Understanding IR35: Off-Payroll Working in the UK - 2021 Update
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According to the latest statistics, there are around 1.4 million freelancers in the United Kingdom. It’s quite an increase over the last 20 years, and over 50% of these independent contractors even work full time.
But how many of them are really independent contractors? Employee misclassification is a common issue in the US, and the situation isn’t much different in the UK, with both employers and freelancers being guilty of “employee disguisement” with the goal of tax avoidance. With the number of freelancers skyrocketing, the government felt the need to offer a regulation to resolve their employment status.
If you’re working off-payroll or you hire independent contractors in the UK, you should be in the know when it comes to the IR35 legislation to avoid potential penalties and legal issues.
What is this legislation? How do you know if it applies to you and what changes did the new IR35 bring after the latest update? This article will answer all your questions.
What is IR35?
Intermediaries legislation, known as IR35, is tax legislation that applies to those who work for clients through an intermediary. An intermediary may be the worker’s own limited company or a “personal service company”, or as an independent contractor.
This law was first announced in April 2000 in a press release published by HMRC. Back then, the institution was called Inland Revenue, which is what the IR35 was named after.
This set of tax laws is a measure taken to combat tax avoidance. Both employers and independent contractors used intermediaries to avoid paying employee taxes, so independent contractors offered their services as freelancers via intermediaries. In reality, if the intermediary was removed from the equation, the contractor would be considered a regular employee.
In fact, the HMRC calls these workers deemed employees, and if they’re caught by IR35, their income is significantly reduced since they have to pay the National Insurance Contributions just like regular employees.
People employed by companies or working through umbrella companies have to pay higher taxes, while contractors and individuals working through a limited company pay corporation taxes at 20% of their profit. That makes contractor taxes more affordable, but not legal.
What does "inside IR35" mean?
IR35 rules apply to people working off-payroll. If they provide services for a client through an intermediary but would be considered an employee if there wasn’t for that intermediary; it means that if they’re inside IR35 - the legislation applies to them.
In this case, “the client” refers to the company receiving the services from the independent contractor, who can be operating as an individual, partner, or a personal service company. The client may also be called the hirer, engager, or end client.
How do you know your IR35 status? Well, once a year, all intermediaries need to fill in the P35 declaration, on which they need to state whether they’re inside IR35. That means the government leaves it up to the parties involved to figure out their own tax liabilities.
According to the information from the official government website (gov.uk), employers from the public sector used to be responsible for evaluating the collaboration - they would typically hire an expert to determine whether they’re inside IR35. In the private sector, the contractor was expected to determine if the IR35 rules applied to them - not the client, regardless of the company size. This law changed in April 2021 and we’ll tackle these changes later in the article.
It’s also worth mentioning that the government can run a background check and review working practices and contracts - up to six years retroactively. That’s why such tax avoidance is a great financial risk. If the authorities discover you tried to cheat the system, you may suffer financial and legal consequences.
Being "outside IR35"
Simply put, it means the IR35 rules don’t apply to you. If you’re operating as a business, you may have several clients (not all your income is coming from a single client), you have your own equipment, website, etc.
In this case, you’re not paying National Insurance and Contributions for any income you withdraw after you receive your salary because it’s considered as dividends. You only need to pay profit taxes at the corporate rate, which is 20%.
Who does IR35 apply to?
If you determine the IR35 rules apply to you, you will need to pay several types of taxes: income tax and national insurance contributions. These can reduce your income greatly, or increase your costs- if you’re the one hiring a contractor.
The rules may affect you if:
- You are an end client - a business receiving services from an independent contractor who’s a disguised employee. You receive these services through the contractor’s intermediary
- You are an independent contractor, a freelancer, or you have your own company, and you provide services through an intermediary
- You own an agency and you provide your workers’ services through an intermediary
The IR35 compliance checklist
If you fall into the group that needs to determine on their own if they’re inside IR35, and you don’t want or can’t afford to hire an expert to take care of that for you, here’s something that may help.
Answer the following questions to determine your employment status - make sure you check your contract for specific details.
- Does your client or someone hired by them supervise your work or provide instructions on how you should perform the work?
- Does your client supply you with the necessary equipment to perform the work? (for example, IT contractors should have their own computers, software, etc.)
