What is IR35?
IR35 refers to a set of legislation that aims to tackle the issue of ‘deemed (or disguised) employment’. This is where organisations hire workers on a self-employed basis, through an intermediary (often a limited company) rather than an employment contract, when in practice they are employees. Hiring workers in this way saved organisations a significant amount of money as they did not have to pay National Insurance Contributions (NICs) of 13.8%. They also did not have to provide any employment rights or benefits.
The legislation aims to prevent tax avoidance by deemed employees. If deemed employees fall under the scope of IR35, they must be treated as employees and as such must pay income tax and NICs as if they were employed.
The first piece of IR35 legislation came into force in April 2000, as part of the Finance Act. It was consolidated in the Income Tax (Earnings and Pensions) Act 2003 and the Statutory Instrument Social Security Contributions (Intermediaries) Regulations 2000. The legislation is collectively referred to as IR35 due to the original press released published by HMRC announcing its creation.
How does IR35 work?
IR35 is underpinned by employment legislation and IR35 case law. The legal principle behind the rules is that 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 three main principles used to determine employment status of an individual are:
- Control: What degree of 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.
Why are new rules being introduced?
IR35 is heavily criticised by businesses and tax experts as it causes unnecessary costs and hardships for small businesses. The government is replacing the original IR35 legislation with the new off-payroll working rules. This new legislation was introduced to the public sector in April 2017 and will be extended to the private sector in April 2020.
What changes do the new rules make?
The three main changes under the new legislation are:
- 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 new rules do not change who is classified as employed and who falls under the rules, however they do change the responsibility and risk for making the assessment. They shift the responsibility from the contractor to the employer. It is 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
It hasn’t yet been confirmed, but it is believed the new rules will not impose any new obligations on small businesses. The responsibility to submit a quarterly intermediaries’ return to HMRC, with details of workers placed with clients where they do not operate PAYE will remain. HMRC is to release guidance which will clarify these obligations.
The importance of obtaining expert legal advice
HMRC plans to introduce an updated 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 expert advice in order to ensure they are issuing correctly assessed SDSs. Incorrectly determining employee status can lead to serious consequences such as being faced with a HMRC investigation, which can be costly and time consuming, and tax liabilities of potentially thousands of pounds.
Medium and large businesses will need to update their contracts with existing and future contractors in light of these new rules. It is imperative that businesses seek specialist legal 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 these issues and assist in drafting and negotiating the contractual provisions required to protect your business. Call 0113 284 5000 or alternatively email Richard.Coulthard@isonharrison.co.uk.