IR35 changes & off payroll working rules

IR35 changes took effect on 6 April 2021, impacting how private sector organisations engage contractors for off-payroll working.

The latest reforms were due to go live on 6 April 2020 but were postponed by a year in light of the coronavirus pandemic.

Below we examine the nature and extent of the IR35 changes, and how employers in the private sector can comply with the off-payroll working requirements.

What are the IR35 changes from 6 April 2021?

The IR35 tax reforms are aimed at reducing tax avoidance and increasing compliance with the existing off-payroll working rules in the private and third sectors, including voluntary and community organisations such as registered charities and self-help groups.

Typically referred to as IR35, the changes were applied first to public sector organisations engaging the services of contractors or off-payroll workers through intermediaries.

Under the extended regime, all medium and large-sized organisations outside of the public sector are now, as with public sector authorities and other public bodies, responsible for determining the IR35 employment status of individuals who work for them through, for example, their own limited company.

The net effect of the ‘IR35 changes 2020’ is that where a determination is made that the IR35 rules do apply, the deemed employer of that individual will be required to deduct the right tax and National Insurance contributions (NICs), instead of the worker’s intermediary deciding what deductions are to be made.

Why the off payroll rules have been reformed

When engaging the services of contractors and off-payroll workers it is commonplace for businesses to engage with an individual through an intermediary, rather than directly with the worker on a self-employed basis. An intermediary will usually be the worker’s own personal service company (PSC), although it could also be a partnership or a managed service company.

However, the IR35 off-payroll working rules require that where an individual works in the same way as an employee and, but for the PSC would have been regarded as an employee of the engaging business if they had been contracted directly, that individual is liable to pay similar taxes to other employees.

The IR35 rules were introduced back in 2000, based on the rationale that it is only fair that two individuals working similarly for a business pay broadly the same income tax and NICs, even where one of them works through a company.

As such, the aim of the off-payroll working rules is to remove the tax advantages of providing services via a limited company for individuals who are not truly in business on their own account. This essentially means that anyone working like an employee, but operating via an intermediary, will still pay the same or similar tax and NICs as an equivalent employee.

To work out whether the IR35 off-payroll working rules apply, a person or organisation is required to make a decision about whether an individual worker is employed or self-employed for tax purposes. This is typically known as an IR35 employment status determination.

In 2017, the UK government changed the off-payroll working rules for those in the public sector engaging workers via PSCs and other intermediaries. The reform shifted responsibility for determining IR35 employment status from the worker’s PSC to the public sector authority or other public body they work for.

As such, all public sector organisations are already responsible for determining the employment status of a contractor or off-payroll worker, and whether the IR35 rules apply to that individual.

However, in the Autumn 2018 budget, the UK government announced that it would be rolling out similar reforms to the private and third sectors, albeit giving businesses time to adjust and prepare. By extending the rules, this would bring these sectors of the economy in line with the public sector changes, ensuring consistency and compliance across the labour market.

Under the current rules, for organisations outside the public sector, it is the individual worker via their PSC or other intermediary, and not the engaging business, that is responsible for making this status determination and, where appropriate, accounting for any tax and NICs.

However, therein lies the problem that has led to reform; namely that the intermediary has essentially been required to self-assess as to whether the rules apply. In consequence, the IR35 rules have been largely ineffective, where it is estimated by HMRC that currently only one in ten people who should comply with the off-payroll working rules within the private sector do so.

Determining status under the new rules

Under the new IR35 rules, the burden of responsibility to determine employment status lies with the organisation engaging the contractor.

In other words, the organisation responsible for engaging the contractor or off-payroll worker will be liable for determining that individual’s IR35 employment status for tax purposes, and whether the IR35 rules apply.

There is no strict test to apply when determining whether an individual is an employee or otherwise, but employers should consider the following questions:

• How much control does the employer have over the individual, what they do and how they do it? The more autonomy the individual has, the more likely they are to be deemed self-employed.
• Does the individual have to complete the work personally, or could they use someone else to perform the work? Where the work can be carried out by someone else, it is more likely to be a self-employed status.
• Is the individual obliged to take on the work, and is the employer obliged to offer work to the individual? Where there is no obligation, it would be generally be considered self-employment.

