Business Advice, Tax & Admin

IR35: What’s its current status and how is it impacting U.K contractors and businesses?

Business Advice | 15 May 2023 | 1 year ago

The off payroll working rules, commonly referred to as IR35, have been subject to considerable confusion over the last three years or so, with changes being proposed, dropped, reintroduced and then dropped again.

Consequently, although form IR35 has been a part of the taxation system for some time, many freelancers and organizations who regularly engage contractors have been left in a state of flux, unsure as to where they stand. 

What is IR35 and who does it affect?

In any discussion of off payroll working rules, it is important to understand what is covered by IR35 and what isn’t.

The aim of IR35 legislation is essentially to make it more difficult for individuals to set up and operate as a limited company (often referred to as a personal service company or PSC), rather than being directly employed by an organization for whom they work, with the aim of avoiding paying tax. 

The legislation was thought necessary because a PSC arrangement can mean that individuals doing work that could be performed by employees — but are instead doing the same work but through their own limited company — do not pay the same Income Tax and National Insurance as employees.

IR35 was therefore intended to specifically impact individuals who, if they did not operate under the auspices of a limited company arrangement, would be classified by the business they are working for as an employee.

A brief history of IR35 reform

There have been several proposed reforms to the IR35 rules, dating back over several years.

Prior to 2017, it was the responsibility of the individual, when they were ostensibly working for a company as a PSC freelancer, to make the determination themselves as to whether they should be categorised as self-employed, or as an employee, for taxation purposes. 

A process of reform began in 2017, when public sector organisations that engaged contractors were required to assume responsibility as to how freelancers are classified, i.e., as an independent contractor or as an employee. 

This was significant because organisations are responsible for paying the National Insurance and Income Tax 

for employees, while contractors operating as limited companies are responsible for their own tax obligations. 

These rules, which required organisations to determine worker status and were intended to cut down on tax avoidance by what were referred to as “disguised employees.”

The plan was that these revised rules would then be rolled out for medium and large companies in the private sector in 2020. However, the proposed changes were delayed until April 2021, as a response to covid.

Are the IR35 rules changing or not?

Then, in September 2022 it was announced that these legislated reforms would be repealed.

In effect, this meant that as of April 2023, the responsibility for determining tax status would revert to contractors (as was the case prior to 2017 and 2021).

At the time, it was argued that the change would ensure that a worker who supplies services through a limited company, but who would be classed as an employee if they were engaged directly, pays the same amount of tax and National Insurance as if they were an employee. It was also intended to make tax avoidance more difficult. 

The rules were also intended to be applied to each individual contract, so that some of the contracts under which a worker operated would be considered as off-payroll, while others not so. For the purposes of off-payroll tax, and in the eyes of HMRC, a contract could be a written, verbal or implied agreement between two parties.

However, in October 2022 it was announced that these changes would not now be implemented, meaning that the current arrangements would stay in place. 

Therefore, it remains the responsibility of businesses who engage contractors under the auspices of a limited company (i.e., a personal service company or PSC), to determine whether that individual should be classified as off payroll or regarded as an employee.

If the latter is the case, the company is required to pay the income tax and, where appropriate, contribute towards the worker’s National Insurance.

What are the implications of IR35 for UK business?

The fact that classifying contractors remains with businesses therefore continues to be a potential challenge for businesses, in that there are risks of inadvertently misclassifying workers, which can cause fines and other penalties.

It’s crucial that companies who employ individual contractors through intermediaries, and pay tax liabilities in the UK, classify them correctly so that if they are regarded as employees, the appropriate Income Tax and National Insurance contributions can be deducted from any fees paid.

It is also highly advisable that companies take advantage of HMRC’s Check Employment Status for Tax tool. This is a relatively simple and straightforward way of determining whether off-working payroll rules apply to any given contract, and whether a worker should be regarded as employed or self-employed for tax and NI purposes.

Compliance is crucial, as it will ensure that companies are operating within the law and, where appropriate, paying employees the appropriate benefits regarding sick pay, holiday pay, minimum wage, etc., that contractors working as a PSC are not entitled to receive. 

Misclassifying workers can make companies liable to fines and penalties. In addition, remediation will likely be required, and damages may need to be paid. Therefore, businesses need to remain as vigilant and thorough as ever in ensuring that all workers are properly categorised, as not doing so could be a costly mistake.

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