What is IR35?
IR35, which stands for Inland Revenue press release issue no. 35, is an anti tax-avoidance legislation which was introduced in April 2000 to ensure the correct amount of tax would be paid in relation to contracts between an independent worker (contractor) and their client.
It was designed to address the prevalent issue of disguised employment - individuals working for all intents and purposes as employees of a business, but being paid as contractors, through a limited company, therefore incurring fewer taxes, and at a lower rate.
What does the off-payroll tax update mean?
According to HMRC, the majority of contractors have continued to file incorrectly despite the introduction of the legislation. In an effort to change this, in 2017, the Government announced an update to IR35, called ‘off-payroll’ tax, a reform which shifts the responsibility of determining each contract’s IR35 status from the contractor to the client.
This shift was implemented in the public sector in April 2017 and was originally going to be introduced in the public sector in April 2020. However, due to COVID-19, the update has been pushed back to 20th April 2021 for private sector businesses.
The update means that for each individual contract between a client and a contractor, the end client (rather than the contractor) must perform an assessment to determine whether the contract is ‘inside IR35’ and therefore subject to Pay-As-You-Earn tax (PAYE) and National Insurance Contributions (NIC), or ‘outside IR35’.
Unfortunately, the onus of IR35 sitting with clients has had a negative knock-on effect for contractors: some businesses are put off by the risk that comes with determining the status of each contract and the administration and costs that come with organising PAYE and NIC for contractors. This has already led to many reducing the work they’ve previously depended on contractors to perform.
Who do the rules apply to?
The rules apply to each individual contract between a business and an off-payroll worker. This means that each time a new contract is drawn up, it needs to be assessed as either ‘inside’ or ‘outside’ IR35 legislation.
Note that the off-payroll update does not apply to small businesses. To be subject to the update, the business must meet two or more of the following criteria:
- The company has an annual turnover of more than £10.2 million
- The company has a balance sheet total (assets in the company’s balance sheet, before deducting liabilities) of more than £5.1 million
- The company has more than 50 employees
For more information on the application of these rules, see gov.uk’s guidance to the April 2021 changes to off-payroll working for clients.
What does ‘inside IR35’ mean?
It means that the contract has been identified as subject to PAYE and NIC. This means that the client, would need to deduct tax and national insurance contributions from the contract before paying the contractor.
What does ‘outside IR35’ mean?
It means that the contract has been identified as outside PAYE and therefore all tax contributions can be dealt with by the contractor rather than the client.
How to determine whether a contract is inside or outside IR35
As a rough guide, three key factors to think about are:
- Has your client hired you personally? This doesn’t necessarily put you inside IR35, but it’s less likely that if you’ve been sourced through a consultancy, for example, that you’d fall within IR35.
- Does your client control your work? Including factors such as:** the work you carry out, where you work and at what hours you work. If they do, this makes the contractor-client relationship akin to an employer-employee one.
- Are you obliged to continue to work for the client? Are they dependent on the continuation of your services? If so, this again makes the contractor-client akin to an employer-employee relationship.
To find out more about why a contract may fall within IR35, deemed ‘inside IR35’, Contractor Calculator has put together a great list of reasons why this may happen.
Finally, gov.uk has created the Check Employment Status for Tax (CEST) tool for determining employment status for tax reasons. Contractor Calculator has put together a useful guide to navigating CEST.
How are the rules applied?
Before April 2021
Public sector end client
If you enter an off-payroll contract with a public sector end client, it’s their responsibility to determine your employment status.
Private sector end client
If you enter an off-payroll contract with a private sector end client, it’s your responsibility to determine your employment status.
From April 2021
From April 2021, the same rules that currently apply to contracts involving a public sector end client will apply to contracts involving private sector end clients, meaning that it’ll be the responsibility of the end client to determine the contract’s status, as inside or outside IR35.
Note that payments are calculated on a payment basis rather than by contact date. So, for example, if work was completed before April 2021, but not paid until April 2021, the new rules will apply (making the client responsible for designation of contract’s IR35 status).
Does IR35 apply to sole traders?
No, it only applies to incorporated companies.
What IR35 means for your business insurance
IR35 is complex legislation and the Government believes that a large proportion of contractors are currently not following it correctly. Having the right insurance, as a contractor, can give you access to legal advice, if you ever find your position questioned, and protection for compensation costs in relation to your work as a contractor.