Following this assessment, the organisation will need to notify the affected individual and/or agency of the assessment result.

If the sub-contractor is considered to be a worker, the organisation will be responsible for the tax and national insurance contributions

Further, where an engagement falls within the off-payroll working rules, the organisation, agency or other third party responsible for paying the worker’s company will also become responsible for deducting any tax and NICs by way of Pay As You Earn (PAYE), in addition to any employer NICs. As such, the contractor business will be taxed at source exactly as if it were an employee.

Ultimately, this means that the responsibility for undertaking employment status assessments will become the responsibility of the business or body using the services of the contractor or off-payroll worker, ie; the ‘end-client’, whilst the responsibility for operating PAYE and paying employer NICs will be that of the entity paying the PSC, ie; the ‘fee payer’.

Which employers are affected by the IR35 changes?

The new rules apply to medium or large-sized organisations in the private sector that meet 2 out of the following 3 conditions:

• An annual turnover of more than £10.2 million.
• A balance sheet of more than £5.1 million.
• More than 50 employees.

The balance sheet total refers to the total amount shown as assets on the balance sheet before deducting any liabilities.

However, a simplified test will apply to businesses with an annual turnover of more than £10.2 million that are not a company, limited liability partnership, unregistered company or overseas company.

Additionally, there are rules that cover connected and associated companies, such that if the parent of a group is classed as medium or large, their subsidiaries will also have to apply the IR35 private sector off-payroll working rules.

If you meet the conditions above, or otherwise fall within the scope of a medium or large-sized organisation, you must start applying the rules when the changes come into force. It is important to bear in mind, however, that the conditions as to size only apply to end-clients, where small-sized fee payers will still be responsible for applying the off-payroll working rules.

It is important to bear in mind that the reforms do not introduce a new tax, but rather they change the way in which tax is collected when a contractor or off-payroll worker falls within the scope of IR35 and is deemed employed for tax purposes. As such, the IR35 private sector changes do not prevent individual contractors from working through their own limited companies, nor do they affect the self-employed who are outside the scope of the rules.

The new off-payroll working rules will only affect people working like employees and through a company, where self-employed people working through a PSC or other intermediary will continue to be taxed as they are now. It is estimated that two-thirds of people currently working through a company are genuinely self-employed and will not be affected by these changes.

Equally, the changes to the off-payroll working rules do not affect the smallest 1.5 million businesses in the UK. As such, small-sized private sector businesses will not have to decide the employment status of their contractor or off-payroll workers, where this will remain the responsibility of the worker’s intermediary.

Complying with the IR35 private sector rules

Organisations can expect HMRC to begin robustly reviewing compliance, so it is crucial to ensure you have adequate internal systems and processes in place:

• Identify and review current engagements with intermediaries, including PSCs and labour supply agencies and whether the off-payroll working rules will apply to any contracts extending beyond the date for implementation.
• Having identified your PSC population, undertake a comprehensive risk assessment to establish your exposure to IR35 and review whether changes need to be made to HR and procurement processes when engaging with contractors through PSCs.
• Where necessary, design new internal processes and controls to manage the operational impact of the changes, including payroll software, process maps, as well as HR and on-boarding policies
• Consider any necessary contractual amendments, and communicate with both PSCs and any agencies to support with any necessary transition.
• Put in place processes to determine if the off-payroll rules apply to future engagements with contractors and off-payroll workers, including deciding who in your organisation should make this determination and how payments will be made to contractors falling within the scope of the rules.
• Consider the cost implications, as well as how to manage and mitigate additional national insurance costs to your business.

All medium and large-sized organisations outside of the public sector will be responsible for deciding the IR35 employment status of contractors and off-payroll workers for tax purposes.

