The UK’s controversial IR35 changes extended to private sector
By William Kirwan, VP Advisory
If your business hires contractors or temporary workers in the UK, you’re likely familiar with off-payroll working rules, commonly referred to as IR35. You’re perhaps just as likely to be frustrated by them. Despite having been in force for nearly 20 years, IR35 continues to be heavily criticised for being complex and difficult to implement. Unfortunately for UK employers, recent changes to IR35 promise to make the legislation even more difficult to understand and follow.
Formally introduced in 2000, IR35 rules were designed to combat tax avoidance by so-called ‘disguised employees.’ These are workers who perform similar duties to full-time employees, but bill their services through a personal service company, or PSC. The use of a PSC allows workers to draw income in the form of dividends, which are exempt from National Insurance Contributions (NICs).
By contrast, a regular full-time employee’s wages are subject to an income tax of up to 45% and NICs of up to 12%. The use of a PSC can, then, significantly increase a workers’ take-home pay. According to HM Revenue and Customs (HMRC), this arrangement is unfair, as two individuals who work in the same way should pay broadly the same income tax and NICs. IR35 rules were implemented to address this inequity.
To comply with IR35, an employer must properly classify a worker’s status as either a contractor or a regular employee. To assist with the assessment process, the government has developed a series of tests that focus on three key principles of employment:
- Control: A worker will be considered an employee if the client has a right to exercise control over what, how and when the work should be completed.
- Substitution: A worker will be considered an employee if they are not permitted to send a substitute to complete the work on their behalf.
- Mutuality of obligation: To be considered an employee, a worker must be obliged to offer their services and an employer must be obliged to accept them.
Other factors to consider are how a worker is paid, who supplies the necessary equipment to complete the job and employment exclusivity, among others.
Originally under IR35, the contractor was responsible for determining their own status. Following a 2015 review of the legislation, however, HMRC found that only 10% of contractors who should be applying IR35 rules do so. If left unchecked, this failure to apply the rules would cost the Exchequer 1.3 billion pounds by 2023.
Recent IR35 reforms
In an effort to at least partially address the problem of contractors failing to apply IR35 rules, in 2017 the government reformed the rules for the public sector. The reforms shifted the responsibility of IR35 assessments from the individual to the public organisation which engages them.
Since 2017, increased compliance within the public sector has raised an additional 550 million pounds in income tax and NICs. In response to the reform’s success, the government announced plans to extend these provisions to the private sector, effective April 2020. The measure will have a significant impact on: individuals who provide their services through a PSC; recruitment agencies and other intermediaries that supply staff through PSCs; and the large and medium-sized companies outside the public sector that engage them (known as end-clients).
The remainder of this post will cover the specifics of the new provisions and the steps your business should take to prepare for the changes.
Small business exemption
The smallest 1.5 million UK businesses will be exempt from the new provisions if they meet two or more of the following criteria:
- No more than 50 employees
- Annual turnover of no more than 10.2 million pounds
- Balance sheet total is no more than 5.1 million pounds
Where the end-client qualifies as a small business, the responsibility for determining the IR35 status of a contract remains with the private service company. (There is no small business exemption for public sector organisations.)
Additionally, the government has included clauses in the legislation to prevent off-payroll workers from being routed to small associated companies and subsidiaries connected to a large end-user.
IR35 status determination statement
The end-client must confirm the IR35 status of a contract by providing a ‘Status Determination Statement’ (SDS). The SDS must be provided in writing to both the contractor and the party responsible for paying the private service company.
IR35 status dispute resolution process
According to the new rules, if a PSC does not agree with an IR35 status decision, it may dispute the decision. In the event of a dispute, the end-client must review the decision and provide a reasoned response within 45 days.
Transfer of employment tax liabilities
The legislation is designed to ensure that the end-client, or the fee-payer if an agency is involved, is responsible for any employment tax liabilities. The new rules allow HMRC to recover tax liabilities from another ‘relevant person’ if the fee payer fails to pay taxes due under IR35. A relevant person is any party involved in the payment to a private service company.
5% administration allowance
A 5% allowance is currently available to private service companies to reflect the cost of administering the off-payroll working rules. Because responsibility is shifting from the PSC to the end-client, this allowance will be removed for medium and large organisations, but will continue to be available for small businesses that qualify for exemption.
How to prepare
The impact of these changes should not be underestimated. Many businesses will be faced with immediate cost implications and substantial operational challenges. While HMRC has promised further administrative guidance on the new measures, all affected parties are encouraged to act now in order to ensure compliance with the new rules. Suggested actions to prepare include the following:
- Identify individuals who supply their services to your company through the use of a PSC
- Determine if IR35 rules apply to any contracts that will extend beyond April 2020
- Talk to your contractors about whether IR35 rules apply to their role
- Put processes in place to determine if IR35 rules apply to future engagements