When employees and independent contractors work together in an organisation performing the same tasks, lines become blurred. The government introduced IR35 tax legislation as a way to help bring a sharper definition to a contractor’s employment status for tax purposes. Keep reading to learn more about the latest IR35 rules and how they’re applied.
What is IR35?
IR35 describes tax legislation introduced in 2000 to prevent tax avoidance. These rules apply specifically to contracted workers supplying services to clients through an intermediary company. Without the use of this intermediary, the contractor would simply be an employee. Workers who fall under this category are called ‘deemed employees’ by HMRC, and according to IR35 rules they must pay the same National Insurance contributions and income tax as any other employee.
How do IR35 rules work?
IR35 was brought into tax legislation to prevent tax avoidance by contractors operating as employees in everything but name, a growing problem in the gig economy. For example, a consultant might operate through a limited personal services company to pay less tax, yet still works in the client’s office Monday through Friday just as a regular employee on the payroll might.
Under IR35 rules, an intermediary might be any of the following:
Personal service company
Workers supplying services through these intermediaries must pay the same National Insurance contributions and taxes as employees would.
Who do the IR35 rules apply to?
There are three main groups impacted by the IR35 tax rules:
Agencies providing services through intermediaries
Clients who receive worker services via an intermediary
Workers providing services to clients through an intermediary
There are a few ways to determine a worker’s employment status. For tax purposes, all workers are either employed or self-employed. Self-employed contractors do not have to worry about IR35 rules, while employed workers must pay all applicable fees.
The principal tests of employment include:
Control: How much control does the client have over the worker’s activities? Does the client have ultimate control over how, where, and when work is carried out?
Substitution: Can the worker send in a substitute to complete the service, or is personal service required?
Mutuality of obligation: Is the employer obliged under contract to offer work, and does the worker have to accept this work?
If the answer to any of these tests is yes, then it indicates to HMRC that there is some form of employment relationship. However, it’s important to look at the bigger picture to determine employment status. Self-employed workers will usually have their own separate office, business website, job titles, and other indicators of separation from the client.
What are the latest changes to IR35?
The original IR35 legislation is in the process of being replaced with a new off-payroll tax, which will still be referred to as ‘IR35’. Under the newer rules, firms must assess each contractor’s employment status while paying employment tax on top of the usual contractor fees. This new employment tax is the ‘off-payroll tax’.
The off-payroll tax came into effect in 2017 for the public sector, and will impact the private sector starting in April 2021. These changes are meant to streamline the rules and reduce unfair hardships on legitimate small businesses. It’s important to note that the new off-payroll rules will apply on a contract-to-contract basis. Some contracts might fall within these regulations, while others don’t.
Rules before April 2021
Under the old rules, the employment status of workers with clients in the public sector was decided by the client. However, if you’re a worker with a client in the private sector, it will be your intermediary’s role to determine employment status. Private sector clients could include third sector companies like charity organisations.
Rules after April 2021
By contrast, when the new IR35 rules take effect in April 2021 all public and private sector clients are responsible for determining employment status.
The exception would be when a worker provides services to a smaller-sized private sector client. In this case, the intermediary determines employment status as before.
How to avoid IR35 taxes
Because rules are applied on a contract-to-contract basis, there’s no single answer for those wondering how to avoid IR35 taxes. Companies could hire all contractors using fixed-term employment contracts, but this would require the company to still pay all extra employment taxes as a result. Firms can hire self-employed contractors to avoid IR35 taxes, because self-employed individuals are responsible for filing and paying their own income tax.
If you’re not sure what category you fall under, use the Employment Status Checker on the HMRC website to find out.
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