As an essential part of UK tax legislation, IR35 changes impact any UK business that works with non-payroll workers under their roof.
With the UK being home to almost 2.2 million freelancers, and that number growing each year, IR35 (also referred to as the off-payroll working rules) has been placed in the spotlight since its 2021 update. Let’s look at the history of IR35, and the latest IR35 changes that could impact your business.
This article is part of our guide on independent contractor taxes.
What Do I Need to Know About the History of IR35?
IR35 was first introduced back in the year 2000. The UK government created the legislation to address what was considered an unfair tax advantage for those workers who provided their services through a third-party intermediary. This was often their own limited company (also known as a personal service company (PSC)), which they could structure to pay less income tax and National Insurance contributions (NICs) than required if they were a direct employee.
However, in practice the government felt there was often no difference between these workers and employees, leading to the term “deemed workers” – employees in disguise.
When IR35 (officially called the Intermediaries Legislation) came into action, the responsibility was firmly on the intermediary to consider whether they were a direct employee in all but name, and pay employee taxes as a result.
Understanding what Non-Compliance with IR35 Looks Like
Let’s say for example that Sharon, an IR35 worker, is performing tasks for your company. She is talented, passionate about the role, and always available. She quickly becomes your go-to freelancer, and when she isn’t available – you’d rather wait than ask the agency for a substitute.
Over time, your reliance on Sharon grows. It’s a win/win situation! You have no need to pay employer’s National Insurance contributions of 13.8%, no Apprenticeship Levy obligation of 0.5%, and Sharon doesn’t qualify for additional employment rights and benefits. As a result, Sharon gets a higher rate for her tasks, she feels like she has job security and steady income, and you get the best candidate for the job. Sharon wouldn’t dream of adding another client to the mix – you keep her busy enough!
Sharon is happy with the salary, and is used to working as an independent contractor through her own business or via an agency. However, she isn’t working for anyone else, and as a result, she isn’t truly in business on her own account.
This means that, in reality, Sharon is your employee and your freelancer. Your company is actually misclassifying her and not paying the taxes you should be paying on her behalf per the UK HMRC IR35 guidelines.
The IR35 Test of Employment
IR35 rules apply to any workers who, like Sharon, are an employee in all but name. And the above case is pretty clear. But is it always black and white? As a general rule of thumb – think about what the relationship would look like if you took the intermediary away. Would your worker be like any other employee on your payroll? If so – chances are that IR35 rules apply to you. If it still doesn’t feel clear, see if you can answer “yes” to the following three questions:
Do you have the right of substitution?
This exists if you feel comfortable that you can replace the intermediary with someone elsewhere necessary, for example, if the freelancer is away or off sick? If they are personally necessary, or you feel beholden to continue a specific working relationship – you may not have this.
Does the worker have control over their environment?
If you’re working through an intermediary, the worker should be able to choose their hours of work, their location, and even their salary. As the client, your control should be limited to the scope of work and individual tasks.
Have you ensured no Mutuality of Obligation?
In an employer/employee relationship there is an obligation on both sides. You have a responsibility to provide work, and the employee has a responsibility to say yes to that work. While you may have M.O.O for specific contracts or short-term arrangements, indefinite or ongoing obligation is the mark of employment.
If you answer “no” to any of these questions, it sounds like you could be at risk of being non-compliant with IR35.
IR35 Changes in April 2017
Before 2017, non-compliance would have largely been the intermediary’s problem. They determined whether they were compliant with IR35 or not, and would need to pay additional taxes where relevant. However, in 2017, IR35 changes meant that for public authorities, the onus shifted to the employer. Under IR35 rules, it became the employer’s responsibility to ensure that any fees paid to Sharon had employment tax deductions applied, calculated at the end of the tax year. Widely known as the “off payroll tax”, this change made it much harder for employers to misclassify workers in order to avoid PAYE, intentionally or otherwise.
Considering a Fair Status for Workers: If intermediaries are “deemed workers”, businesses will need to operate PAYE, account for income tax, and pay Employer NICs and the Apprenticeship levy if relevant. However, the intermediary does not get employee rights such as PTO, redundancy pay, sick leave or minimum notice periods. You may consider whether it would be more ethical for your company to offer the intermediary a full-time position under these circumstances.
IR35 Changes as of April 2021
More recently in April 2021, the IR35 rules were updated again, this time to include medium and large organizations in the private sector. All payments or services provided or paid for after April 6th 2021 are included in this ruling. “Small” businesses that are exempt from IR35 will be in their first financial year of trading, or satisfy two of the following three statements:
– An annual turnover of less than £10.2m
– A balance sheet of less than £5.1m
– An average of 50 or fewer employees in the financial yearIf you are exempt, make sure to let your intermediaries know, as the responsibility for IR35 will remain with them. If you are not exempt, you’ll need to provide your intermediaries with a Status Determination Statement, explaining your decision on their status. You can use this tool from HMRC to make your calculation.
US-based companies should follow the IRS guidelines by submitting form 1099-NEC.