Changes to the IR35 Rules Explained

Claire Halle-Smith, partner at law firm Wright Hassall, explains the background to the new IR35 rules governing the use of contractors and freelancers and how businesses need to prepare.

Businesses in almost all sectors have traditionally used the services of self-employed contractors, consultants and freelancers as an additional pool of skilled resource in order to complement their permanent workforce.

With the uncertainty of the pandemic and ongoing Brexit negotiations prompting businesses to enlist freelance support so they can continue growing in the current climate, it’s important that business owners keep a close eye on IR35 developments.

If you are a contractor, or a client company with contractors on your books, you will know the IR35 rules will be changing from 6 April 2021 which will impact the way services of such contractors are purchased.

How we arrived at this point

By providing their services to an organisation via an intermediary, usually a personal service company (PSC), contractors, and the client company using them, were able to enjoy significant tax advantages.

However, HMRC’s belief that PSCs were specifically being used as tax avoidance vehicles led to the implementation of the off payroll working rules (otherwise known as IR35) in 2000, designed to address ‘disguised’ employees.

In 2017, the IR35 rules were amended. Public sector organisations were made responsible for determining the employment status of those they contracted via PSCs and for paying the income tax and NIC for those deemed to have employee, rather than self-employed status.

From 6 April, this requirement is being extended to large and medium-sized businesses in the private sector, meaning adjustments will need to be made.

What now for employers?

All client companies in the private sector will have to comply unless exempted by meeting at least two of the following criteria:

• An annual turnover of less than £10.2m
• Balance sheet total of less than £5.1m
• Fewer than 50 employees

Non-exempt organisations must determine the nature of the employment relationship they have with their contractors. This has proved key in a number of recent challenges brought by HMRC and the four main principles on which the relationship will typically be judged are:

1. Control: what control do you have over the contractor (e.g. what, how, when and where they work)?
2. Substitution: can the contractor substitute a suitably qualified person to act in their place?
3. Financial risk: how much financial risk is borne by the contractor?
4. Mutuality of obligation: are you obliged to give the contractor work and are they obliged to accept any work you give them? (The HMRC online test to check employment status, CEST, does not consider Mutuality of Obligation, assuming that it exists in every contractor engagement).

Having assessed the employment status of their contractors, the organisation must issue them a ‘Status Determination Statement’ (SDS) which confirms whether the contractor is genuinely self-employed or now considered an employee, giving reasons for the determination.

HMRC will deem the client company liable for tax and NI contributions until the contractor (and agency or other organisation that contracts with the client company) is told of the status determination and reasons for it.

When the contractor is deemed to have employee status, subject to tax and NI contributions, both parties will need to consider how to deal with the additional tax cost.

Companies must ensure their systems are structured appropriately for IR35 and create a system for addressing any challenges raised by contractors in terms of the employment status determination, with legal advice a helpful step in getting things right.

Drawing the right conclusion

Organisations that employ the services of contractors and those people currently providing those services, either directly or via a PSC, should review the terms of their engagement thoroughly.

Client companies are liable for tax and NI contributions until they tell the contractor and the person the contractor contracts with, of its determination and the reason for it.

HMRC shows no sign of softening its stance towards those it suspects of tax avoidance and it will be learning from experience to improve its future success rate in court.

Do not be tempted to bypass IR35 by other means and treat any advice to implement a tax avoidance scheme with considerable caution, as most do not work and do not have HMRC’s blessing.

If you are unsure about any of the developments outlined, then contact an experienced team of lawyers for advice and guidance, who will help you maintain compliance once the new rules are introduced.

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