- Does your client set working rules (such as working hours, days, or location)?
- Are you paid on a time basis?
- Are you required to complete additional tasks, not defined by the contract?
- Do you receive sick pay, have paid annual leaves, or other employment rights or benefits?
- Do you only provide long-term services to a single client instead of working project-by-project with multiple ones?
- Do you market your company on your own account? (you have an office, a website, etc.)
Mutuality of obligation (MOO)
- Are you in obligation to accept any work your client offers you?
- Does your client take the whole financial risk?
- Can you delegate work to someone else?
- Can you hire employees?
If your answer was “yes” to most of these questions, the government doesn’t consider your situation as self-employment. You’re likely inside IR35 since you’d be considered an employee if you didn’t have an intermediary or operated through your PSC (your own personal service company).
You also need to ensure that all the clauses in your contract align with your actual working practices to avoid penalties and issues. If this checklist still leaves you in doubt about your employment status, here’s an online tool that can help. The HMRC enabled employees, contractors, and employers to use CEST - Check Employment Status for Tax and easily determine whether they fall into the IR35 category.
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What are the latest IR35 changes?
New rules regarding off-payroll working were supposed to be put into effect in April 2020. However, due to the coronavirus pandemic, the reform was postponed and scheduled for April 2021.
The explanation from the government was that they wanted to avoid putting another burden on businesses that were already collapsing under the negative impact of the coronavirus outbreak.
Public vs. private sector
As of April 2021, there have been a few changes in terms of whose responsibility is to determine if you fall inside the IR35. Before the reform, clients from the public sector needed to determine the contractor’s real employment status, while in the private sector, the independent contractor was the one in charge.
Now, the rules that only applied to the public employers also cover the private sector. If a worker provides services to large or medium-sized clients from the private sector, they need to determine if they’re inside IR35.
Another change gives the contractors the right to learn the reason behind the client’s decision. This explanation can be found in the Status Determination Statement, and the contractor can open a dispute to reevaluate the decision if they don’t agree with it.
On the other hand, if an individual provides services for a small business from the private sector, the contractor is in charge of determining whether or not the IR35 rules apply to that particular case - this instance hasn’t been changed with the new policy.
The end client also has the obligation of making corresponding deductions on the contractor’s payment in case they’re inside IR35. For the fee-payer, those are NICs, income tax, and the Apprenticeship Levy.
Apprenticeship Levy is a tax paid at a rate of 0.5% of your annual bill, and you’re subject to it if this bill is over £3 million or you’re connected to any charities and companies with the purpose of receiving the Employment Allowance reduction.
Does IR35 apply to sole traders?
No, IR35 legislation doesn’t apply to sole traders. However, they can use the same set of questions to determine their employment status and determine if they’re a disguised employee in any case.
If you’re a contractor and you have your own limited company, but according to the IR35 rules, you’re actually an employee, your hirer (end client) will need to cover the tax due.
You will not be responsible for paying the penalties, but you will receive a reduced payment since your NIC taxes will be deducted from the total sum you’ve agreed with the end client. It’s called deemed payment and it accounts for the income taxes and NICs you’d have paid as an employee.
Does IR35 apply to small companies?
Yes, IR35 applies to small companies. If you’re not sure whether your business is considered small, check the following criteria:
- You have 50 or fewer employees
- Your annual turnover isn’t higher than £10.2 million
- Your balance sheet total isn’t higher than £5.1 million
Does IR35 apply to self-employed?
If an individual works via an umbrella company that connects contractors and end clients, IR35 rules don’t affect them. They get paid via the PAYE system and have a contract with the limited company that acts as the intermediary.
However, if they own a limited company and use it as an intermediary to provide services to an end client, IR35 applies to them.
When does IR35 start?
The latest guidelines regarding IR35 have been put into effect on April 6th, 2021.
To avoid legal trouble, additional paperwork, and financial penalties, it’s important to stay in the know when it comes to changes in regulations regarding employment.
This article has provided a comprehensive guide on how to find out if you’re inside IR35, how this legislation has changed with the newest reform, and who it affects from now on.
Now you can move on to do business legally and work with contractors or clients for your mutual benefit.
Disclaimer: This is article is informational and should not serve as legal or tax advice. Always check official sources or consult a legal or tax expert.