IR35 (also known as Off-payroll working) is the abbreviation for the 'intermediaries legislation', a set of tax rules that apply to contractors who work for a client through an intermediary – (a limited company or "personal service company" which is how many people work). We wrote about it last year. In April 2020 major changes to the law will mean that clients need to be more careful and make sure these arrangements are ok with the tax authorities in the UK. We reached out to an expert in employment law Sophie Clifford from Temple Employment Law, who is also our legal partner covering the UK. Sophie told us about the current regime, what is changing and what you can need to do about it.
EDIT, April 2020: Due to the Coronavirus outbreak, IR35 has been pushed back to next year. We will keep this article updated as we learn more.
IR35 - What it means now
- It’s a set of tax rules introduced in 2000
- It’s about HMRC getting more money from contractors who look too much like employees even though they operate through a LTD company (HMRC calls it “disguised employment”)
- HMRC want to tax contractors through normal PAYE (pay-as-you-earn tax) and ensure they get full employer and employee National Insurance contributions
- They can look back 4-6 years for income tax and 6 years for National Insurance contributions
- If caught, there may be the historic tax liability as well as interest and penalties (up to 100%)
- Pre April 2020, the risk of disguised employment was with contractor’s limited company (not the client)
What difference does it make for contractors to be caught by IR35?
Let's take the example of a contractor who is paid £600 per day:
- Their current net monthly income is £7,013
- If they get caught by IR35, this decreases by £1,999 (17%) to a total of £5,814
- If caught, raising their rate by £204 (34%) to £804 achieves the same income
- They can lower their rate by £112 and earn the same as someone inside IR35
- They can take an extra 11 weeks holiday and earn the same as someone inside IR35
- To get the same income via permanent employment would require a salary of £139,022
Data according to www.contractorcalculator.co.uk
So what is changing?
- New rules (now called “off-payroll working”) are coming into force in April 2020
- HMRC are making it the client’s problem
- The client must decide if IR35 applies and if so operate PAYE (or get the fee payer if there is an Agency in the arrangement to operate it)
- If the client doesn't do this, it carries the risk and could face the penalties
The good news
You can ignore all this (for now) if you are a “small company”, that is a company having two or more of:
- An annual turnover not exceeding £10.2m
- A balance sheet total not exceeding £5.1m
- An average over a year of not more than 50 employees
IR35 is not yet law (just a plan for April 2020) so make sure you stay updated and follow any developments.
How to decide if off-payroll rules apply? (i.e. contractor should be taxed like an employee)
There are a few steps you can take to assess if you fall under IR35. The easiest way is to use the online HMRC tool called CEST and answer questions like:
- Does your organisation have the right to move the worker from the task they originally agreed to do?
- Has the worker paid another person to do a significant amount of this work?
- Does your organisation have the right to decide how the work is done?
CEST is not 100% foolproof. HMRC has lost many cases before the First Tier Tax Tribunal where contractors challenged its IR35 assessment. But a client should carefully consider whether it’s worth taking that risk especially bearing in mind the penalties.
What are the client's options if off-payroll rules apply?
- Take the contractors on as employees (with all the perks and benefits)
- Keep them on as contractors through their limited companies (or umbrella companies) and tax them through PAYE (pay-as-you-earn). They will either get less and accept that or they will increase their rate to make up the shortfall
- Use a consultancy company instead of contractors
- Review how you work with them and make them genuine contractors - e.g. give them a real right of substitution.
Which option you go for will depend on how much you need the contractors, headcount restrictions, costs etc. There is not one size fits all. When these changes took place in the public sector a few years ago, contractors using genuine umbrella companies (they become the employees of the umbrella company which deducts the right tax etc but the contractor maintains the freedom to contract for multiple clients, move around between contracts etc) proved popular.