IR35 legislation came into force as part of the Finance Act in April 2020. It was combined with the Income Tax Act 2003 and the Statutory Instrument Social Security Contributions Regulations 2020. This legislation is referred to as IR35.
IR35 relates to anti-avoidance taxi legislation. The legislation tackles the issues of deemed or disguised employment. This is when organisations hire workers on a self-employed basis, through an intermediary limited company, rather than an employment contract, but are employees.
Hiring workers this way saved organisations money-as they don’t have to pay National Insurance Contributions. They also don’t have to provide employment rights or benefits.
IR35 prevents tax avoidance by deemed employees. If deemed employees fall under IR35, they must be treated as employees and as such must pay income tax and NICs as if they were employed.
IR35 is criticised by businesses and tax experts as it causes unnecessary costs and hardships for small businesses.
How IR35 Is Determined
A HMRC inspector can disregard a written contract between an individual and employer, and create a ‘notional’ contract based on the actual nature of the working relationship. The main principles used to determine employment status of an individual are:
- Control: What control does the client have over what/how/when/where the individual completes the work?
- Substitution: Must that individual personally complete the work or could they send a substitute in their place?
- Mutuality of obligation: This is the principle that the employer is obliged to offer work and worker is obliged to accept it.
- The ‘end-client’ (the employer) will need to confirm IR35 status by providing a ‘Status Determination Statement’ (SDS) to the worker and agency if an agency is involved.
- The end-client must put in place arrangements for disputes about the SDSs. The legislation states a time limit of 45 days for the end-client to respond, in writing, to the worker with an outcome of the dispute.
- The liability will shift from the worker to the fee payer. The fee payer could be the employer or the recruitment agency.
The rules do not change who’s classified as employed; however they do change the responsibility and risk for making the assessment. They shift the responsibility from the contractor to the employer. It’s important to note that for small businesses, the responsibility will remain with the contractor.
The Companies Act 2006 defines a small company as a business with two or more of the following features:
- turnover of £10.2m or less
- a balance sheet total of £5.1m or less
- 50 employees or fewer
Crack down on IR35 rules: HMRC win against BBC presenters
HMRC recently brought a case against Lorraine Kelly for £1.2 million, claiming her contract with ITV amounted to her being an employee. HMRC argued that although Lorraine is “more than a newsreader and had a degree of autonomy”, she “retained the contractual right of control, consistent with employment.” Lorraine persuaded the court that when contracting Lorraine, ITV were engaging her brand and that she was providing a contract for services not an employee contract.
HRMC was successful in other cases against three BBC presenters, David Eaves, Tim Wilcox and Joanna Gosling. Judges ruled there was “sufficient mutuality and a sufficient framework of control to place the assumed relationships between the BBC and the presenters in the employment field.”
The three BBC presenters were not taxed as harshly as they would have otherwise been had they not sought proper advice on taxes. This meant the court was reassured they had “not been careless” with their tax affairs and had acted in good faith. This is a clear reminder to companies hiring contractors to take advice on the tax regime.
Whether someone will be a self-employed contractor or an employee can only be determined on a case by case basis, this will require a detailed look at the level of control the employer has over the individual.
The cases have again flagged concern over the accuracy of HMRC’s CEST tool as the extension of the new rules to the private sector. Whilst the tool will provide a good starting point, employers and contractors will need to gain expert advice regarding their contracts before April 2020 to ensure they are not hit with a hefty bill from HMRC further down the line.
Businesses engaging contractors may also face tax penalties as well as the contractor. It’s vital that the relationship between business and the contractor is properly documented.
The significance of obtaining legal advice
HMRC plans to introduce a Check Employment Status Tool (CEST) which employers can use to help determine the status of their contractors. However, there has been criticism of the tool, with many concerned about its effectiveness. This is because an online tool cannot weigh up the multitude of factors that must be considered when establishing whether an individual should be deemed to be an employee. Some of the factors that need to be considered include whether the individual is ‘part and parcel’ of the organisation, whether they are taking a financial risk, whether they use equipment of the organisation, and the contract will also need to be contemplated.
Contractors, freelancers, employers in medium and large businesses, and recruiters should seek advice to ensure they’re issuing correct SDSs. Incorrectly determining employee status can lead to serious consequences such as a HMRC investigation, which is costly and time consuming, and tax liabilities of potentially thousands of pounds.
Medium and large businesses need to update their contracts with existing and future contractors. It is imperative that businesses seek specialist advice in doing so to avoid potential claims and costs further down the line.
The determination of whether a contractor is a deemed employee, and therefore falling under the IR35 scheme, or a genuine self-employed or commercial agent will come down to the individual circumstances of each situation.
At Ison Harrison our team of expert commercial solicitors can advise on issues and assist in drafting and negotiating the contractual provisions required to protect your business. If you are a business who engages contractors or are yourself a contractor, it is important that you take the correct legal advice. Call 0113 284 5000 or alternatively email Richard.Coulthard@isonharrison.co.uk.