Kineo demystifies compliance complexity to forearm readers with simple practical takeaways.
In this blog we will convey to HR leaders what IR35 is, how to identify and manage the implications of IR35 on your contract workers, and ultimately, minimise associated risks.
What is IR35?
In a nutshell, IR35 is a piece of UK legislation to address HMRC predictions around the cost of non-compliance in the private sector to amount to £1.2b annually by 2022/23. It announced this reform to medium and large companies in the private sector and charities, applicable from 6 April 2020.
Gov.uk’s guidance notes Understanding off-payroll working (IR35) detail this legislation does not apply to small businesses with a turnover of less than £10.2m and with less than 50 employees.
During the nineties employees (particularly in the area of IT) realised they could reduce a significant amount of employee tax by instead contracting to their employer. Instead of receiving a PAYE salary, paid and taxed on a monthly basis they could set up a limited company and contract to the ‘client’ for gross pay directly or via a nominated agency saving themselves thousands of pounds in the amount of Income Tax and National Insurance to be deducted.
The nineties denoted a trend of employees leaving their places of work on a Friday and returning as contractors the following Monday. (“Friday to Monday” scenario).
Stamping out tax evaders
By 1999, the UK’s Chancellor of the Exchequer, Gordon Brown, announced that measures would be introduced to counter tax avoidance by the use of so-called “personal service companies” to prevent workers from setting up limited companies via which they would work effectively as employees, but saving on Income Tax and National Insurance.
The Inland Revenue (now HMRC) has taken measures to enforce compliance, firstly to public organisations in 2017, and now private medium and large entities in April 2020.
Once enforced, IR35 is to be determined by the end client (organisation) or nominated agency – not the contractor – and reviewed on a contract by contract basis. This classification process is referred to as end status determination statement (SDS) and the administration is placed with the agency or the end client.
Where does IR35 apply?
We are now aware that IR35 seeks to assess workers that are contractors and freelancers to determine if they are ‘inside’ or ‘outside’ of the IR35 rules. The term ‘disguised employee’ refers to those contractors that behave as employees do, where essentially they would be caught inside IR35. HMRC seeks to stamp out those falling inside the rules, as this is classified as tax avoidance.
The government and HMRC determines IR35 status across 3 categories;
- Full time employees
- Limited company director
- Employed (where the tax is handled by company)
When receiving services from a worker through their intermediary here’s what to look for April 2020 changes to off-payroll working for clients.
In the case of those individuals that fall outside of the rules HR payroll is obliged to tax the contractors fee at source, like that of an employee yet provide them with no employment rights.
Where organisations are contracting individuals that have been caught inside IR35, there’s a significant chance of a HMRC investigation. An arduous and costly exercise can be avoided by a straightforward status assessment.
Key factors for calculating IR35
The courts have the final word whether contractors are inside or outside in accordance with case law. As a HR leader with contractors ‘on the books’ the following factors will assist with defining an individual’s working status as ‘inside’ or ‘outside’ the rules.
What are the terms of agreement in place between you as the organisation and the worker?
Ensure these are clear and leave no room for ambiguity.
Who controls the work that is being done? The employer controls the employee. If a contractor – there is an agreement. The contractor is taken on for a specific role or project and carries out that work out in the way they see fit as the expert. The latter is outside of IR35.
3. Mutuality of obligation (MOO)
Whereas employees are expected to stay on site for 8 hours, there is no expectation for the contractor to remain on site once the ‘project’ is carried out. There is also no arrangement for them to take on other work or be paid beyond what has specifically been agreed within the terms of their contract.
4. The right of substitution
It is in the interests of the contractor to send in somebody to do their job on occasion if the arrangement they have with the client is longer term. This is a clear marker for the contractor to qualify as outside of IR35.
5. Financial Risk
Employees are paid a salary and have a higher level of security, whereas contractors should be explicit about their financial risk in any contract between their limited company and the companies they work for.
6. Employee benefits
Employee benefits refers to the benefits that permanent employees receive, such as holiday, sick, parental pay, training and pension contributions. Contractors do not receive any entitlements over and above the payment terms agreed with the client.
7. Provision for equipment
This is not a high priority rule, yet demonstrates that the contractor has taken responsibility to carry out services for your organisation, and is independent.
HMRC created The CEST tool, (Check Employment Status for Tax) although contested as “unreliable and biased towards tax collection” and that it falls short of reproducing all real-life scenarios, it can offer useful guidance for what information to collect based on the above points.
When IR35 approaches go wrong
In the public sector where the rules have been enforced since 2017, there have been a number of high profile cases, where at an organisation level, all workers were given a blanket ‘inside IR35’ treatment.
This is not the government’s modus operandus and for the organisation, it is not foolproof. If the organisation treats everybody as inside IR35 there will be an inevitable revolt from workers, as with;
Both public sector organisations had to revise their approach.
Recommendations for IR35 best practice
Increase knowledge on the rules and prioritise assessing those that work in your organisation now! It’s important to fully realise the level of information required to calculate ‘inside’ or ‘outside’ IR35 and an independent tool such as Sitepass, primarily a contractor management system, has the capability to log individual detail, send notifications and flag risks across your entire workforce.
Although Sitepass wasn’t developed for the purpose of managing IR35, the workforce management software can solve many of the IR35 challenges in identifying who your workers are. Find out how you can achieve more transparency in your organisation to be compliant with IR35 through Sitepass. Read more about how you can manage your contractors effectively or take a free demo of Sitepass to experience first hand how you can be ready for IR35.
 Nominated agency – used by a company that employs agency contractors who work on temporary contract assignments. The company issues invoices to the recruitment agency (or client) and, when payment of the invoice is made, will typically pay the contractor through PAYE with the added benefit of offsetting some of the income through claiming expenses. Companies that hire contractors via an agency are termed as ‘Umbrella companies’ and these have become more prevalent in the UK since IR35.
 The term “personal service company” is not defined in law, but it is used by the UK government to refer to “someone who works through their own limited company” as opposed to someone who is self employed and pays Class 2 and Class 4 National Insurance. IR35