“IR35” – it could almost be mistaken for a character from the latest Star Wars film, and whilst IR35 is not a new concept, it will be hitting the private sector in 2021*. If your business currently engages consultants or contractors operating as part of a personal service company, this is a premiere that you ought not to miss.
What is “IR35”
“IR35” refers to existing legislation that was designed to close a tax loophole whereby an individual could in theory, work as if an employee of an end user client but seek to avoid being subject to PAYE deductions by supplying their services through an intermediary, usually a personal services company. Like the Hokey Cokey, you were either ‘in’ or ‘out’. If inside IR35, you were caught and the individual should be paid via PAYE. If outside of IR35, then the arrangement was regarded as genuine self-employment for tax purposes.
So, what has changed?
Firstly, the old regime required the consultant / contractor to determine their own status for tax purposes, and they generally bore the risk of getting this wrong. With effect from April 2021, and in respect of the private sector, the onus passes to the entity engaging the individual, which in many cases will be the end user who receives the services. The engaging entity will therefore have to satisfy themselves as to whether the consultant / contractor is inside or outside of IR35.
In addition, if the consultant / contractor is inside IR35, and the new rules applies to the entity engaging the individual (see below), then in principle that entity becomes responsible for accounting to HMRC for tax and national insurance in respect of the payments made to that individual. The situation becomes more complicated if a recruitment business is involved, where it supplies the individual to the end user entity and pays the individual directly.
This change of approach already applies to the public sector and insofar as the private sector is concerned, it only applies to engaging entities that are not “small”.
A “small” company is one which satisfies two or more of the following requirements:
- Its annual turnover is not more than £10.2 million.
- Its balance sheet total is not more than £5.1 million.
- It has not more than 50 employees.
How do you know whether a consultant / contractor is ‘in’ or ‘outside’ of IR35?
HMRC have an online questionnaire, known as CEST, which is designed to give you a definitive answer to this conundrum. If the questions are answered honestly, then it can be relied upon in the event of a later dispute. However, some of the questions are difficult to answer, and a possible outcome of CEST is that it is unable to make a determination on the matter!
As it happens, the test under IR35 is similar to (but not the same as) that which applies in employment law, in determining an individual’s employment status. This means that particular focus will be placed on the extent to which the end user controls the consultant / contractor, the extent to which the services need to be performed personally by the consultant / contractor (as opposed to having a right to substitute) and the extent to which mutuality of obligation exists between the parties. It also means that the label that the parties attach to the arrangement is far from determinative.
What should you do?
If you engage consultants / contractors, we would recommend you take the following steps:
- Review those arrangements and consider utilising CEST;
- Ensure that you have a written contract that formalises the arrangement, and is drafted to best protect your business;
- Take specialist advice – your accountant on the tax side, and an employment lawyer on the legal side.
It follows that if you decide that somebody is ‘inside’ IR35 and will be treated as an employee for tax purposes, that equally will make it more likely they will be regarded as an employee for legal purposes, and that carries its own separate implications.
*As of 17th March 2020, the Government announced the delayed introduction of IR35 to the private sector to April 2021.