IR35 initiated in 1999, is tax legislation whose purpose is to combat tax avoidance. They supply their services to clients through a limited company as its mediator. They are known by HMRC as “disguised employees” since these individuals act, behave and even look like employees. However, despite being on the payroll they are registered as limited companies due to which they need to pay less tax.

A significant amount of capital can be saved in your business by employing these individuals as “contractors”. Through this, you no longer need to pay NICs or even provide employment benefits like sick leaves, paid holidays, pensions, etc. Making it ideal for both businesses and contractors.

Inside IR35 & Outside IR35

An Inside IR35 is a term used by HMRC, for individuals enlisted as limited companies who act like employees but are in breach of this regulation.

Whereas, outside IR35 is a term used for companies that don’t violate IR35 due to which no penalties will be inflicted on such companies nor would they have to pay an additional fee for it.

How to Determine Your Status?

Every business big and small will be accountable for setting its contractor’s tax status, since April 2020. The company would be penalized if the tax status is believed erroneous. Which shows the severity of tax status.

HMRC can investigate the tax status of the contractor at any time they want. While they evaluate whether the individual is an inside or outside IR35. They will disregard the written agreement and instead they will consider the relationship between contractor and business to create a “national contract”.

Three factors will be considered by them which are as follow:

Control:

Here the power held by the business will be assessed like how, when, why, and where the contractor completes the assigned task. The more control a business has, the more plausible that the contractor is inside IR35.

Substitution:

It means whether the task assigned can be completed by someone or is person-specific.

If the latter is applied then you are most probably inside IR35.

The mutuality of obligation:

Is the business obligated to give tasks? Must the contractor receive or accept it? If yes then you are most likely inside IR35.

Many more considerations are given by HMRC regarding the contract, their role in an organization, financial risks, and whether the desired equipment is provided by the company.

Reason For Crack-down

It has almost been two decades since IR35 came into existence. IR35 was mostly ignored up until 2018. It was up to contractors to choose whether their line of work falls inside or outside IR35 and charged accordingly. Soon the problem arises that most of the contractors decide to belong outside IR35. Due to this, they reaped many benefits of full-time stable work without the need to pay any tax.

Hence, HMRC estimated these contractors avoided a total of 1.3 billion pounds in taxes annually as 90% of people chose to fall outside IR35 by setting their IR35 status.

Impact of IR35 on Contractors

Due to the IR35 government crackdown, many challenges were faced by contractors. Serious action was taken against those individuals that were assessed within IR35. This made contractors fall into millions of thousands of pounds in debt.

If the contractors are assessed to be inside IR35, they will pay the same NIC and income tax as regular employees. However, they will be devoid of many employment benefits like paid leaves, pensions, sick leaves, etc from the business management.

If assessed within IR35, a serious financial shock is inflicted on the contractor. As its net income is reduced significantly up to 25%. In the worst-case scenario, HMRC will trace back to six years and investigate all the contracts within this period to check if the law applies. Due to this, the contractor may end up with hundreds or even thousands of pounds in debt.

Impacts of IR35 changes on the Public sector

The severe IR35 rules implemented by the UK government in 2017 resulted in the mass withdrawal of contractors. A research study was conducted by CIPD and IPSE on the government IR35 crackdown impacts on the public sector. The results indicated that about 50% of the public sector employing managers thought that they had lost their contractors. On the contrary, 71% were desperately trying to keep their contractors. This whole process has exhausted resources and demands extra time.

If similar IR35 changes continue in the private sector, the private companies can face equivalent impacts. These points have exacerbated the situation and could lead to backlash from both the private corporations and contractors.

Impacts on Recruitment Industry

Due to the IR35 crackdown, many contractors are now looking for permanent jobs. Once the law is put into effect it will be difficult for the companies to hire contractors. They will be charged for hiring a new employee.

Earlier, contractors demanded higher salaries in exchange for their career rights. However, their Earning potential is exceptionally reduced due to the IR35, which affects this type of Employment request. Now either the company will downsize the employees or increase their fees to acclimate to the new law.

Some businesses, like media and IT, will especially become aware of a difference as these businesses have a greater need for long-term contractors. So, a reduced pool of eligible people may easily lead to a skills shortage and companies will need to find new ways to attract contractors.

History demonstrated that certainly, this was the case following the public sector crackdown. Approximately 80% of public sector hiring managers reported a rise in workload due to employing and paying contractors.

On the other hand, the Government still has not prepared the plans for the IR35 crackdown. So, for now businesses of private contractors will run as usual.

IR35 rules tackle tax avoidance through off-payroll working

When a contractor is a ‘disguised’ employee, they’re taking advantage of the tax efficiency of working through a limited company, but otherwise they should be classed as an employee.

Consider the example of an employee who quits their job, leaves on the Friday and starts back at the company in the same position on the Monday, but as a contractor working through their limited company. Has the arrangement changed in any material way?

‘Disguised’ arrangements benefit employers too, because they don’t have to pay employers’ National Insurance contributions (NICs) or give any employee benefits to contractors.

So self-employed IR35 rules tackle those arrangements by testing the contract itself, working out whether it’s ‘inside IR35’ or ‘outside IR35’:

• if your contract is inside IR35, it points towards employment. HMRC sees you as an employee and you face an income tax and National Insurance burden, just as employees do
• if your contract is outside IR35, it points towards self-employment, and you can enjoy the tax efficiency that self-employment brings (as well as all the associated risks)

IR35 changes: what happened in April 2021?

After a delay, private sector IR35 changes were introduced in April 2021. These changes introduced public sector rules to the private sector, shifting responsibility for working out IR35 status from the contractor to the client.

April 2021’s IR35 changes mean that:

• medium-sized and large businesses are responsible for working out the contractor’s employment status, not the contractor
• contractors should be given the reasons behind the decision in a Status Determination Statement, and can dispute the decision if they disagree with it (public sector clients also now need to give contractors a Status Determination Statement)
• small businesses are exempt from the changes, so if a contractor works for a small client, the contractor will still be responsible for working out their employment status

End clients in both the private and public sector need to show they’ve taken reasonable care when working out IR35 status. If they haven’t, HMRC holds them responsible for getting things wrong. They also need to keep records relating to employment status determinations, including how they’ve made their decisions.

Do you find the IR35 rules too complex? Let Account-Ease help you navigate through it. Consult us today, so you can know about your legal accounting and tax requirements as a contractor or an individual business owner.