IR35 is here and we need to understand this regulation especially if we are working as or employing flexible workers such as contractors. That is why we are very happy to have great relationships with our clients especially when they can help provide useful information on employment legislation!
We are very grateful to our friends at Thackray Williams Solicitors who have provided some guidelines and insight into what the legislation includes. We hope this is useful.
The IR35 legislation was first introduced to tackle a form of tax avoidance whereby individuals may seek to avoid paying employee income tax and national insurance contributions by supplying their services through an intermediary (usually a personal service company) and paying themselves in dividends.
The Social Security Contributions (Intermediaries) Regulations 2000 (the Regulations) and Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) set out various conditions that, if met, will mean that IR35 applies. The questions set out in the Regulations and ITEPA that need to be addressed in order to determine whether an arrangement will be caught by the IR35 legislation are mainly straightforward, however, determining a worker’s employment status is less straightforward and in both the Regulations and ITEPA, one of the key questions is whether the worker would (for tax or NICs purposes) have been an employee of the client if they had been working directly for it.
IR35 pre-April 2020
The IR35 legislation, pre-April 2020, requires the intermediary to determine whether the worker would have been deemed an employee of the end-user client, but for the existence of the intermediary. i.e. if the worker contracted directly with the client company, would there be an employer/employee relationship and, therefore, the worker subject to employee income tax and national insurance? If so, the intermediary must operate payroll, make deductions for income tax and employee national insurance contributions and pay employer’s national insurance contributions on the fees received for the services.
IR35 from April 2020
In July 2019, the government published draft legislation that, with effect from April 2020, medium and large companies in the private sector that contract with personal service companies will have to account for tax and national insurance through PAYE. The effect of the new rules is that, consequently, IR35 will no longer apply and the off-payroll working rules will apply instead.
The off-payroll working rules mean that the burden of making a determination of employment status falls on medium and large “end-user clients” who then need to notify their contracting party and the worker of that status determination. In other words, from April 2020 the burden of determining the status of the contractor falls on the company as opposed to the intermediary. If the off-payroll working rules apply, then the fee-payer is responsible for deducting tax and national insurance and paying it to HMRC.
It is worth noting that, where an end user client qualifies as “small” they will be exempt from the off-payroll working rules but the original IR35 legislation will continue to apply. Small companies are defined in the Companies Act 2006, as a company having two or more of:
- An annual turnover not exceeding £10.2m;
- A balance sheer total not exceeding £5.1m;
- An average over a year of not more than 50 employees.
When determining the deemed employment status of the worker, the same factors should still be considered, regardless of who is responsible for operating payroll deductions.
What end user clients will need to do from April 2020
From 6 April 2020, end user clients will need to determine the employment status of a worker. Once the determination is made, the end user client will need to pass the determination, and the reasons for it, to the worker and the person or organisation that they contract with. Detailed records of status determinations should be kept, and processes should be in place to deal with any disagreements that arise from the status determination. The end user client must take care when determining a worker’s employment status as failure to do so will result in the worker’s tax and national insurance contributions becoming the responsibility of the end user client.
In the event that a worker, or the agency paying the worker’s intermediary, disagrees with the determination reached, the end user client will need to consider the reasons given for the disagreement, decide whether to maintain the determination or provide a new one and keep a record of the representations made and reasons given. The end user client must provide their response to the disagreement within 45 days of receiving the same and during this time should continue to apply the rules in line with the original determination. Failure to respond within 45 days will result in the worker’s tax and national insurance contributions being the end user client’s responsibility.
Determining an individual’s employment status
In determining an individual’s employment status, there are many factors that companies engaging contractors will need to look at and HMRC provides guidance, including, but not limited to, the following factors:
- Personal service – for a worker to be an employee, they must be obliged to provide their services personally. Therefore, if a worker is entitled to appoint a substitute in their place to provide the services, this may point away from an employer/employee relationship;
- Mutuality of obligation – in an employment relationship, there will be an obligation on the worker to provide their services and an obligation for the engager to provide payment to the worker for that service. If there is no obligation on a company to offer work on a regular basis and no obligation on a worker to accept any work offered, the worker is more likely to be considered self-employed;
- Right of control – an employee will usually be expected to work set hours each day or week whereas an independent contractor is likely to have the freedom to work as and when they wish;
- Right of substitution and engagement of helpers – as advised above, the right to appoint a substitute will usually indicate self-employment;
- Provision of own equipment – a self-employed contractor is more likely to be responsible for providing their own equipment required to carry out their services;
- Financial risk – individuals who risk their own money are less likely to be employees e.g. paying for training, rectifying unsatisfactory work in their own time for no additional pay, or quoting a fixed price for work to be carried out with the risk of bearing additional cost if the work overruns;
- Length of engagement – this is not likely to be determinative, however, it is more likely that an employee will have an open-ended contract;
- Part and parcel of the organisation – e.g. someone taken on to manage the company’s staff will normally be seen as integral to the organisation and, therefore, an employee;
- Employee type benefits – if a worker is entitled to a pension, paid annual leave or other employee benefits that an organisation offers, this could indicate that an employer/employee relationship exits;
- Right to terminate contract – a right to terminate other than in circumstances of a serious breach may be indicative of employment status;
- Mutual intention – a stated intention of the relationship, whilst not determinative as other factors will be taken into consideration, could assist in determining self-employed status.
HMRC has made available an online tool (CEST) to determine whether, if the contract were directly between the worker and end client, the engagement would have the nature of employment.
Practical points to consider
Whilst it is important that contracts are drafted in such a way as to reduce the risk of IR35/the off-payroll working rules applying, it is also important that the practical reality is in accordance with the terms. In order to limit the risk, the following should be considered:
- Include a right of substitution within the contract that is drafted so as to be as wide-ranging as possible. If the right is actually exercised in practice this will help to demonstrate that there is no requirement of personal service.
- Avoid an obligation to provide and accept work. Case law suggests that providing a notice period will point towards a mutuality of obligation and should therefore be avoided if possible.
- The intermediary should be subject to as little control as possible. E.g. if possible, the intermediary should be free to set their own hours and place of work and determine how the work is done.
- Contracts should, if possible, be structured by reference to completion of a project or a specific piece of work, rather than by duration.
- Payment should be structured by reference to completion of a project rather than time worked. If possible, financial risk and reward should also be incorporated into the contract e.g. penalties/bonuses for late/early completion of work.
- The worker should not be integrated into the company more than is necessary.
- If possible, the contract should require the intermediary to provide its own equipment.
- It is also helpful, although not determinative, to stipulate that the contract is not intended to be one of employment.
It is important to note that HMRC guidance is not definitive and case law has determined that each case depends on its own facts and therefore the outcome in any individual case is impossible to predict.
If you have any queries regarding employment status, do not hesitate to contact one of the employment law specialists at Thackray Williams.