When it first published the Intermediaries Legislation in 2000 (more commonly known simply as the ‘IR35 rules’), HMRC attempted to set out clear tax rules distinguishing ‘disguised employees’ from genuine independent contractors.
Prior to the legislation, workers were allowed to accept payments from clients through their own limited companies and account for it as revenue like any small company could. The wide definition of a ‘client’ stretched to companies from which they were now indirectly employed, allowing for cunning ‘contractors’ to receive their wage packet through dividends and not on the PAYE system.
Receiving income via this method meant that earnings were taxed at a lower dividend rates, but also that neither employee nor employers needed to pay National Insurance (NI) contributions. Since the inception of IR35, the main complaint from contractors has been that the legislation is too complex to be fit for purpose. For this reason, the government set out to clarify the rules and tasked the newly formed Office of Tax Simplification (OTS) to improve the efficiency of IR35 in 2010.
Following the involvement of the OTS, there have been numerous changes to the legislation in an attempt to make it more accessible (and less scary!). Perhaps the largest wave of reform to IR35 came in 2017. From April 2017, any contractors that worked in the public sector has had their IR35 status determined by their client. This means that should a client deem it appropriate for IR35 to apply, the onus is on the ‘employer’ to inform HMRC. From that point the contractor will be taxed at source deducting PAYE and NI from their wage packet exactly as if they were an employee, thereby removing the ‘unfair’ advantage enjoyed by contractors.
But in a big change, potentially affecting many more contractors, the government decided that they would be rolling out similar changes across the private sector. Initially planned for 2020, but now taking effect from 6 April 2021 all medium and large sized private sector businesses will be responsible for determining the IR35 status of their contractors. So how will that affect contractors exactly?
- In future, when a medium or large end-client engages a contractor who operates via a personal services company (PSC), the end-client will be responsible for carrying out an assessment of whether IR35, and issuing a “status determination” setting out their conclusions.
- The status determination will be passed to the contractor and also to any intermediate party in the contractual chain (e.g. an agency).
- The “fee-payer” (either the end-client or, if there is a longer contractual chain, the party which pays the PSC’s invoice) will then be responsible for deducting PAYE income tax and national insurance and paying this over to HMRC.
Inevitably, disputes will arise over whether status determinations are correct. It will be the responsibility of the end-client to seek to resolve these disputes. If they cannot be resolved, then PAYE will need to be deducted from any payments to the contractor. It will still be open to the PSC to file its tax returns on the basis that the status determination is incorrect and claim a refund of any excess tax paid, but HMRC can be expected to scrutinise such claims carefully.
“Small” end-clients will not be subject to the new rules, at least for now. The definition of “small” for this purpose is that the company/group satisfies at least two of:
- Annual turnover is no more than £10.2 million
- Balance sheet total is no more than £5.1 million
- No more than 50 employees.
Overall, the reforms will result in a very different system for all such contractors, not just those who have been working in the public sector, as well as larger companies who have been used to paying contractors outside of PAYE. Inevitably the tax burden for some contractor relationships will rise, and it remains to be seen whether contractors or end-clients will bear the majority of this additional tax/NI cost.
Companies should review their contractor workers as a matter of urgency to ensure they are complying with the new rules and anyone who thinks they might be affected should take specialist tax advice to ensure they are paying the correct amount of tax. Those companies which have already carried out reviews to comply with the new rules have often found that the transition is much more time-consuming and administratively burdensome than they had been expecting, and that very careful management of contractor relationships has been necessary. HMRC have stated that there will be a light-touch approach to compliance for the first year, but it would be unwise to take this as an indication that nothing needs to be done.
