IR35 is the name given to tax legislation, introduced back in April 2000, that is intended to identify individuals who could be paying less tax than they should be. Most contractors, by their own admission, have not fully understood its implications.
The legislation specifically targets those people who supply services to clients via their own company, generally known as a personal service company (PSC) whether it is a limited company or a limited liability partnership. In many instances, the HMRC believe these individuals are simply just ‘disguised employees’. IR35 is intended to ensure that two people working in a similar role for the same employer pay the same PAYE taxes and National Insurance.
Under proposed changes to legislation due to come into effect in April 2021, medium and large companies will be responsible for determining whether the contractors they hire fall within the scope of IR35 legislation and are liable to pay a higher rate of tax. This is a seismic change, not just for the burden it puts on the end client, but also for the contractor. Overnight, contractors will have to prove they are providing a business service and are not, for all intents and purposes, just acting as a temporary employee. Contractors that do get caught up in the change could be deemed an employee by HMRC but would still not be under direct employment by the company providing the contract, therefore potentially missing out on bonuses, benefits or ‘perks’ that employees often have.
A contractor generally takes many more risks running their business than an employee does. There is significantly more uncertainty when operating as a contractor. One benefit that has helped many mitigate this risk is a more tax efficient way of taking money out of their PSC – generally a mix of salary and dividends and allowable expenses. If this benefit is wiped out, many contractors may seriously question the viability of the risks versus the rewards. People contract for many reasons – not just financial – but it is forcing a significant and essential part of the workforce to reconsider their options.
It is generally agreed that there are four main areas that HMRC would review to determine if you are operating within or outside of IR35:
- How much control do you have? Can you always demonstrate that you are in charge of the services you perform, where you perform them, when you perform them and how you perform them? In a bid scenario with immovable deadlines it might be very hard to prove that you have control of when and how the service is delivered. More often than not, you would be working to a clients’ bid plan and timescales.
- Are you exposed to financial risk? Can you prove that you have the same financial risks as other directors operating similar businesses? Employees typically have no financial risks. If HMRC can see a regular monthly ‘salary’ from one client, it might argue there is no financial risk and that IR35 is applicable.
- If your clients provide you with the equipment to deliver your services (IT, phone, proposal templates, proposal software, etc), HMRC might interpret this as an employee / employer relationship as opposed to business to business. The contractor is not taking any real financial risk in regard to purchasing equipment to deliver the service.
- Working Relationship. HMRC looks very closely at the implied relationship of any service contract to determine if it mirrors employee / employer or limited company / client. For instance, if the contract explicitly details notice periods or a fixed period of work, it would be deemed too similar to employment, not delivery of a service. Also, could you readily send in a substitute contractor to deliver the services without the client’s prior approval?
It is fair to say there is still much confusion surrounding this legislation and even the government has contradicted itself on several occasions. Two examples (taken from the HMRC website) are provided below demonstrating the potential difficulties and how a contractor may have a mixture of IR35 and non-IR35 turnover under the new legislation.
|John would be considered self-employed for this contract||John would be considered an employee for this contract.|
|John is taken on by a manufacturing firm to design and implement a new bid process. John and the firm have agreed a price for the job and when he will deliver the new process. John will mainly work at home, using his own equipment to complete the task. John is free to work for other clients but faces a contractual penalty if he doesn’t deliver the process on time, to the agreed standard. This represents a significant financial risk to John if he fails to deliver the final bid process as agreed.||The manufacturing firm needs someone to maintain and update a bid library. It hires John to work for three days a week, eight hours each day. The firm provides John with a laptop so he can work at its offices or at home with permission. He reports to the Head of Bids and must follow their style guide and format to update the bid library. The firm is responsible for providing and updating the proposal software John needs to do his work. If John must work longer than his contracted hours, he will be paid overtime. John can work elsewhere on the days he is not working at the firm, with their agreement.|
Without wishing to state the obvious, we are by no means tax experts and the information provided here is purely for background. If you are unsure about your IR35 status, we strongly recommend you consult a solicitor and an accountant.
This article was written by Bid Solutions.