What is IR35?
IR35 is a tax anti-avoidance rule designed to combat “disguised employment” in situations where an individual contractor is providing their personal services (i.e. their labour) to an end-user via their own intermediary, such as a personal services company (PSC) or partnership.
IR35 applies when the contractor would be an employee (or officeholder) for tax purposes if they were hired directly by the end-user. If IR35 applies, PAYE and NICs must be operated in respect of the fees paid to the PSC (eg Limited Company).
Under current (i.e. pre-April 2021) IR35 rules, the contractor is responsible for assessing whether IR35 applies and, if so, operating PAYE and NICs on the fees the PSC receives (excluding VAT) less certain statutory deductions.
How is IR35 changing?
The plans for reforming IR35 in the private sector arise from concerns of HM Revenue & Customs (HMRC) about non-compliance with it. IR35 was reformed in the public sector in April 2017.
Under the reforms, responsibility for assessing whether IR35 applies will move from the contractor/PSC to the end-user. If the end-user determines that IR35 applies, the responsibility for operating PAYE and NICs will move from the PSC to the “fee payer” – that is, the entity which contracts directly with the PSC. The reforms will apply to any payments made on or after 6 April 2021, unless all the contractor’s labour was provided before that date.
HMRC’s expectation is that, as a result of these reforms, IR35 compliance will become easier to police. It is also predicted that end-users will take a more compliant approach to IR35 assessments and will be more likely to conclude that contractors are in scope, resulting in increased tax and NICs.
Overview of the new process
The end-user is required to assess whether the contractor is employed or self-employed for tax purposes. It must take reasonable care in making that assessment and confirm its assessment together with reasons in a Status Determination Statement (SDS).
The end-user must provide the SDS to the contractor before making the first payment to them. If there is an agency in the chain (see below), the SDS must also be provided to the agency. In practice, we expect that contractors accepting a new assignment are likely to want to know in advance whether they will be assessed as within the scope of IR35.
The end-user is required to have a dispute resolution procedure to enable the contractor to challenge the assessment. A contractor is unlikely to challenge an SDS which assesses them as falling outside the scope of IR35. HMRC may review the assessment, however, so it is important that the SDS sets out in sufficient detail the basis on which the decision is made, showing that reasonable care has been taken.
If the assessment concludes that the contractor is out of scope of IR35, the PSC can continue to be paid gross. If, however, the contractor is assessed as within IR35, the fee payer is responsible for operating PAYE and deducting employee NICs on the fees it pays to the PSC (excluding VAT). The fee payer must also pay employer NICs and, where applicable, the apprenticeship levy.
Which end-users do the IR35 reforms affect?
Subject to anti-avoidance provisions, “small” private-sector end-users will be exempt from the new rules and will not be required to determine whether IR35 applies. Instead, the current rules will continue to apply - the contractor/PSC will remain responsible for determining whether IR35 applies and the fee payer can still pay the PSC gross.
A corporate end-user which is not part of a group will be treated as “small” in its first financial year and will remain small until it ceases to be so. Small companies will become medium or large if they meet at least two of the following conditions for two consecutive financial years:
- annual turnover of more than £10.2 million
- balance sheet total of more than £5.1 million
- more than 50 employees
If two of these conditions are satisfied, the company must apply the IR35 rules from the start of the tax year following the accounting filing date for the second financial year. Where the small company is part of a larger group of companies, the group turnover and revenue will need to be considered - please contact us for advice.