IR35 and Off-Payroll Working Rules Explained

January 19, 2021

The long awaited changes to the Off-Payroll working rules finally came into effect earlier this month. Despite this, there seems to be a lot of confusion around Off-Payroll Working rules and IR35. In this article we help demystify some of the key concepts to help you work towards ensuring compliance.

Why do Off-Payroll Working rules exist?

The IR35 rules have been around since 2000, when they were introduced by the Inland Revenue (now HMRC) aiming to close a perceived tax loophole where individuals, who weren’t genuinely self-employed, worked for end clients via a personal service company (PSC) and avoided being classified as an employee. These individuals benefitted from tax efficiencies because, by invoicing for their services through a PSC, they avoided paying income tax and national insurance contributions (NICs).

The IR35 rules exist to ensure that an individual providing services via a PSC and who would have been an employee if they were providing their services directly to an end client, pays broadly the same income tax and NICs as an employee would.

NOTE: whilst IR35 applies to services provided via PSCs, the rules on designation of employment status also affect sole traders (which we cover in more detail below).

What’s changing and when?

At present in the private sector, it is the PSC which is responsible for determining whether a person who provides services through it would be regarded as an employee of the end client if engaged directly by the end client. If the PSC’s determination is a “yes” then it must pay the necessary income tax and NICs to HMRC. So currently, the end client does not need to make the determination or account for any resulting tax liability.

The new rules for the private sector come into force on 6 April 2021 (this has been delayed by a year due to COVID). From that date, it will be an end client’s responsibility (rather than the PSC’s), to determine the employment status of the individual. The end client will have to confirm the IR35 status of each assignment by providing a ‘Status Determination Statement’ (SDS) to the PSC and worker. If the determination is that the individual has employment status, then the end client will be responsible for paying the applicable deductions for income tax and NICs from sums paid to the PSC (if the PSC is paid by an agency, the agency is responsible for such deductions). This has been the position in the public sector since 2017.

The new rules will not affect the ability of an end client to engage staff which are genuinely self-employed, but to ensure that this is the case (and to provide an audit trail confirming the reasons for a determination), an individual’s status will need to be assessed and an SDS produced.

How is employment status determined?

HMRC has published an Employment Status Manual detailing the factors which are relevant in ascertaining employment status for the purposes of IR35. Generally, there isn’t one specific factor which is decisive; rather it is a matter of “evaluating the overall picture that emerges from a detailed review of all the facts”. HMRC has its own tool, the Check Employment Status for Tax (CEST) tool which can be used to ascertain employment status. Some of the key factors here are:

  1. Personal service - an employee will generally be obliged to provide their services personally. If the worker is genuinely free to send someone else to carry out the work, it is unlikely that the worker is an employee;
  2. Right of control - an employee will be subject to a certain degree of control by the end client. This control may, for example, relate to the way in which a worker performs their services, what tasks have to be performed and when and where they must be performed;
  3. Financial risk – if the individual is not taking any financial risk in providing their services, then this is more likely to indicate an employment relationship. Conversely, individuals who risk their own money (e.g. buying assets, paying for overheads) are more likely to be self-employed;
  4. Mutuality of obligation- HMRC guidance states that as a minimum, in an employment relationship there must be an obligation on the part of the worker to provide work or skills and the obligation on the part of the engager to pay the worker for that service.

Are all end clients affected by the new rules?

The new rules will not apply to an end client which is a “small business” where at least 2 of the following apply:

  • Annual turnover is no more than £10.2 million;
  • Balance sheet total is no more than £5.1 million; and
  • No more than 50 employees.

What if we get it wrong?

If IR35 is found to apply to a worker providing services via a PSC (i.e. the worker has employee status), then the end client will be responsible for deducting tax and NIC’s due on the sums paid to the PSC for those services. HMRC may also look back over 6 years to examine past services the worker has provided and, if they are also within IR35, any tax and NIC deductions which should have been made, in which case additional penalties and interest may be payable. The government has indicated that it will take a lenient approach to errors in the first year (except in the case of deliberate non-compliance) and that they will not open new investigations into PSCs (based on information coming to light as a result of the new rules) for tax years prior to the new rules coming into force, unless they suspect fraud or criminal behaviour.

There is also a potential risk of criminal liability for the offense of facilitating tax evasion (under the Criminal Finances Act 2017), which could occur if an end client, which has determined that a worker has employment status, knowingly allows the worker to continue to provide their services via a PSC in the same manner and to continue to declare themselves as outside IR35.

One practical solution for those concerned that certain workers may fall within IR35 would be to offer such workers a fixed term contract of employment, thereby providing relative flexibility whilst ensuring that all income tax and NIC contributions are made correctly and avoiding the need for any further status determination.

What about sole traders?

Sole traders aren’t directly affected by IR35, which applies only to incorporated companies. However, the rules on employment status apply equally to sole traders (as provided by existing Agency Legislation). So, if an end client engages a sole trader to provide services, the end client could be responsible for unpaid tax and NIC’s should that individual be found to have employee status by virtue of the services they provide.

Where do we start?

Although April may sound like a long way away, ensuring compliance with the Off-Payroll Working rules should be a priority for all businesses who receive services through contractors. A good starting point is to take a sample of workers providing services via a PSC, and use the CEST tool to ascertain their likely employment status. If the result is ‘employee’ then you’ll know that further steps will be required in order to comply. But fear not! We're here to help – contact us if you have any queries on the new rules and how they might affect your business.

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