What is IR35?
IR35 applies to the supply of workers in the private sector until April 2020. It seeks to combat tax abuse through disguised employment. It will apply where an individual provides services to a client through a personal service company (PSC) (or similar) in what would have been an employment relationship if the arrangement had been made between the individual and the client directly.
Under these arrangements, the client pays the PSC, and the individual has the ability to pay themselves dividends through the PSC. Such arrangements can result in significant tax and NI savings in comparison to paying income tax through PAYE in the normal way.
What are the off-payroll rules?
The off-payroll rules currently apply where payments are received by a PSC directly or indirectly from a contract with a public authority. The rules will apply where a worker provides employee-like services through a PSC or other intermediary to a public authority.
What are the implications where IR35 applies?
Until April 2020, under IR35, a PSC is under an obligation to consider, at the end of each tax year, whether each engagement undertaken during the year constitutes deemed employment. If it does, then profits after a deduction of 5% for expenses are treated as deemed employment income, and the PSC must account for tax and NICs on those profits. The PSC must also pay tax and NICs on salary payments to its owner/ director.
In practice, the government is of the view that many PSCs are not applying the IR35 rules in the way they intended, and are instead continuing to pay themselves dividends (despite having undertaken “employment” during the year).
What are the implications where the off-payroll rules apply?
In the public sector, the “off-payroll” rules apply. Where a public authority is paying a PSC (and there would otherwise be an employment relationship between the public authority and the individual), it is the public authority’s responsibility to deduct tax and NI through PAYE.
From April 2020, these rules will also be extended to apply to the private sector.
The off-payroll rules do not apply to workers supplied by an employment agency or an umbrella company where those workers are already treated as employees of the agency, or to workers supplied by a managed service company that operates PAYE. However, for all other types of workers, the rules apply in the following way:
1. Firstly, it must be determined whether a worker falls under the off-payroll rules. Where a worker is:
- an individual;
- working through a company in which they have more than 5% of the shares and votes; or
- working through a partnership in which they (or a family member) is entitled to at least 60% of the profits (or where their share of the profit is linked to the payments received under the contract),
the client must consider whether deemed employment status applies.
2. Deemed employment status will apply where the services that the worker personally provides (or is obliged to provide) are similar to that of an employee. Responsibility for this determination lies with the client.
3. Having determined that the worker falls under the off-payroll rules and deemed status applies, the “fee-payer” (the end client or whoever actually pays the PSC), must deduct tax under PAYE on payments made to the worker.
4. Tax has to be deducted on amounts that can “reasonably be taken” to be for the worker’s services to the client: the starting point for this calculation being the fee invoiced by the PSC to the fee payer. Whether or not to make deductions of expenses met by the PSC is at the discretion of the fee-payer.
HMRC has powers to charge interest and penalties on income tax or NICs owed, and the penalties can be more severe if the rules were deliberately ignored. At the moment, in the private sector these risks fall on PSCs and not the end client but this is set to change.
What can you do to prepare?
By 2020, HMRC will (hopefully) have produced more robust guidance on applying the rules. Until then, useful steps to take include:
- Auditing your existing workforce to establish reliance on PSCs;
- Assessing a sample of contractors to see how many are essentially “employees” for IR35 purposes;
- Consider whether to continue engaging PSCs, and negotiate where necessary. Anecdotally, public authorities found contract prices were negotiated upwards to reflect that contractors would be taking home less pay. This might be mitigated by the fact that contractors won’t be able to move to another sector where IR35 doesn’t apply;
- Prepare your payroll system for the new PAYE and NICs obligations;
- Review contracts with PSCs, and the PSC’s contract with the individual.
Lastly, it’s worth noting that a determination by HMRC on the tax position does not affect the employment status of the worker. However, the tests used to determine status under both the tax and employment jurisdictions are similar, so HMRC’s decision could be used to give an indication as to what an employment tribunal may decide.