HMRC recently brought into force further IR35 legislation intended to ensure that, where applicable, contractors pay the same Income Tax and National Insurance contributions as their employed counterparts.
Suzanne Grant, a member of Stowe’s Forensic Accountancy Team, explains the latest changes and the implications for all medium and large private sector businesses.
More and more frequently we are seeing cases where our client provides their services through a limited company which has historically operated successfully under IR35 rules, but from which a reduction in future available net take home pay is envisaged due to the impact of recent IR35 changes.
What is IR35?
IR35, often referred to as the off-payroll working rules, is a tax legislation designed to combat tax avoidance by contractors supplying their services to clients via an intermediary such as their own limited company (known as a Personal Service Company ‘PSC’) but who would otherwise be classed as an employee and taxed as such if that intermediary was not used.
IR35 rules were first introduced in 2000 by HMRC to ensure that contractors working in the same way as permanent employees paid the same tax and national insurance contributions (‘NIC’) as an employee. Consideration of the working arrangements was necessary to determine if they represented a contract of service (deemed to be ‘inside’ IR35) or a contract for services (deemed to be ‘outside’ IR35).
In other words, the legislation sought to try and stop the practice of contractors leaving their jobs as employees, setting up their own limited company and immediately returning to the former employer as a self-employed individual undertaking the same work as previously, but now effectively employing themselves and working on behalf of their own PSC.
A Contractor’s Perspective
A contractor’s take home net pay ‘outside’ IR35 is often significantly higher than a contractor’s take home pay ‘inside’ IR35, as those outside the legislation can benefit from reduced NIC by taking the bulk of their income in dividends on which NIC is not paid. ‘Inside’ IR35, their income is subject to the same level of taxation as an employee under PAYE. Under such arrangements, there are also financial benefits to the employer who does not pay employer’s NIC or any other contractual benefits such as sick pay or holiday pay.
For the majority of the time since IR35 was first introduced, the decision as to whether or not the contractor’s working arrangements fell within IR35 rules has effectively been the responsibility of the individual worker via their PSC. Thus, to a large extent the actual business engaging the worker (client) had little to worry about in terms of tax and employer’s NIC because even if HMRC subsequently found the arrangement to be ‘inside’ rather than ‘outside’ IR35, any additional tax and NIC liability fell to be met by the PSC rather than the client who had engaged the contractor.
Public Sector
To try and rectify this, in 2017 HMRC changed the decision-making responsibility for all public sector organisations to the end user, ie the business (client) which receives the services of the contractor. At that point, those public sector organisations became responsible for deciding whether an engagement fell ‘inside’ or ‘outside’ IR35.
Private Sector
This process was further extended by HMRC with effect from 6 April 2021 to include all medium and large private sector businesses, meaning that many businesses are now responsible for the decision making process in relation to the contractors they engage and whether they are ‘inside’ or ‘outside’ of IR35. A record of that decision (recorded via a Status Determination Statement) must be passed by the business to the entity with whom it has contracted.
Considerations
IR35 rules now place a significant burden on the end user (client). However, there remain a number of ways in which labour can be supplied by a contractor without the need / involvement of a PSC. For example, the client recruits the contractor as an employee, the client contracts directly with the contractor on a self-employed basis and not through their PSC, or the contractor goes through an agency in which there is no PSC in the chain meaning that the contractor is engaged either directly by an agency or as an employee via an umbrella company.
For small businesses the decision as to whether the working arrangement falls ‘inside’ or ‘outside’ IR35 currently remains the responsibility of the PSC.
Failure to take these changes on board can have significant consequences. HMRC have the power to look back at IR35 contracts for at least 6 years to determine if contractors fall within IR35 rules. When a contractor is deemed to be ‘inside’ IR35 and subject to the legislation, HMRC will look at each contract, deduct the tax that has been paid from what an employee would ordinarily have paid through PAYE, and backdate this tax charge.
This article is intended as a guide only. If you are unsure about anything or would like further insight and support with IR35 arrangements, please seek professional advice.
