What is IR35?

The off-payroll working rules apply if a worker provides their services through an intermediary to close a loophole in the tax system. The intermediary will usually be the worker’s own personal service company (PSC) where the worker would pay less tax. 

A PSC has not been clearly defined by HM Revenue and Customs (HMRC) but usually refers to limited companies with a sole or majority director/shareholder who personally provides the services of the company.

However, despite a contract being with a limited company, the reality can be more like an employer-employee relationship, where the worker should be taxed as an employee. This is referred to as a deemed employee.

The IR35 legislation looks to identify deemed employees and ensure they are taxed correctly, however, IR35 can impact those operating genuinely through a limited company structure due to the subjective nature of the legislation. The rules make sure that workers, who would have been an employee if they were providing their services directly to the client, pay broadly the same income tax and National Insurance contributions (NICs) as employees.

Workers may be affected by these rules if they are:

• a worker who provides their services directly to an end-hirer client through a PSC
• an end-hirer  client who receives services directly from a worker through a PSC
• an agency providing services to an end-hirer client via a workers’ PSC.

If the rules apply, tax and NICs must be deducted from fees and paid to HMRC.

When will the rules apply?

The rules apply if a worker provides services to an end-hirer client through a PSC, but would be classed as an employee of the client if they were contracted directly to the client.

The Check employment status for tax (CEST) service provides guidance to decide if the off-payroll working rules apply.

To use the CEST you need:

• details of the contract
• details of your responsibilities
• who decides what work needs doing
• who decides when, where and how the work is done
• how you will be paid
• if the contract includes any benefits or reimbursement for expenses.

What does ‘outside IR35’ mean?

If a contract is judged outside IR35, a worker is considered self-employed for tax purposes and can pay themself in the most tax efficient way, which is typically through a mixture of salary and dividends taken from your PSC.

If you are working outside the scope of IR35, you are responsible for making sure all personal and company taxes are calculated correctly and paid on time.

What does ‘inside IR35’ mean?

If a contract is judged inside IR35, a worker is considered an employee for tax purposes and will have to pay income tax and NICs on all earnings.

Contract with the client

It is crucial to be able to demonstrate to an end-hirer client and, if required, HMRC, that a PSC is not a vehicle used to disguise employment status.

In order to limit the risk of an arrangement being judged inside IR35, contracts should include the following:

• the right to provide a substitute which is a factor in the assessment of tax and employment status. Although, one factor on its own will not typically mean you are inside IR35 or outside IR35, it is worth ensuring the PSC contract has a genuine right of substitution. (Note: the CEST tool will automatically class a worker inside IR35 if there is no substitution clause in a contract)
• avoid mutuality of obligation to provide and accept work is another factor in assessing tax and employment status. It would appear from case law, that including a notice period in the contract will point towards a conclusion that there is mutuality of obligation, so this should be avoided if possible
• the PSC should be subject to as little control as possible, which is also another factor in assessing tax and employment status. If possible, a worker should be free to set their own hours and place of work and to determine how the work is to be done
• contracts should, if possible, be structured by reference to completion of a project or piece of work, rather than by duration. Similarly, payment should be structured by reference to completion of a project, rather than time worked. If possible, some element of financial risk and reward (other than payment of fees) should be incorporated into the contract
• the PSC should ideally maintain insurance in respect of claims arising out of services provided by a worker and this should be specified in the contract
• a worker should not be integrated into the client company more than is absolutely necessary. For example, a worker should not be held out as a member of the company, should not be subject to its policies and procedures, and should not be entitled to participate in employee-type benefits
• if possible, the PSC should provide its own equipment, rather than the client providing this to a worker
• neither the PSC nor a worker are tied to one client but are free to work for other.

All of the above points need to be weighed against the commercial requirements of the contract with the client, which will almost inevitably require an obligation of personal service. Therefore, it should be appreciated that this may bring some IR35 risk with it.

Contract  between a worker and the PSC

Although less important than the contract with the client, there should be an employment contract in place between the worker and the PSC. The key consideration with the employment contract is to ensure that it is not linked too closely to one particular client.

The contract should also avoid linking the amount of salary and benefits to the client. Rather, a worker should get such salary and benefits as the PSC determines. HMRC is less likely to investigate an arrangement if a worker is paid a meaningful salary, at least roughly in line with market rates, than if income from the client is distributed primarily by way of dividends with only a very small salary paid to the worker.

The contract should also specify that a worker will be subject to the control and direction of the PSC (rather than the client to which it is providing services).

 Consequences if IR35 does apply

If the contract is judged inside IR35, the sums received by the PSC are, in effect, treated as employment payments by the PSC to a worker for tax and NICs purposes and will therefore be subject to pay as you earn (PAYE) taxation. However, this is calculated at the end of the year on the deemed income, after allowing a 5% deduction to cover general expenses (unless there is supervision, direction or control, in which case PAYE must be accounted for monthly on actual payments made throughout the year).

Therefore, if IR35 applies, the relevant tax and NICs are payable by the PSC, not the client. HMRC may also charge interest and penalties to the PSC on overdue tax and NICs payments.

A worker can challenge a finding by HMRC that the arrangement with the client is inside IR35 by appealing to the First-tier Tribunal. HMRC has produced guidance dealing specifically with IR35 enquiries and how to appeal against a determination.

Private sector reform

If a worker is working via their own PSC, they will lose the right to set their own IR35 status from 6 April 2021 unless the end-hirer client is a small company in the private sector. During a 12-month period, a business is deemed to be a small company if it meets two or more of the following criteria:

• turnover – not more than £10.2 million
• balance sheet total – not more than 5.1 million
• number of employees – no more than 50.

The responsibility for determining IR35 status will transfer to the end client, with the tax liability shifting to the ‘fee-payer’ in the supply chain.

This reform is similar to PSCs in the public sector, which came into force in 2017.

The fear amongst PSC workers is that organisations do not have a strong enough grasp of the IR35 legislation to make well-informed decisions regarding tax status and will instead class PSC workers inside IR35 to protect the liability they will often carry.

Assessing IR35

A status determination statement which outlines the end-hirer client’s IR35 status decision must be provided to both a worker and the PSC. The end-hirer client must demonstrate that reasonable care has been taken when determining status. Until this is provided, then the end-hirer client will remain responsible for collecting tax and NICs.

If a worker does not agree with the end-hirer client’s IR35 status decision, there is a disagreement process, which obliges the client to review a decision and provide a reasoned response within 45 days. If they fail to do this, then the client (not the PSC) will assume the IR35 liability.

The material contained in this web page is provided for general purposes only and does not constitute legal or other professional advice. Appropriate legal advice should be sought for specific circumstances and before action is taken.