IR35, officially known as the Intermediaries Legislation, is a set of tax rules in the United Kingdom aimed at identifying and addressing situations where individuals are providing services through an intermediary, such as a personal service company (PSC), but are essentially working as employees. The goal is to prevent individuals from avoiding paying employment taxes by disguising their employment status.
Key points of IR35 include:
Purpose: To ensure that workers who would be employees if the intermediary did not exist pay similar taxes to employees.
Scope: It applies to freelancers and contractors who operate through a PSC or other intermediary.
Assessment: The determination of whether IR35 applies depends on the nature of the working relationship. Factors include the level of control the client has over the worker, the financial risk assumed by the worker, and the degree of independence.
Responsibilities:
Private Sector: As of April 2021, medium and large-sized private sector businesses are responsible for determining the IR35 status of contractors.
Public Sector: Public sector organizations have been responsible for determining IR35 status since April 2017.
Consequences: If a contractor is found to be inside IR35, they are subject to PAYE (Pay As You Earn) and National Insurance Contributions, similar to an employee.
IR35 is designed to prevent "disguised employment," where individuals avoid higher taxes by presenting themselves as contractors rather than employees. Compliance with IR35 involves evaluating contracts and working practices to ensure correct tax treatment.
What happens if a worker is found to be inside IR-35?
Being found inside IR35 does not necessarily mean that the person must be hired as an employee. Instead, it means that for tax purposes, the individual is treated as if they are an employee. Here’s a detailed explanation:
Tax Implications: If a contractor is found to be inside IR35, the income received from their contract is subject to PAYE (Pay As You Earn) tax and National Insurance Contributions (NICs) as if they were an employee. This means the intermediary (e.g., their personal service company) must deduct these taxes and remit them to HMRC.
Employment Status: The IR35 determination affects only the tax status, not the actual employment status. The contractor remains a contractor in terms of their contractual relationship with the client. They do not automatically gain employment rights, such as holiday pay, sick pay, or pension contributions.
Contractual Relationship: The client and the contractor can continue their working relationship under a contract for services. The key difference is how the contractor's income is taxed.
Decision Making:
For Public Sector: Since April 2017, public sector bodies are responsible for determining the IR35 status of the contractors they engage.
For Private Sector: Since April 2021, medium and large private sector companies have been responsible for determining the IR35 status.
Consequences of Non-Compliance: If a contractor or the hiring business fails to comply with IR35 rules, they may face penalties and be required to pay back taxes, including interest.
In summary, being inside IR35 means that the individual’s income is treated for tax purposes as employment income, but it does not change their contractual status to that of an employee. The individual continues to operate as a contractor, but their take-home pay will be reduced due to the increased tax liabilities.
What does a company need to do if their worker is found to be inside IR-35?
When a worker is found to be inside IR35, a company must take several steps to ensure compliance with tax regulations and properly handle the worker's tax affairs. Here is a detailed breakdown of the actions required:
1. Determine Employment Status
First, the company must determine whether the worker is inside or outside IR35. This involves assessing the nature of the working relationship, which includes evaluating control, substitution rights, mutuality of obligation, and other relevant factors.
2. Issue a Status Determination Statement (SDS)
For both public sector clients and medium or large private sector clients, a Status Determination Statement (SDS) must be issued. This statement should:
Clearly state whether the worker is inside or outside IR35.
Provide reasons for the determination.
Be communicated to the worker and any other parties involved, such as agencies.
3. Operate PAYE
If the worker is determined to be inside IR35:
The company must deduct Income Tax and National Insurance Contributions (NICs) from the worker’s fees.
The deductions should be made using PAYE (Pay As You Earn) and reported to HMRC.
Calculate how much Income Tax and National Insurance Contributions to deduct
4. Adjust Invoicing and Payment Processes
Ensure the worker or their intermediary (e.g., Personal Service Company) is invoicing correctly, reflecting the PAYE deductions.
Adjust payment processes to reflect the deductions before making payments to the worker’s intermediary.
5. Maintain Accurate Records
Keep detailed records of the status determination process, including the reasons for the decision.
Maintain records of the PAYE and NICs deductions made.
6. Communicate with the Worker
Explain to the worker the implications of the IR35 determination and how it affects their take-home pay.
Provide them with the necessary documentation, such as payslips showing PAYE deductions.
7. Review Contracts and Working Practices
Regularly review contracts and working practices to ensure ongoing compliance with IR35 rules.
Make necessary adjustments to contracts to reflect changes in the working relationship.
8. Use HMRC’s CEST Tool
Consider using HMRC’s Check Employment Status for Tax (CEST) tool for guidance on status determinations. While not legally binding, it can provide useful insights and help in making a determination.
9. Seek Professional Advice
Given the complexity of IR35, it might be beneficial to seek professional advice from tax specialists or legal advisors to ensure full compliance and avoid potential penalties.
Summary
Determine status: Assess whether the worker is inside IR35.
Issue SDS: Provide a Status Determination Statement.
Operate PAYE: Deduct Income Tax and NICs.
Pay employer NICs: Account for the employer’s contributions.
Adjust processes: Reflect PAYE deductions in invoicing and payments.
Maintain records: Keep accurate records of determinations and payments.
Communicate: Inform the worker about the IR35 determination and its implications.
Review practices: Continuously review and adjust contracts and practices.
Use CEST: Consider using HMRC’s tool for guidance.
Seek advice: Get professional help if needed.
By following these steps, companies can ensure they comply with IR35 regulations and manage their tax obligations appropriately.