This involves carrying out an assessment for each and every contract you agree with an agency or individual worker via their PSC. In particular, you will need to undertake the following steps:

• Make your determination as to the worker’s employment status
• Provide reasons for the determination to the worker and the person or organisation you contract with
• Retain detailed records of any employment status determination, including the reasons for the decision and fees paid
• Put in place clear processes to deal with any disagreements that arise from your determination.

How to determine an individual’s employment status

There is no precise legal test to determine whether an individual should be treated as employed for tax purposes, rather the test is based on a number of different factors. However, HMRC has put in place various measures to help businesses and other organisations get their status determinations right.

This includes, in some cases, one-to-one support and direct communications, as well as workshops, online learning and an enhanced online tool. The ‘Check Employment Status for Tax’ (CEST) tool has been specifically designed to help organisations determine whether the off-payroll working rules apply.

Having undertaken your assessment, you must provide the worker and the agency, or other organisation you contract with, your determination, regardless of whether or not your determination shows that the IR35 off-payroll working rules will apply. This is known as a ‘Status Determination Statement’ (SDS).

Further, the SDS must not only set out the decision made as to the individual’s deemed employment status, but also the rationale for reaching this conclusion. You will also remain liable for any tax and NICs until you tell the worker, and whomever you contract with, of your determination and the reasons for it.

It is important to bear in mind that if you make a status determination that an engagement falls outside IR35, you must ensure that reasonable care was taken during the decision-making process and that the determination itself is reasonable. Any failure to exercise reasonable care will invalidate your decision and make you liable for any unpaid taxes.

Retaining records of your determination

As an affected medium or large-sized organisation, the new IR35 private sector changes will potentially expose you to significant tax implications. As such, it is vital that you keep clear and accurate records of your IR35 employment status determinations and your reasons for reaching those decisions.

In the event that you determine that the contractor or off-payroll worker is employed for tax purposes, your business, or the agency through which the contractor has been hired through, will be required to pay the necessary tax and NICs before paying the contractor.

If, on the other hand, you determine that the individual is self-employed, they will remain responsible for meeting their own tax obligations. The new rules will not apply where there is a genuine self-employment or consultant relationship.

Dealing with any disagreements over a determination

In circumstances where the contractor or off-payroll worker, or the agency paying the worker’s intermediary, disagrees with the determination you have reached, you will need to have a process in place for dealing with disagreements.

In particular, as part of your status disagreement process, you should:

• Reconsider the employment status determination based on the reasons given to you for disagreeing with your original determination, including any further information provided
• Decide whether to maintain the original determination if you feel it is correct and give reasons why or, alternatively, provide a new determination where you agree that it was wrong
• Retain a record of your decision and the reasons for this, as well as records of the representations made to you by the worker or agency paying their intermediary.

You will be required to provide a response within 45 days of receiving notification that the worker and/or agency disagrees with your IR35 employment status determination. In the interim, you should continue to apply the rules in line with your original determination.

Any failure to review your decision and provide a reasoned response within 45 days will result in you, rather than the worker or any agency, assuming responsibility for the worker’s IR35 tax and NIC liability.

Can PSCs still be used under the new IR35 changes?

Notwithstanding the shift in responsibility for determining the IR35 employment status, thereby making the hiring of contractors and off-payroll workers less attractive to medium to large businesses that IR35 applies to, the new regime will not stop anyone working through an intermediary if that suits them, or from businesses engaging with individuals who continue to work through a PSC.

The use of a PSC can still be beneficial to both the individual contractor and the business looking to engage their services. In particular, the limited liability status of a company will protect the worker from any potential claims against them, whilst for businesses, the use of PSCs provide increased flexibility, especially where it operates in a sector with fluctuating labour demands.

By engaging with contractors through PSCs, this can also create significant costs savings for organisations, where these workers will not accrue any statutory employment rights, such as an entitlement to sickness and holiday pay, simply by virtue of them providing a service.

In other words, although the individual worker impacted by the new measures may have to pay tax like an employee, their employment status will not change, so they will not receive the rights and benefits that go with employment.

IR 35 Private Sector Rules: FAQs

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Legal disclaimer

The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.