What is IR35?
IR35 is a piece of Inland Revenue (UK tax) legislation that was first introduced in 2000. The legislation was created to collect the correct amount of employment status income tax and national insurance from contractors and individuals who work under their own limited company or personal services company.
Working via a personal services company can enable contractors to be taxed as a business rather than as an employee: IR35 aims to identify those personal services company contractors who, if they did not work under their own limited company, would be more like an employee of the end client. These contractors who are most like an employee of their end client will soon be classified as ‘Inside IR35’ and therefore taxed as an employee rather than as a business. Originally delayed by one year due to the Covid-19 pandemic, the legislation changes will come into effect on 6th April 2021.
3 Myths and Facts About IR35
1. Status Is Simple and Quick to Determine
Contractors and their recruiters may be under the impression that off-payroll status will be, if not exactly easy to determine, fairly straightforward and simple to understand if done according to the rules. However, depending on the exact terms used in work contracts and communication, and the changing work environments and situations of both project and contactor, status determination may need significant investment and regular reviews.
Many elements must be considered to accurately determine whether an employment-type relationship exists between the end client and the contractor, and therefore whether the worker is inside IR35 or outside IR35. Considerations include:
- The relationship of authority and supervision between the individual and the client
- Holiday and sickness pay
- Mutuality of Obligation (MMO) – whether an employer is obligated to offer work and whether the worker must accept
- Damage liability and professional liability insurance
- Substitution or replacement agreements
- Whether the individual is able to regularly undertake other work outside of the client
- Whether the contract worker uses their own tools and equipment or whether these are provided by the client.
One rule for one contractor will almost certainly not apply to the next contractor, even for those working on the same project at the same time. Recruitment agencies managing large volumes of contractors for one client may be tempted to create a ‘blanket assessment’, that predetermines an IR35 status for other contractors based on the status assessment of a similar contractor or project. This decision would likely deliver inaccuracies: assuming an IR35 status based on job description or working role does not take into account the multiple factors affecting each individual contractor, the different roles they play in the project and their varied responsibilities and relationship with management.
Blanket assessments would constitute a lack of ‘reasonable care’ taken to determine off-payroll status, which could result in an inaccurate status determination that delivers a large financial penalty for the end client. To fully mitigate risk, recruitment agencies must support their clients and reinforce the importance of conducting an individual status assessment for each contractor, despite the heavy administrative burden.
2. Contractors & Their Recruiters Don’t Need to Take Any Action
Although the responsibility for determining IR35 status will in April shift from the contractor to their end client, recruiters and their contract candidates must pay close attention to the determination made by the end client.
The UK Government has in recent years developed a Check Employment Status for Tax (CEST) tool, which has been used by public sector employers to determine the off-payroll rules of their contractors since 2017, and HMRC have advised private sector businesses to follow suit. However, this tool has been proven to deliver incorrect status determinations in around 15% of total cases, and results from recent IR35 tribunals have identified several flaws which are yet to be fixed.
Most private sector employers will not possess the legal background and knowledge to accurately determine tax status using a confusing, fallible tool without instructions or expert advice. Incorrect status determinations could result in a lengthy legal investigation or financial penalties for the employer, but can also affect recruiters themselves. Recruitment agencies may face financial liability depending on the care taken by their client: agencies must deduct tax for workers deemed inside IR35. If a client produces the wrong status result, but has proven that they took reasonable care over their determination, the staffing agency may be at risk of liability.
Incorrect status determinations could significantly and irreparably damage the relationship between recruiters and their clients. In the event of an HMRC investigation into the end client, the recruitment agency can only pass liability to the client by committing to the conviction that the client did not take reasonable care. Businesses that have been caught out by off-payroll rules will likely be deterred from using contract workforces wherever possible, and contractors may be discouraged from working with these clients to mitigate their own risk.
If staffing consultancies and contractors remain close to the end client in the status determination process, they can proactively identify the possibility of an incorrect result and avoid compliance and financial risk. Contractors can appeal against an inside or outside IR35 decision – and reverse an incorrect result – at any point until they finish their assignment or receive final payment.
3. Contracting Is A Thing of the Past
The IR35 updates are likely to permanently change ways of working across industries, and are expected to negatively impact end clients and contractors. Businesses will face additional administrative burdens for every contractor they employ, and risk non-compliance and legal consequences for lack of care or inattention to detail. Contractors and recruiters alike are concerned that the major changes will dissuade companies of all sizes from employing short-term and contingent labour, shrinking the contracting market and presenting fewer employment opportunities for freelance and independent workers.
However, business leaders across the UK are already invested in the benefits of contract labour, and Covid-19 is set to deliver silver linings to short-term workforces. After thousands of employers were forced to deliver mass redundancies and delay projects in 2020, vaccine optimism and the socially distanced processes developed to work around Covid-19 will see most markets jumping full-steam ahead as markets reopen and investment again pours in. Companies will be operating with smaller budgets but will still need the same levels of expertise to deliver projects and products that fulfil customer demand. Apprehension over building back permanent workforces only to lose them again in the event of another economic downturn, or investing valuable resources into permanent employees who are only strictly necessary for a few months at a time, will drive the urgent demand for flexible, highly skilled workers across industries.
For those businesses that cannot afford the additional resource and admin burden, many are requiring their contractors to transition to working under an umbrella company in order to continue to work with them. Signing up to an umbrella and contractor management provider means that the individual will no longer trade as their own company and will join the umbrella’s payroll, relieving both business and contractor of the majority of status determination and liability.
Find out more about how an umbrella company could help you.
How Contractors and Recruitment Agencies Can Work Best After IR35
Partnering a payroll and contractor management company with an on-site compliance team could be the difference between accurate IR35 status determination and significant legal implications.
Read more about the IR35 responsibilities of recruitment agencies.