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IR35 has been implemented by the government since 2000, but the legislation has been subject to continual changes and advancements – the latest being the rules around the private sector. HM Revenue and Customs (HMRC) created the IR35 legislation to combat tax avoidance by contracted employees. The legislation has caused some frustration within the contractual workforce, with many battling with HMRC to prove that they are outside of IR35, and therefore not eligible to be taxed at a higher rate by their employer.
In 2018, the Chancellor announced that the government will reform the off-payroll working rules in the IR35 Private Sector, following the implementation of the legislation in the Public Sector in 2017. This change results in a significant change for businesses that employ workers who have their own Personal Service Company (PSC), who are also known as Limited Company Contractors.
So, how do the IR35 reforms change the working practices that involve businesses employing contractors for their services?
IR35 targets contractual workers who operate through an intermediary, usually a limited company, to offer and provide services to an end business, but, who would be deemed a full-time employee if they did not work through such intermediary. HMRC defines these workers as “disguised employees” as they may be awarded the same rights and benefits that a full-time employee have, but are not paying the tax to match up to their position.
HMRC are running checks on such individuals to discover whether or not they have been using their limited company status to avoid paying the higher tax and national insurance that a permanent employee is subject to. If these individuals are found to be inside IR35, they will have to pay HMRC what is deems unpaid tax and national insurance.
Since the implementation IR35 in the private sector, there have been several amendments made by HMRC to ensure that contractors are paying the correct tax. However, there are still beliefs that a lot of limited company owners are still inside IR35 and paying too little tax and national insurance. Because of this, new ‘off-payroll’ rules were implemented in April 2017 for contractors working for public sector organisations.
In the original legislation, it stated that the sole responsibility for paying the right amount of tax according to IR35 rules sat with the contractor. This has changed so that the obligation now also sits with the company that has hired the contractor for works. If their contractor is found to be inside IR35, the end user client must now deduct employees’ national insurance and tax from the contractors pay, as well as paying the correct amount of employers’ national insurance. These rules apply to most private sector businesses from April 2021, although some small businesses are excluded.
Ultimately, medium and large businesses will be responsible for concluding whether or not their contracted employees are inside or outside IR35. They will have to deduct the relevant tax and national insurance from their pay cheque and give this to HMRC.
Being inside IR35 simply means that the contractor is subject to PAYE, and is expected to pay the correct amount of tax and national insurance that a permanent employee would have deducted from their pay cheque.
If a contractor is investigated by HMRC and found to be inside IR35 when they have claimed to be outside, they could face a penalty charge to cover the unpaid income tax and national insurance.
If a contractor is deemed as Outside IR35, then they would be operating legitimately as a limited company.. The contractor will have the responsibility for determining the right amount of tax to pay.
Testing whether or not IR35 applies, comes down to how you are treated and behave within a business. Here are the four factors that HMRC use to determine whether or not IR35 applies:
1. Substitution: If the contractor or the end business is able to send a substitute to complete works in the contractors' place, this suggests the contractor isn’t providing a personal service, and the worker isn’t a disguised employee.
2. Control: If an end business controls the workload of the contractor or how the work is carried out, it suggests the person is inside IR35 as they are not providing a specialist service as a contractor.
3. Mutuality of obligation (MOO): If both parties pass the above tests, it is unlikely that MOO applies as it will be deemed outside IR35 anyway. MOO can be present in both contracts of service and contract for service.
4. Risk: If a contractor can make a profit or a loss i.e. financial risk this would suggest that the contractor is outside IR35.
If you’re working as a contractor, it’s never been more important to understand the rules around IR35 and whether you fall inside and outside the legislation. For more helpful tips and updates on the latest workplace legislation, visit our dedicated career advice section.
This material is intended for general information purposes only and does not constitute legal advice. Specialist legal advice should be taken in relation to specific circumstances.