Last updated on October 14th, 2019 at 04:01 pm
In 1999, the UK’s Inland Revenue introduced new tax-avoidance measures with the aim of limiting the ability of contractors and small business owners to limit the amount of income tax and national insurance contributions they had to make via intermediary, or “personal-service”, companies. It had been common before the introduction of these measures, which are known as the “IR35” rules, for self-employed workers or contractors to establish their own small limited companies to act as an intermediary in regards to the fees they take from the companies they do work for.
By using intermediary companies, individuals in the past could take advantage of a few different means of limiting their tax liabilities by, for example, sharing ownership of their small company with a family member to place themselves in a lower income tax band, or by having their pay granted in the form of dividends which are not subject to NI contributions. Another common means of lowering tax liability would be to work on one contract from Monday to Friday, and then work on a new but essentially identical contract the week after so as to only incur NI contributions up to the monthly ceiling, rather than making contributions every month as a regular employee would. Those who work in a similar way to a normal employee of a company but are paid through a separate intermediary company are known as “disguised employees” and are subject to the IR35 rules whereas the genuinely self-employed are not.
IR35 changed the previous situation concerning personal-service companies and contractors by introducing rules which require disguised employees to pay roughly the same tax and NI contributions as a regular employee. This means if you are found to be “inside” the IR35 rules, and are defined as a disguised employee, you could have your NI and income tax percentages increased to broadly mirror the tax contributions made by direct employees of the company which is paying your fee. HMRC appoints inspectors to investigate cases which fulfil their “risk criteria” of potentially disguised-employees.
You may be investigated under IR35 rules if, for example, you work in a sector which HMRC have deemed to be particularly at risk of non-compliance with tax rules, such as the technology, health consultancy, and even London haulage sectors. Failing to complete detailed business records or inconsistencies with tax payments may also lead to an investigation. HMRC now uses increasingly sophisticated software to analyse the tax records of individuals on a case by case basis, so it is vital that contractors or those working through agencies maintain proper standards of record keeping to avoid the ire of HMRC.
These rules have been in force for private companies since 2000, but recent changes in HMRC’s approach to these rules in relation to public authorities have heralded a new series of changes which will take place in April 2020.
How is IR35 Going to Change?
Previously, the intermediary company of the contractor, or self-employed person, was responsible for assessing whether the intermediary worker fell within or outside of the IR35 rules. In 2017, HMRC updated its procedures surrounding the application of IR35 to public authorities in response to what was perceived as an increasing amount of lost tax.
Under the new rules, public bodies like the NHS, or local authorities, are now responsible for checking whether their contractors or intermediary workers are self-employed. This decision on the status of intermediary workers is also to be made on a specific case-by-case basis, rather than on a broader level for certain categories of workers. HMRC is now going to expand these changes in rules to the private sector.
From 2020 onwards, private companies will become responsible for assessing the status of those who work for them through intermediaries. Liability for failure to comply with IR35 rules will also shift to these private companies. These changes had a significant impact on the function of the NHS due to the organisations reliance on professionals who work through intermediaries. A quarter of NHS locums responded to a survey undertaken by Contract Calculator stating that they had decided to leave the NHS altogether as a result of IR35 reform, with 60% of the sample locum group also reporting that they had been deemed “inside IR35” after the NHS resorted to using illegal blanket assessments to limit the increase in administrative costs. Small businesses are to be excluded from these changes, and for the purposes of IR35, a small business is defined as having at least two of the following three features:
- A turnover of £10.2 million or less,
- £5.1 million or less on their balance sheet,
- Have 50 employees or less.
The new IR35 rules introduce the concept of a status determination statement (SDS). This is a comprehensive statement which is to be made by the engager following an IR35 assessment. It declares a contractor’s deemed employment status together with the reasons behind reaching this decision. From 6 April 2020, an SDS is to be completed for each new personal service company (PSC) engagement and each existing PSC engagement due to receive a payment after this date.
Not only will these changes affect the private sector; there will also be additional responsibilities for public sector clients. The current rules for the public sector do not require the IR35 determination to be shared with all parties in the labour supply chain. However, there will now be an obligation for the client to share the SDS with the contractor and the next party in the supply chain if applicable. If the supply chain is longer; this party must then pass the statement through the chain until it reaches the fee-payer.
Another amendment to the legislation will be the introduction of a client-led status disagreement process which will allow contractors to challenge an SDS if they believe the conclusion made in it is incorrect. The client must respond to the appeal within 45 days of receipt and either maintain the existing status determination; providing the reasons behind this or change its original decision. If changing the status determination, the client should withdraw the previous statement and issue the worker with a new SDS which contains the updated decision. It is unclear what would happen if a contractor was still not satisfied with a client’s response. More clarity is also needed as to how much detail should go into the reasoning given in an SDS. Although, to reduce the risk of contractors challenging an SDS if they feel their case has not been considered in enough detail, clients should ensure that statements are as comprehensive as possible.
