus no employment contract, so this is definitely not favourable for the worker. As a worker caught by IR35, there would be increased PAYE tax and Employees NIC deducted from the full rate of pay. Compared to their previous arrangement they would be paying far more tax and NIC now and thus have much less cash in the pocket, as the PSC may no longer be able to reap any commercial benefit or any tax advantages from being a limited company. It may therefore be necessary to re-negotiate a higher rate and/or revised working terms and businesses are realising this may be necessary to keep key workers engaged and on side.

Got a student loan?

It is worth noting that a worker with an outstanding student loan will not have their deductions made in the usual way as would be the case under employment. It may well therefore come as a great shock when the Tax Return is prepared and a large student loan repayment is required so we recommend making allowances for this personally by putting some savings aside or setting up a monthly repayment directly to the Student Loans Company covering the period.

If I’m the worker, am I caught?

In order to test whether IR35 applies, there is a normal employment status test that can be applied to the ‘hypothetical relationship’. This is:

‘If the intermediate company or companies did not exist, would the relationship between the end client and the worker be that of employer and employee?’

A decision must be made based on the balance of probability and that can be defined by 5 test categories;

1. Control - What, where, when, how and why? Alongside personal service, this is probably the most important aspect to consider. What are the terms? What are the hours and rates of pay and who decides? (hourly, daily or project based). Where is the place of work? Who chooses the terms? What is the framework of the contract and the task involved? Is there a statement of work in place? Are you expected to take on ad-hoc tasks outside of your contracted tasks?

2. Personal Service - Who? This is also as important as control. Is there a right of substitution? ie can you send someone else in to do your job, at your discretion and decide who and what you pay? Is this applicable in practice or just written in the contract? Are there arduous restrictions in place? ie the need for an interview of the substitute by the end client.

3. Mutuality of Obligations - Is there exclusivity in place? Do you have any other clients? Can you decide your terms? What is the relationship?

4. Integration - Do you look and act like an employee? Do you have your own desk, provide your own tools, have a name badge, are seen on the client phone list or website? Are you doing the same as other employees? Can I use the staff canteen or gym?

5. Economic Reality - Are you really in business? Who provides the tools? Do you have capacity to make both profits and losses depending on the decisions you make? Do you have other clients and can you freely choose who to work with and when? Are you insured as a business? Is there an element of risk?

Each of the above tests are made up of multiple questions and it is important to consider each question on the balance of probability. None of these tests are exclusive and some will conflict, and this is typical. The legislation is complex and lengthy. These questions are used to determine what the status is for tax purposes and therefore whether the worker should be ‘self-employed’ and thus will have a Contract for Services or ‘employed’ and need a Contract of Service. This may well give rise to some subjectivity, but it is important to look at the facts and not just what is written on paper.

HMRC have provided a tool called CEST - Check Employment Status for Tax which is an online questionnaire, and this will enable a worker, agency or the end client or organisation to work through a series of questions to help them come to a decision. The link can be found here. Unfortunately, this is still not cut and dry, or completely accurate, or exact. However, HMRC do accept the outcome of their test provided the facts entered are correct.

For more detailed information, you can find out more within HMRC’s Employment Status Manual.

What needs to happen?

In order to determine the status of a worker, the end client must make a Status Determination Statement (SDS), which can just be a letter setting out whether they think a worker is or is not liable for IR35, and this must be issued to the worker or the agency paying the PSC if there is one, which must then be passed on to the PSC. It must give the reason, and reasonable care must be taken in applying the test, otherwise it may not be valid. This is to avoid firms taking a ‘blanket’ decision and thus making the SDS not valid. Although it is worth noting that many big organisations still appear to be taking a ‘blanket’ approach regardless and in some cases reducing pay rates to reflect the Employer NI contributions becoming due. The worker can disagree and ask for it to be reviewed within 45 days and the end client must provide reasons for the conclusion.

In Summary

The new IR35 rules will affect a lot of people and place a lot of burden on to businesses. In some instances, employment contracts will be offered to ex-contractors and this would be more favourable to most than falling into the pitfalls of IR35. However, very often the end-client may be open to negotiation and a review of contract terms to minimise the impact. In all instances, we recommend you take professional advice.

Please note that the terms used herein are only relevant for tax rules and NOT for the purpose of Employment law.

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We will be running the next Live Tax Clinic on Friday 16th April where we’ll also be covering IR35 and many other tax points so you can plan for the year ahead.

If you would like to attend, you can book direct here.

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FUSE is an independent Chartered Certified firm of accountants and tax advisors based in Highgate Village, North London. We provide a dynamic range of services to clients working in property, media, entertainment, and professional services. Our clients vary in size from self-employed sole traders, small enterprises and medium-sized businesses. We believe that comprehensive financial planning and sound business financial advice are the keys to growth and profitability.