Reforms to IR35 will be introduced by the government in April 2021, which will extend the off-payroll working rules to medium and large organisations who engage contractors.
We outline below how the reforms may impact your business and ways that you can prepare for the changes ahead.
What is IR35?
IR35 is a piece of legislation which aims to prevent tax avoidance and allows HMRC to collect employee income tax and national insurance contributions from ‘self-employed contractors’ who are in reality employees of the end-user client.
IR35 covers arrangements where an individual avoids paying income tax and national insurance contributions by working through an intermediary, often a personal service company, so that they are not an employee of the end-user client.
Currently under the IR35 legislation, the responsibility is on contractors engaged by private companies to determine their own status and make the necessary tax deductions from their fee.
Following a number of public scandals, the government introduced ‘off-payroll working’ rules for the public sector in 2017 to enhance the IR35 legislation.
The off-payroll working rules place the responsibility on the end-user client, rather than the contractor, to determine and declare the true tax status of the individual.
It is important to note that IR35 only relates to employment status for tax purposes and any contractor who is placed on payroll under these rules will not be entitled to any employment rights.
The reforms, which have been delayed from April 2020 to April 2021, will extend the off-payroll working rules to medium and large private companies.
Therefore, organisations covered by the rules who engage contractors will need to consider their true employment status and may be responsible for paying employer’s national insurance and an apprenticeship levy.
There is a free online tool called ‘Check employment status for tax’ (CEST) on the government website which can help you determine the status of any contractors you engage and ensure that you comply with the new rules.
Who will be affected by the reforms?
The reforms will apply to medium and large private organisations who are engagers of contractors.
The size of an organisation is determined according to data from the previous two financial years.
An organisation will be medium and therefore be covered by the rules if it satisfies at least two of the following requirements for two financial years:
- The total assets are worth £5.1 million or more
- The annual turnover is £10.2 million or more
- There are at least 50 employees
The size of a company that is part of a group will be determined by the size of the group rather than the individual company itself.
What type of arrangements are covered by the reforms?
The off-payroll working rules only apply to personal services, whereby a specific individual (contractor) is engaged to offer a service through an intermediary (personal service company) and a relationship is created between them and the end-user client (engager).
The rules don’t apply to outsourced services, such as cleaning or maintenance, where the organisation requests a service from suppliers, and they have no preference or control over who carries out the service.
The involvement of agencies
If you use an agency (also known as a ‘fee-payer’) to engage contractors, the responsibility will still be on you as the end-user client to determine the contractor’s employment status.
As the contractor is providing you with personal services, only you and not the agency will know the true nature of the working relationship.
Therefore, you must inform both the contractor and the agency of the contractor’s status and if necessary, the agency will make the relevant tax deductions from the contractor’s fee.
They will of course charge you for the costs they incur by doing this and you may also be subject to an administration charge for conducting the contractor’s payroll.
If you use an agency to engage temporary or casual workers who are already on the agency’s payroll, then this relationship will not be affected by the reforms as their tax and national insurance is sorted by the agency.
Status Determination Statements
The reforms will introduce a formal process which the engager must follow to inform the contractor that they have been subject to IR35, so that the necessary tax deductions can be made.
From April 2021, public and private sector engagers must issue the contractor with a Status Determination Statement (SDS) and there is the opportunity for an appeal and dispute process.
If you use the government CEST tool mentioned above, it will provide you with an appropriate SDS.
If this formal process is not followed, the engager may be liable to pay the employer’s national insurance and apprentice levy as well as the contractor’s tax, through transfer of liability.
This will be a considerable cost, particularly for large organisations who engage hundreds or thousands of contractors.
Disagreement between the engager and contractor
If the contractor appeals against your SDS that they are subject to IR35, you need to process the appeal within 45 days.
This means that you must consider any arguments or information the contractor puts forward and decide whether to uphold your original decision or issue a new SDS.
This is not a particularly rigorous appeal process as there will be no outside involvement, such as from HMRC, and the appeal decision will be completely up to you as the engager.
If your appeal outcome is that the contractor is not subject to IR35, then you must ‘reverse’ payroll by recovering all the tax deductions you have made and take the contractor off your payroll.
This will be a difficult process, especially since the contractor may have been placed on your payroll for months before appealing.
Fixed-term contracts as an alternative
Large engagers may be tempted to avoid the scrutiny of HMRC by placing contractors on fixed-term contracts.
However, this may be problematic, as contractors are unlikely to agree to this if they run their own business.
It also means engagers will have the added expenses associated with employment rights, such as paying holiday pay and pension contributions, which contractors subject to IR35 are not entitled to.
It may create an issue of equal pay if the contractors’ fees are considerably higher than the organisation’s salary bands for employees who carry out similar work.
If you use an umbrella company to engage contractors, it is important that you understand the details of the arrangement.
In this situation, it is likely that the umbrella company will deal with the contractors’ PAYE.
However, you must be aware of who is responsible for paying the contractors and who will be responsible for paying the employer’s national insurance once the reforms are introduced.
Effect on past liabilities for tax and national insurance
The off-payroll rules will not be applied retrospectively, except for cases where there is suspected fraud or criminal activity.
Therefore, any contractors who have been engaged prior to the introduction of the reforms who become subject to IR35 will need to be placed on payroll for any engagements from April 2021 onwards.
Preparing for the reforms
Preparation for the reforms cannot be solely the responsibility of HR and payroll.
It will require input from senior management so that an effective business strategy can be formed.
There may be serious implications for the business, if it is forced to place its contractors on payroll, considerably increasing the size of its workforce.
Before the reforms are implemented in April 2021, organisations that will be affected should review the arrangements they have with contractors to determine whether they are likely to be subject to IR35 and if so, if there any changes that can be made to avoid this.
Considerable changes may need to be made to how the business operates, so it will be useful to take the time to make the right decisions for the business.