If you’re a business who outsources work to freelancers or contractors, chances are that IR35 and its upcoming changes will affect you. What is IR35 however? What changes will be taking place and how can you prepare for them?
These changes were originally due to come into effect in April 2020, however due to the impact and pressure of COVID-19 this was delayed until 2021. These changes will now come into effect on 6th April 2021, so it’s important to understand how you may be impacted and what you need to do.
You can find out what you need to know about the legislative changes here.
What is IR35?
IR35 legislation, also known as off-payroll working, was introduced in April 2000 to counter the use of Personal Service Companies (PSC’s), limited companies set up by contractors to avoid being seen as an employee for tax purposes. The use of such companies allowed contractors to pay significantly less tax than they would have done as an employee.
IR35 ensures that workers who would have been an employee if they were providing their services directly to the client are treated as employees for tax purposes, regardless of the contractual arrangements in place. These workers are taxed through Pay As You Earn (PAYE) and make National Insurance contributions (NICs) just like a traditional employee would.
The responsibility for compliance with IR35 sat with the limited company set up by the contractor.
Off-payroll working applies to:
- Workers who provide their services through their intermediary (such as a PSC)
- Clients who receive services from a worker through their intermediary
- Agencies who provide workers’ services through their intermediary
For further information, you can find out everything you need to know about IR35 on the Accountancy Age website.
What IR35 changes are due to take place?
From April 2021, the responsibility for determining the employment status of a worker will shift from the contractor’s limited company to the end user of the contractor or freelancer services. This change was made in 2017 for public sector organisations and will now apply to all medium and large sized businesses within the private sector.
Workers need to be classed as employed or self-employed for tax purposes. If a contractor is deemed to be employed, known as ‘inside IR35′, as the client, you must operate PAYE, deducting tax and employees’ NICs from their fees, and also paying employers’ NICs on their fees.
There is an exemption for small businesses, however. As defined by the Companies Act 2006, your organisation is classed as a small business if you meet two or more of the following criteria:
- Your annual turnover is no more than £10.2 million
- Your balance sheet total is no more than £5.1 million
- You have fewer than 50 employees
If you are classed as a small business, responsibility for determining the IR35 status of a contractor remains with the PSC and you don’t have to worry about the upcoming changes.
Preparing for the IR35 changes
If the IR35 changes are applicable to your business, below is a handy guide detailing what to do next to help you keep compliant.
1. Determine the employment status of your workers
The first step is to conduct a full review of all your staff and contractors so you can identify who will be affected by the new rules.
It will be up to you to decide the employment status of a worker. This must be done for every contract you agree with an agency or a worker and you should also be able to explain the reasoning behind your determination.
It’s a good idea to keep detailed records of your determination and the reasons for it as well as any fees you’ve paid. These records make dealing with HMRC much easier and it will also help should any disagreements arise.
HMRC looks at a wide range of areas when deciding employment status which means there’s no definitive list for determining someone’s IR35 status. Some key areas to look at however include:
- Control: is the person free to work as they wish or do you require them to work certain hours or from a particular location?
- Financial risk: employees rarely risk financial loss by being employed whereas a freelancer or contractor will experience financial loss if a client fails to pay.
- Benefits: will they receive holiday, sick pay or pension contributions? Benefits should only apply to employees of the company, not contractors.
If you’re unsure of someone’s IR35 status, HMRC has a tool you can use which will help to determine this. It’s worth noting however that this tool isn’t always 100% effective so it’s always worth checking with HMRC. You can also hire a professional, such as an accountant or solicitor to help.
2. Review contracts
One of the key elements of deciding IR35 status is how independent a worker is from your business. Are they free to pursue work outside the company? Do they have to work specific hours? Do they need to work from a certain office? The more control your business has over a contractor or freelancer, the more likely HMRC is to deem them an employee.
3. Communicate with your contractors
Even if you’re still trying to navigate the rules, ensure you’re communicating with your contractors throughout the process.
Let them know you’re taking reasonable care to assess their status and once you’ve determined this, have an open conversation to reassure them and minimise the risk of any confusion or disagreements.
Switching to PAYE could reduce a contractors’ take-home pay so be prepared for questions and in some cases, a parting of ways. Four-fifths of contractors do however say that they’re more likely to work for a company with proper IR35 policies in place so by being open and honest, you’re more likely to retain this talent.
4. Be prepared for price increases
Some contractors may increase their daily or hourly rate in order to compensate for their tax and NICs being deducted by employers. Again, this highlights the importance of communicating with your contractors so you’re not blindsided by sudden price increases.
5. Implement new recruitment procedures
When hiring new contractors, make it very clear if the role is for a contracted period of work for a self-employed individual or if it’s a more permanent internal role.
Being clear from the outset means your contractors know whether or not they’re likely to be bound by the IR35 changes and it also means that as an employer, you can ensure their payroll is conducted properly from day one.
6. Set up your payroll system
Contractors being brought in-house will need to be set up on your payroll system. It’s a good idea to group all your contractors and freelancers together in their own payroll cycle. This can really simplify the process and it also helps with your data analytics.
If you use contractors through an agency, it’s the agency’s responsibility to deduct tax and NICs from them if you have informed the agency that the contractor is inside IR35.
7. Have a process in place to deal with disagreements
It’s a good idea to have a process in place to deal with any disagreements that arise from your determination.
If a worker or an agency disagrees with the employment status determination you’ve reached, you’re obliged to consider their reasons. You must provide a response within 45 days of receiving notification and during this time, you should continue to apply the rules in-line with your original determination. Failure to respond within this timeframe will result in the workers’ tax and National Insurance contributions becoming your responsibility.
If you feel your decision is correct and you plan to stick to it, you must explain why. Alternatively, you can change your determination if you feel it was wrong.
Always remember to keep a record of your determinations and the reasons for them as well as records of representations made to you.
What if I don’t comply with IR35 changes?
Failure to comply with the new off-payroll working rules can lead to:
- Backdated demands for PAYE, tax and NICs
- Fines for delays and late submissions
- Damage to your reputation which could affect your ability to attract freelancers and contractors
What if I’m a contractor or freelancer?
If you’re working for a recruitment agency or a large or medium-sized client, you’re likely to be affected by the IR35 changes.
To help ensure that you’re compliant with the legislation:
- Review the status of any existing assignments using HMRC’s Check of Employment Status Tool (CEST).
- Contact existing clients to find out where they stand with regards to IR35 and how this may affect you. This also applies if you’re working for a company through a recruitment agency.
- If you disagree with a client’s decision, you can submit a request to review the status determination within 45 days. You will need to write to your client and explain why you disagree with their determination. Ensure you keep all records of correspondence.
- Seek professional advice from an accountant or solicitor if you’re unsure about any aspect of IR35.
By carrying out the necessary checks and putting the correct procedures in place, both parties can reduce the risk of potential liabilities or costly back payments.