Don’t get caught out by changes to IR35!
Changes are being brought in to test worker’s employment status and prevent them from avoiding tax by working ‘off-payroll’.
Contractors who work through a limited company (also known as Personal Service Company, or PSC) can pay themselves a lower wage, then top up their earnings by paying themselves in dividends. This ensures they pay a lower tax rate on their income and is completely legal, as long as they are truly self-employed. Employers also benefit from hiring workers in this way because they don’t have to pay employers’ National Insurance contributions or give contractors employee benefits. Happy days.
Except if the worker is, in effect, employed. If the PSC were removed from the equation, would the individual be considered an employee? If the answer is yes, then they need to be taxed accordingly. HMRC believe thousands of individuals are manipulating the system to avoid paying more in tax.
IR35, aka ‘off-payroll working rules’, was established in 2000 to sniff out cases of ‘disguised’ employment and reduce tax avoidance. Since inception, it has been the contractor’s responsibility to determine whether they fall ‘inside IR35’ (employed) or ‘outside IR35’ (self-employed).
From April 2021, medium-sized and large businesses will be responsible for working out the contractor’s employment status, not the contractor. You may be thinking, “I thought we’d been through all of this last year”, and you’d be right. We had expected the changes to occur in April 2020, but they were delayed by a year due to the economic impact of COVID 19. Going forward, it will be the employer’s responsibility to make the determination, and contractors should be given the reasons behind the employers’ decision. They can dispute the decision if they disagree.
Small businesses will remain exempt from the change. If the contractor works for a small business client, they will still be responsible for working out their employment status. A business is classed as small if they have:
- an annual turnover of no more than £10.2 million
- a balance sheet total of no more than £5.1 million
- no more than 50 employees
Note: small businesses are exempt; however, employers will need to confirm their size if asked by the person or organisation they contract.
I’m an employer in a medium/large business. What do I do now?
You will need to assess and determine all workers’ employment status and contractors working for you before April 2021. You will also be expected to continue the employment status’s supervision for every contract you agree with an agency or a worker for any change in employment status.
Employers are required to communicate the determination using a Status Determination Statement (SDS). An SDS will need to:
- be passed to the worker and the person or organisation you contract with
- give your conclusion and the reasons for coming to it
- make sure you keep detailed records of your employment status determinations, including the reasons for the decision and fees paid
- have processes in place to deal with any disagreements that arise from your determination
- confirm the size of your organisation if asked, by the person or organisation you contract with, or the worker
Employers can use HMRC’s ‘Check Employment Status for Tax’ (CEST) to make these determinations: https://www.gov.uk/guidance/check-employment-status-for-tax
Employers are expected to take reasonable care when they decide about the employment status of a worker. Getting it wrong will result in the worker’s tax and National Insurance contributions becoming the employer’s responsibility, which could be a costly mistake.
I’m a contractor. What do I do now?
That depends on whether you are engaged by a small or medium/large business. If you are working for a medium or large company in the private sector, the responsibility for determining your IR35 status (and paying relevant tax) will be passed from you to the businesses engaging you – like in the public sector. This also means that the ‘engaging’ companies will be held liable should HMRC decide status has been incorrectly assessed, i.e. they would get the penalty, not you. Since the legislation exempts small businesses in the private sector, if you are working for one of them, you will need to assess your IR35 status and ensure the correct Income Tax and NIC are paid.
What if my status is challenged?
If a contractor is working outside of IR35 (self-employed), and HMRC have reason to question this, they may open an IR35 enquiry. In this case, they will begin by sending a letter asking for evidence that they are working outside the legislation.
If they decide the evidence is not satisfactory, they will conduct an in-depth review of written contracts and working practices. From this, they will make a final decision on the status of the contract. If they decide that a contractor is inside IR35 (employed), they will make their demand for the retrospective Income tax and NIC, plus interest and a possible penalty.
HMRC can investigate arrangements at any time, which has the potential to be time-consuming, costly, and stressful. They can go back up to six years and evaluate past contracts to see if the legislation should have been applied.