Do the new rules on IR35 affect me?
There has been so much talk on the news about the new rules on IR35 (also known as the intermediary rules or Personal Service Company (PSC) rules)) and the impact that they are going to have…but will anything really change for you?
The new rules only impact those who are providing services to the public sector or to medium or large clients (see part 3) by shifting the burden of responsibility to the Client.
However, the changes in the rules, and the excitement it has caused is a great opportunity for all contractors to review their position and ensure that they are adopting the correct treatment for the work they perform.
In this article we consider:
Part 1:- Employed v self-employed rules and why they matter
Part 2:- The meaning of IR35, when it applies and it’s impact
Part 3:- The 2021 changes and who they may impact
Part 1 Employed v Self-employed
Whether or not someone is an employee is not necessarily determined by the wording of their contract but rather by the relationship between the worker and the client for whom they provide services.
For example, we can imagine two IT consultants, Alex and John. Each of them has a contract to provide services to a large client, Bigbank. Both of their contracts are ‘contracts for services’ and both refer to Alex and John as self-employed contractors.
Alex carries out work for Bigbank when they require new systems to be implemented. He does the majority of his work from home, is paid a fixed fee for each project he completes, he provides all of his own equipment and only attends the offices of Bigbank to provide a training session for the staff once he has completed the project. He works for many different clients and only takes on projects with Bigbank when he has the availability to complete them and can fit them in around his other client work.
John has been engaged in a long-term project with Bigbank for 2 years and works at the offices of Bigbank from 9am -5pm 4 days a week. He has his own desk in the IT department of Bigbank and is managed by the IT Director of Bigbank. Apart from using his own laptop, Bigbank provides John with everything he needs to carry out the work he does on the project. John is paid £6,000 per month for his work.
While Alex and John work under the same contract, the way in which John works is much more akin to an employment relationship then the way in which Alex works.
How do I decide if I am employed or self-employed?
There are lots of factors to consider when deciding employment status.
The following would be indicative of employment:
- You have to do the work yourself and cannot provide a substitute
- You are told where to work, perhaps at the client’s premises
- You are told when to work, perhaps having fixed hours
- You are told what work to do, perhaps by a manager
- You are paid a regular amount – perhaps a fixed monthly fee
- You are integrated into the organisation, perhaps managing other staff employed by them
- Your equipment is provided by the client
- You do not have financial risk – for example; you are not in a position to make a loss on the work, you are paid for your time rather than having a fixed price per project regardless of how long it takes, you do not have to pay to correct errors that you make.
- You only work for one client
If most of these apply, on balance you are likely to be an employee, otherwise you will be deemed self-employed.
John is likely to be an employee, but Alex is likely to be self-employed.
HMRC have an online test that can be completed to help determine employment status – https://www.gov.uk/guidance/check-employment-status-for-tax
Why does it matter?
While being an employee brings employment rights, many contractors would rather be deemed self-employed as it has several tax benefits:
|National Insurance Contributions (NICs)||Class 1 primary paid by the employee at 12% above the primary threshold.
Class 1 secondary paid by the employer at 13.8% above the primary threshold
|Class 2 at £3.05 per week
Class 4 at 9% above the primary threshold.
The overall National Insurance liability is likely to be significantly less as a self-employed worker.
|Deductible expenses||As an employee, only expenses which are wholly, exclusively, and necessarily incurred for the employment are able to be deducted – this is a very strict test.||The deductibility of expenses are less restricted as a self-employed person with a wider range of expenses being deductible as they do not have to be necessarily incurred.|
|Timing of tax payments||Tax is deducted via PAYE – it is, therefore, taken as the money is earned.||Tax is payable in the first year of self-assessment on the 31 January following the end of the tax year.
In future years it is likely to be paid in instalments on the 31 January in the tax year, the 31 July following the tax year and then a balancing payment on 31 January following the tax year.
This is a significant delay in paying tax which offers a cash flow advantage.
The desire to avoid being taxed as an employee despite the relationship being an employment relationship using our employment tests led to the use of personal services companies to try and get around the rules. IR35 essentially refers to HMRC’s response to this practice and we consider this is Part 2 of this Article.
Part 2: The meaning of IR35, when does it apply and why does it matter?
In Part 1 of this article we considered the tests to determine whether a worker was an employee or a self-employed contractor and the tax disadvantages from being deemed an employee.
Where a contractor was providing services which would likely result in them being deemed to be an employee, a practice emerged whereby they would avoid being a deemed employee of the client by setting up an intermediary, usually in the form of a company (we will focus on corporate intermediaries for the purpose of this article). The intermediary company would then provide the services to the client and invoice for the work. The company providing the services could not be deemed to be an employee. The contractor would own the company and would pay themselves from their company in the form of dividends rather than salary – dividends benefiting from having no NICs and lower rates of tax than salary.
In 2000, rules were introduced to prevent this practice. Where clients are deemed to have an IR35 or personal service company, HMRC impose a charge which results in the worker being treated as if they were an employee.
For the IR35 rules to apply all of the following must be met:
- An individual is providing services to a Client via an intermediary
- They have a material interest in the intermediary company – 5% by the worker or their associates
- If the intermediary did not exist, they would be deemed to be an employee of the client (see Part 1)
If these conditions are met, the income from the client is treated as a ‘relevant engagement’. If you are a contractor providing services to clients who are not public sector or large/medium sized private sector, it is your responsibility to determine whether a relevant engagement exists.
Where a relevant engagement exists, a 5% deduction can be taken from the income but then HMRC require that the worker is essentially taxed as if they received a salary of that amount from the intermediary company. This means that employers and employees NICs will be charged (see part 1) and income will be taxed at the higher employment income rates rather than at dividend rates.
Contact us at firstname.lastname@example.org if you think you may be in this position and need help with your calculations.
In April 2017, new rules were introduced where contractors were providing services to the public sector. The rules meant that rather than the contractor determining their status, the onus was on the public sector organisation to make this decision. If they decide that the worker is within the IR35 rules, they will then deduct the appropriate NICs and income tax as if the contractor was an employee rather than this being done through the intermediary company.
In Part 3 of this Article we will consider what is changing in 2021.
Part 3 The 2021 changes
In April 2021, the rules which were introduced for contractors providing services to the public sector are extended to contractors providing services to large and medium sized companies.
To be considered large or medium sized, the client must meet 2 out of 3 of the following:
- annual turnover of more than £10.2 million
- a balance sheet total of more than £5.1 million
- more than 50 employees.
If you are supplying services to either the public sector or medium or large clients, you will no longer be able to determine whether you would be deemed an employee in the absence of the intermediary.
The client will apply the employed v self employed tests using the Governments CEST tools discussed in part 1 of this article and if they consider the relationship to be one of employment, they will deduct tax and NICs as if you were an employee.
If you are providing services only to smaller clients the standard IR35 rules discussed in part 2 apply and you must decide for yourself whether you have relevant engagements.
The new 2020 rules do not significantly change how a contractor is taxed, instead they shift the responsibility to determine whether deemed employment status applies to the client.
If you have several clients and one of them is deemed to be a relevant engagement, this does not mean that all client work will be relevant engagements. The income from services that are not relevant engagements can continue to be extracted in a tax efficient way from the intermediary company.
What should I do next?
When acting as a contractor, it is beneficial to speak to an accountant or tax adviser to ensure that you are meeting all of your legal requirements but also to ensure that you are operating in the most tax-efficient way. Contact us at email@example.com or call us on 07867 588816 to arrange a free consultation and learn how we can support you.