A further change to note is that currently contractors who apply IR35 rules are entitled to a 5% allowance to cover administrative costs. However, as the responsibility for determining employment status for IR35 purposes is shifting to engagers, this allowance will only be available to intermediaries who have engagements with small organisations.
The implications for these changes are huge, both for the companies who employ intermediary workers and the intermediary workers themselves. Chiefly, and perhaps most concerning for the 4.8 million people who are self-employed, contractors and intermediary workers will no longer be able to assess themselves as falling outside of the IR35 rules with many potentially finding themselves redefined as being inside the rules following whatever decisions their agency or fee payer comes to on the matter. The fee-paying companies and agencies who now have the responsibility of IR35 compliance will find that they must dedicate a greater amount of time and manpower to assessing the status of every single one of their intermediary employees.
Compliance with the new rules presents a challenge for firms who utilise the services of intermediary workers. Firstly, it doesn’t appear that HMRC’s approach to classifying intermediary workers as either being within or outside of the IR35 rules is changing. The procedure for classification has been criticised for years for being unclear, and unreliable, with some major disputes arising from its application and successful challenges of HMRC’s decisions being brought to court, including MDCM Ltd v HMRC. In MDCM, it was made clear that IR35 cases have become very fact dependant and complex following HMRC’s failure to prove that a construction consultant’s contract with the company paying his fee constituted his employment by that company.
Indeed, HMRC’s own tool (The “Check Employment Status for Tax tool, or, CEST) which it provides to contractors, and will now provide to their agencies and employers, has gained a notorious reputation for its unreliability in cases where heavy, and oftentimes onerous, tax burdens are at stake. With such unclear rules surrounding IR35 compliance issues, the looming threat of liability of failing to comply with IR35 will also be a significant deterrent for companies who have been happy to contract out work in the past.
What do you Need to do to Prepare?
Despite the fact that you may no longer be able to define yourself as a self-employed person, there are a few things people can do to help keep themselves outside of the IR35 rules after the April 2020 changes are in force.
Confirmation of Arrangements Letters may be sought from the company paying your fee, which will help to bolster any arguments you are making in favour of falling outside of the IR35 rules. Qdos offers free templates for CoA letters which you can send for completion by your client company. It may also help to have your contract with your client company reviewed by a third party, which will help present your case to clients in time for the rule changes next year.
Maintaining work with multiple clients also helps strengthen the argument that you are self-employed. Maintaining a certain degree of separation from client companies also indicate self-employment. If you do work under your own small business, having a separate office address or even having an independent company website also indicate self-employed status. Legitimising the business you work through is key to avoiding the tax burdens placed upon regular employees of your client companies.
A vital aspect to consider is that contracts are drafted correctly otherwise this could increase the risk of IR35 applying. It is important to ensure that both the contracts themselves and also the actual working practices accurately reflect the true intended status of contractors. To limit the risk of an engagement falling inside the IR35 rules, some of the following amendments could be made to the contract, although it must still be ensured that what happens in reality is consistent with these terms:
- Including the right of substitution so the contractor is not obliged to provide a personal service.
- Imposing as few restrictions over the intermediary as possible with regards to working hours, place of work, uniform, etc.
- No restrictions over whether the contractor is allowed to undertake other engagements with different clients.
- Including an obligation for the contractor to supply their own equipment, if applicable.
- No obligation in the contract for either party to provide or accept work.
- Including financial risks and/or incentives, for example penalties for late completion of work or bonuses for early completion of work.
- Where possible the contract should be project-focused in terms of duration and method of payment.
- No entitlement to employee-type benefits as this would suggest integration into the client’s business.
In order to prepare, clients engaging contractors should be recommended to undertake a full review of all their current arrangements with intermediaries to identify which are likely to be affected by the new rules. They may wish to make amendments to existing contracts as a result or look to modify template contracts. Organisations may also look to put in place a defined process by which they determine the IR35 status of contractors. In addition, clients engaging intermediaries should consider implementing new recruitment procedures. Advertisements for contractor positions should be made clear as to whether the role is intended for a specific period or more of a permanent internal role, so applicants know at the outset whether the engagement is likely to fall inside the IR35 rules.
It would be beneficial for organisations to calculate the costs to the business and decide whether it is still economically viable for them to engage contractors as there may be additional costs in relation to employer’s National Insurance contributions, and the process of undertaking status determinations is likely to be costly. If following this the business looks to terminate any existing contracts with intermediaries, it is vital to do this before the rules change. Otherwise contractors may then be deemed as falling within the IR35 rules and this could result in them being recognised as employees or workers. Consequently, this could then involve costly and timely formal redundancy procedures. Another option for clients to consider is potentially changing contractors into employees if they are likely to fall inside the IR35 rules. Engagers could look to arrangements such as zero-hour contracts.
The IR35 changes coming in 2020 will represent a tangible shift in working attitudes between businesses and self-employed intermediary workers. As responsibility and control over the status of self-employed workers shifts to businesses and agencies, contractors may feel as if they are being swept along with the tide, but it is important to recognise that client companies will also need to readjust as well. Collaboration between contractors and client companies will become important over the next few years as these readjustments are made.