IR35 in the private sector explained – what contractors need to consider
28th October 2019
IR35 was introduced back in 2000 to tackle tax avoidance, where workers supplied services through an intermediary. HMRC believed those self-employed workers were effectively being treated as employees but not being taxed through payroll as employees ought to be. This is what the Revenue considers to be ‘off-payroll’ services.
At present, contractors who operate through their own 'personal service company' (PSC) are responsible for deciding if the IR35 rules should apply and deducting income tax and national insurance. From 6 April 2020, the extension of the off-payroll working rules will make it the responsibility of the firm that engages the private-sector contractor.
The new rules relate to engagements with large and medium-sized companies (as defined by the companies act) where a contractor provides services to them through a PSC, rather than as an employee. The rules which determine who is or is not within IR35 are not changing, only who is held legally responsible if those rules are not correctly applied. However, these changes have important tax implications for contractors.
What are the conditions that determine if IR35 applies?
Contractors need to consider a combination of factors to determine if they should operate as an employee or remain self-employed, although some factors carry more weight than others.
Mutuality of obligation
Employees and employers have to sign contracts that oblige the employee to perform continuing work and the employer to provide an ongoing paycheck. This is what is known as a mutuality of obligation. However, when it comes to self-employment agreements, there is no continuing obligation on either side as a self-employed individual can choose projects with no obligation to accept them, while a customer has no obligation to offer work to keep them busy.
Contractors who work through a limited company and wish to remain outside of IR35 after April 2020 should ensure a genuine right of substitution exists throughout each contract. To stay outside of IR35, you need to be able to show to HMRC that someone of equal competence, supplied by you, could have carried out the work to the same standard. In other words, that they’re paying for a service, not for you. Should a client specifically ask for you to do the work and reject an equally qualified colleague, the Revenue may interpret this to mean that you are inside IR35.
Bringing your own tools and equipment is one way of proving to HMRC that you are self-employed, as is having several different customers at the same time. Similarly, taking on financial risk by being willing to correct work in your own time and at your own cost, or being paid after submitting an invoice after completion of the task, is proof.
How can I prepare for the changes?
HMRC has confirmed an improved version of its check employment status for tax (CEST) tool should launch before the end of the year, however, if the reform to the CEST tool is not delivered before next April, establishing whether or not you will be treated as an employee or within the off-payroll rules before using the tool would be a good place to start.
If it looks like you will fall within IR35, it may be beneficial to weigh up whether or not you would be better off becoming a permanent employee. Alternative options include closing down a limited company before the rules extend to the private sector or taking on temporary assignments through an umbrella company.
There have been concerns among private-sector contractors that a change in their employment status would trigger retrospective enquiries however, HMRC has confirmed contractors or freelancers who see their employment status change under off-payroll (IR35) rules next year will not face an automatic tax probe. Instead, the Revenue will only open investigations if it has reason to suspect fraudulent or criminal behaviour from the information it receives.
If the impending changes are likely to affect you, we recommend that you contact us so that we can advise you on the best route to proceed for your individual circumstances as well as any tax implications that may impact you.