Forgotten about the IR35 reforms? HMRC hasn’t …. so here’s a reminder of the basics

What is IR35?

IR35 is a reference to an HMRC (HM Revenue & Customs) rule that seeks to tackle tax avoidance. There are various pieces of tax law relevant to its implementation but for the purposes of this note, we’ll just refer to it all collectively as the IR35 legislation. 

The rule applies where an individual contractor supplies their services personally to a client through an intermediary and the intermediary pays the contractor in a way which is outside the usual employment tax regime. In other words, the contractor has tax advantages over regular payroll staff. The most common type of intermediary used is a personal service company, like a limited company. 

The IR35 legislation says that if the individual contractor would be regarded as the client’s own employee for income tax and National Insurance Contributions (NICs) purposes had it engaged them direct (rather than through their personal service company), income tax and NICs must be paid on their fees. This is known as an “inside IR35” determination. 

If, on the other hand, the individual would be regarded as self-employed for tax purposes had the client engaged them direct, the individual’s personal service company may continue to process the fee on a self-employment basis. This is known as an “outside IR35” determination. 

Pre-April 2021 position 

Pre-April 2021, the contractor’s personal service company had to decide if the contractor would be the client’s employee for tax purposes had the client engaged them direct. 

If it considered that it would, the personal service company had to deduct the usual income tax and NICs from the fee before paying the contractor. The personal service company also had to pay employer NICs to HMRC. 

If the personal service company considered that the arrangement was one of self-employment and HMRC took a different view, HMRC pursued the personal service company for unpaid income tax, NICs and late payment penalties and interest. Therefore, historically, lots of end user clients had required their contractors to operate through personal service companies to lower the client’s tax risks. 

Changes from 6 April 2021: who do they affect?

Small companies 

If your business qualifies as small, you are not affected by the changes and the pre-April 2021 position set out above continues to apply. 

A company is small in a tax year in which it satisfies two or more of the following:

• Its annual turnover is not more than £10.2 million
• Its balance sheet total is not more than £5.1 million
• It has not more than 50 employees

A company loses its small business status only if it fails to meet two of these conditions for two consecutive financial years. Where a company is part of a group there are special rules for determining its size. Public companies and certain other companies are never considered small. There are other details around determining who is a small business so feel free to get in touch to find out more.

Medium and large-sized companies

If your business does not qualify as small, you are affected by the changes and the new IR35 regime  applies.  

The new IR35 regime from 6 April 2021 

The new regime sets out specific obligations for the “client” and for the “fee-payer”. The client is responsible for deciding the contractor’s employment status for income tax and NICs purposes. The fee-payer is responsible for deducting income tax and NICS and for paying employer NICs. The fee-payer also has to pay the apprenticeship levy, if applicable. 

Who is the “client”?

In simple terms, the client is the company, organisation or person to whom the contractor provides their services through a personal service company, even if there are also recruitment companies in the chain. 

Who is the “fee-payer”?

The fee-payer is the person/company in the recruitment chain who is responsible for paying the personal service company. This will be the person/company in the recruitment chain immediately above the personal service company. Where the client has a contract with the contractor’s personal service company, the client will be the fee-payer (as well as being the client).  

The legislation also deems other parties in the recruitment chain to be the fee-payer (in place of the person/company that pays the personal service company) where those parties have not complied with their respective obligations under the legislation. They would then have to comply with fee-payer obligations. 

Client’s obligations 

Where the new regime applies, the client has to determine the contractor’s employment status for income tax and NICs purposes, instead of the contractor’s personal service company. The client must provide a “status determination statement” to the individual contractor and to the next person/company in the recruitment chain (where the client uses one). The status determination statement states whether the arrangement is “inside” or “outside” IR35. 

The client must explain the reasons for its decision in that statement and must take reasonable care when making its decision. Therefore, the client will likely be expected to provide the evidence and audit trail on which it based its decisions, including its analysis of the engagement against usual employment indicators. Those include personal service (i.e. is the contractor obliged to provide the services personally or can they genuinely provide a substitute), control, mutuality of obligation, financial risk and integration.

The parties in the recruitment chain must then pass the status determination statement down the chain until it reaches the fee-payer. The client must allow the worker or the fee-payer to appeal the status determination at any time prior to the last fee being paid and respond to the appeal within 45 days.  

HMRC has an online tool called CEST (check employment status for tax) through which clients and others in the recruitment chain can test the arrangement against usual employment indicators. CEST will give an ‘inside IR35’, an ‘outside IR35’ or an ‘indeterminate’ result. HMRC says it will stand by results given by the CEST tool where the user provides accurate information and uses the tool in accordance with its guidance. It will not stand by results achieved through contrived arrangements deliberately created or designed to get a particular outcome. Many commentators though have criticised the accuracy of CEST and so we recommend not relying on CEST alone for your due diligence and status assessments and that you seek specialist advice. 

Fee-payer’s obligations 

If the client concludes the contractor is “inside IR35”, the fee-payer has certain obligations. Remember that the client may be the fee-payer as well as being the client. 

In an “inside IR35” engagement, the fee-payer has to:

• Calculate the amount from which income tax and NICs must be deducted (called the “deemed direct payment”) 
• Deduct income tax and NICs before paying the personal service company, using Real Time Information (RTI) reporting
• Account to HMRC for employer NICS 
• Pay any applicable apprenticeship levy

Where the client concludes using reasonable care that the engagement is “outside IR35”, the fee-payer takes the main risk should HMRC later take a view that the engagement is “inside IR35” and pursue unpaid deductions and other demands. 

Therefore, there can be benefits to using a separate fee-payer in the recruitment chain: (1) the fee-payer takes the brunt of the risk if the client makes an “outside IR35” determination and the client has complied with its obligations; and (2) if it’s “inside IR35”, the fee-payer will deal with the payroll arrangements, calculations and relevant payments.  

Liability may creep back up the chain

Where a party in the recruitment chain fails to comply with its obligations, it may be deemed to be the fee-payer and have to comply with fee-payer obligations. For example, any party that fails to pass on a status determination statement to the next party in the chain will be deemed to be the fee-payer until it passes it on. As another example, the client will remain the fee-payer, even where it uses a long recruitment chain, if it fails to take reasonable care when producing the status determination statement. As a further example, if the client fails to respond properly to any appeal within 45 days it will be deemed to be the fee-payer until it does so.

Regulations have also been put in place which allow HMRC to recover from other parties in the chain any sums that should have been paid under PAYE. HMRC will look to recover unpaid PAYE from any recruitment company the client contracts with in the first instance. Failing that it will then look to the client. Therefore, it is important for clients to ensure they only engage with reputable and financially sound companies in their contractor supply chain. 

Get in touch with our IR35 expert, Declan Bradley, to find out more.