What you need to know about IR35 regulations
Reforms to the IR35 rules on off-payroll working in the private sector come into force on 6 April 2021, having been delayed by a year due to the pandemic. The rules are aimed at reducing tax avoidance for contractors employed via personal service companies.
Under the new rules, the organisation engaging the contractor is responsible for determining their employment status and assessing whether or not IR35 applies. If IR35 does apply, the organisation that pays the individual’s fees is deemed to be their employer for tax and national insurance purposes.
Once the organisation has determined an individual’s classification, it must provide a status determination statement to the individual and to the party with which the organisation has contracted. For the statement to be valid, the client must also provide reasons for the determination.
Employers should review their contracts and put in place the necessary procedures to ensure compliance.
Which organisations are responsible for applying the IR35 rules from 6 April 2021?
Under the reforms to the IR35 rules from 6 April 2021, medium- and large-sized non-public sector organisations will become responsible for applying the rules. Small private-sector organisations will not be covered by the IR35 rules. The rules have applied to all public-sector bodies, regardless of size, since April 2017.
An organisation that is an incorporated entity (e.g. a limited company or a limited liability partnership) is classed as medium- or large-sized if, for the last two consecutive financial years, it meets at least two of the following criteria:
• Its turnover is more than £10.2 million
• Its balance sheet total is more than £5.1 million
• It has an average of more than 50 employees.
If a small entity is part of a medium- or large-sized group, it is the size of the group (including overseas members) that is relevant.
There is a simplified test for unincorporated organisations (for example a not-for-profit employer, trade union or charity). Such an organisation is classed as medium- or large-sized if its turnover for the last financial year exceeds £10.2 million
Which individuals does an organisation need to assess under the IR35 rules?
The IR35 rules apply where an organisation within the scope of the rules engages an individual via an intermediary to provide services.
There are various terms that could be used to describe such an individual, for example, they could be referred to as a freelancer, contractor, consultant, or self-employed person. However they are referred to, the relevant factor is whether or not there is an intermediary involved. For this reason, the use of sole traders does not fall within IR35 (although the engager remains responsible for assessing if such individuals are genuinely self-employed, or if they should be on PAYE as an employee or worker).
An intermediary is usually a personal service company (PSC), but it could also be a partnership, a managed service company or, very unusually, an individual. A PSC is usually a limited company with a single director, and it is the director’s services that are being engaged. In all cases, for the off-payroll rules to be relevant, the individual being engaged must have a material interest in the intermediary of at least 5%.
There could be one or more agencies involved in sourcing, and ultimately paying, the individual. For example, the organisation engaging the individual could contract with an agency, which has a contract with the personal service company.
A client organisation does not have to operate the IR35 rules if, for example:
• An agency already operates PAYE in relation to the individual
• There is an “umbrella” arrangement in place (under which the individual is already on PAYE)
• The client fully contracts out a service (e.g. where the service is outsourced)
• The individual is engaged as a sole trader.
Is employing contractors on fixed-term contracts a solution for ensuring compliance with the IR35 rules?
If an organisation employs a contractor on a fixed-term contract, rather than through the contractor’s intermediary, it would take the engagement out of the IR35 rules. However, while this approach would ensure IR35 compliance, it may not be a practical solution for the parties involved.
Not all contractors will be prepared to accept a fixed-term employment contract, so this approach could lead to organisations being at a disadvantage when competing for skilled contractors.
If a contractor does agree to a fixed-term employment contract, they will be entitled to employment rights, such as holiday pay and auto-enrolment pension rights. This will involve additional expense for the organisation. It will need to decide how much of that expense it will absorb and how much it will seek to pass on to the contractor; however, the contractor may not be willing to significantly reduce their fees to reflect the associated expense.
If the employer does not negotiate the contractor’s fees down, there may be an equal pay issue, as the contractor’s pay could be significantly outside the salary bands for equivalent employees in the organisation.
What are the potential consequences if an organisation fails to use reasonable care when applying the IR35 rules?
Under the IR35 rules, if an organisation within the scope of the rules (the client) engages a contractor for services via an intermediary, the client must determine whether or not the contractor would have had employee status had they been engaged directly rather than through their intermediary. When carrying out this determination, the client is required to take “reasonable care” in reaching its conclusion.
If the client fails to take reasonable care, it will be liable for the contractor’s tax and national insurance contributions (NICs), as well as the employer NICs and apprenticeship levy, with interest charged for late payment.
HM Revenue and Customs also has the power to issue penalties, set at a percentage of the tax and NIC liability, depending on whether the non-compliance was careless or deliberate. HMRC has stated that: “customers will not have to pay penalties for inaccuracies relating to the off-payroll working rules in the first 12 months unless there is evidence of deliberate non-compliance.”
Medium- and large-sized private sector organisations are responsible for applying the IR35 rules from 6 April 2021.
So there you have it – IR35 has the potential to really disrupt the way that medium to large-sized businesses use contractors within their workforce; what has up until now been a valuable way of organisations flexing up resource and expertise during periods of growth, will now be a lot more challenging and potentially restrictive.
If your organisation needs help with its resource planning, get in touch for a complimentary discovery call to see how The HR Consultants can support you.