Changes to IR35 tax rules are due to come into force on 6 April 2021, after being delayed by a year due to the coronavirus pandemic. IR35 rules, also referred to as ‘off-payroll’ regulations, were brought in by HMRC in the Finance Act 2000 in order to crack down on tax avoidance via ‘deemed employment’. In other words, the rules aim to prevent self-employed contractors operating via an intermediary (such as a personal services company) from performing the services of an employee whilst paying less income tax and National Insurance. At the same time, the rules seek to prevent businesses from using contractors as employees in all but name, whilst avoiding the payment of key employee benefits such as holiday and sick pay.
What is changing on 6 April?
Basically, the responsibility for deciding whether a contractor falls under IR35 regulations used to rest with the contractor themselves. From 2017, public sector employers became responsible for this decision and on 6 April 2021, this change will extend to the private sector. Crucially, this means that the responsibility for getting it wrong, and the hefty fines that could ensue, will also transfer from contractors’ shoulders to businesses’.
Evidence suggests that the risk of such high sanctions is leading many businesses to take an overcautious approach, with some blanket banning the use of limited company contractors altogether. According to a survey of 3,000 contractors, 23% say their client has imposed a blanket ban on contractors operating via intermediaries.
Who exactly is affected?
As previously stated, all contractors offering their services through an intermediary have the potential to be affected by the changes, but not all businesses will be; the 2021 changes will only impact medium and large private sector businesses. Where the client is considered a small business (i.e. with an annual turnover of no more than £10.2m per year, a balance sheet of no more than £5.1m and up to 50 employees), the responsibility of determining IR35 status will remain with the contractor.
Inside or out?
So, how does a business go about deciding whether or not their contractor falls inside IR35? Well, truly self-employed people have several important characteristics that help distinguish them from employed or ‘deemed employed’ workers. If a contractor possesses these characteristics, it is highly likely they fall outside IR35.
- The contractor chooses where, how and when they carry out their work.
- The contractor can provide a substitute to perform the work if they are unable to.
- They can work for more than one client simultaneously.
- There is no ‘mutuality of obligation’ between the two parties – i.e., the contractor isn’t obliged to carry out any other services outside of those agreed in the contract, and the client isn’t obliged to give them more work once the contract has been completed.
The view from the inside
Contractors assessed by their clients as falling inside of IR35 rules could stand to lose up to 20% of their income to tax, according to a 2019 consultation. This is because employees pay 20%+ income tax on their salary above the personal allowance, and 12% in National Insurance on earnings between £9,568 and £50,270 as of the 2021-22 tax year. On the other hand, self-employed people can pay themselves a significantly reduced salary to avoid paying income tax, and top up the remaining balance in dividends, on which the tax rate can be as low as 7.5%. And, due to the cautious approach of many end-user businesses, many feel that they will be assessed unfairly as being inside IR35. According to the abovementioned survey, 41% of contractors said they would contest an inside IR35 assessment, while 72% said they would quote a separate, higher rate for ‘inside IR35’ engagements.
Businesses who have not yet assessed their contractors should use HMRC’s Check Employment Status for Tax (CEST) tool to assess potentially affected contractors, and take steps to minimise the financial risk to their business. However, tax experts advise against imposing blanket bans as this could result in the loss of highly talented workers to companies more willing to assess IR35 status on an individual basis, as well as reputational damage.