IR35 Tax Reforms - The Essentials (Part One)

With the Finance Act 2020 receiving Royal Assent in July, reform of the off-payroll working rules (IR35) for private and third sector organisations will go ahead on 6 April 2021. We look at the imminent changes to IR35 and what this means.

IR35 was first introduced in 2000 to prevent tax avoidance and to ensure that someone working like an employee, but through an intermediary - typically their personal service company (PSC) - paid tax like other employees.

Originally under IR35, individual contractors were responsible for making their own employment status assessments to HMRC. In April 2017, IR35 reforms in the public sector shifted the responsibility for carrying out these tax assessments from the contractor to the public sector client. This public sector reform was so successful - increasing HMRC revenue by an estimated £250 million in the first 12 months - that they will soon be extended to the private sector. The changes needed to support the smooth and successful implementation of the amended IR35 rules are set out in the Finance Act 2020.

Therefore, from 6 April 2021, large and medium-sized organisations in the private and third sectors who engage contractors operating through an intermediary, will be responsible for determining the contractors’ IR35 status of that engagement. In this two-part article, we refer to these organisations as the “client” and look at the key questions being raised around the imminent changes.

Will the new rules apply to all clients engaging contractors? 

The rules will only apply to large and medium sized businesses and their subsidiaries.

There is a specific exemption for small businesses. A small business is one that meets two of the following criteria:

• annual turnover of no more than £10.2 million
• balance sheet total of no more than £5.1 million
• no more than 50 employees.

A contractor can ask for confirmation of a client’s size in order to check whether or not the new rules apply and should receive a response to such a request within 45 days.

IR35 will apply only to those contractors who are contracting through a PSC. It does not apply to contractors who are engaged directly nor to any individual who is already subject to PAYE and NIC deductions, such as agency workers, or those providing their services through an umbrella company.

An outsourcing of a service (which does not require personal service) is also outside of the scope of the new rules.

Will the new rules apply retrospectively?

No. The new rules will apply only to services provided on or after 6 April 2021.

What if services started before 6 April 2021 - what is the risk of HMRC investigating employment status for tax in these cases?

HMRC has committed to not opening historic enquiries as a result of information obtained from employment status determinations under the new rules for tax years before 6 April 2021 unless there is reason to suspect fraud or criminal behaviour. There is no current guidance on what may be considered to be fraud or criminal behaviour, but this suggests there needs to be evidence of a contractor doing something deliberately to avoid being inside IR35.

What are the obligations of clients under the new rules?

Clients who use contractors operating through their PSC must decide the employment status for tax for each and every contractor on every engagement undertaken by the contractor. The client must then inform both the individual and the party it has directly engaged in the labour supply chain (either the PSC or a third party), of the outcome and the reasons for the outcome, in a Status Determination Statement (SDS).

The SDS must continue to be passed on down the labour supply chain until it reaches the fee-payer. The fee-payer, also known as the deemed employer, is the party immediately above the PSC in the contractual chain.

If the client determines that the contractor is inside IR35, then the responsibility for employment taxes (deducting income tax and employee NICs and paying employer NICs) and applying any apprenticeship levy falls to the fee-payer before paying the fees due for the services.

There is no prescribed form or format for the SDS, which must state whether or not the contractor would be/is an employee or office holder for tax and NICs purposes if they were directly engaged by the client and provide the reasons for coming to that conclusion.

If a party (including the client) in the labour supply chain receives the employment status determination, but does not pass it on, they will become the fee-payer and will also be responsible for the employment taxes and paying these to HMRC.

If HMRC is unable to collect outstanding tax or National Insurance contributions from the fee-payer or any parties in the chain, then it may seek to recover these sums from the first agency in the chain, failing which, recovery will be sought from the client.

Point of Note

HMRC has frowned upon blanket Status Determinations being applied to any grouping of contractors as employment status will differ from contractor to contractor, depending on the facts of each case.

IR35 case outcomes from first-tier tax tribunals have shown that cases with similar facts may have very different outcomes, and blanket determinations will not work. However, we have seen some businesses requiring contractors to provide their services through umbrella companies or to become employees.

This approach is technically permissible as this takes the working arrangement outside of the new rules, but the issue then becomes a reputational one and a question of whether the best talent may be retained by the client by taking this approach.

Coming soon

In part two of this article, we will look at how a Status Determination should be carried out, what happens if a contractor disagrees with the determination and who bears the liability if the determination is not done properly.