If you are a business that uses contractors then you probably don’t think too much about them. However, this is all set to change from April 2020. You might have heard of IR35 as it has been around since 2000. However, so far it has been the sole responsibility of the contractors themselves, or more recently public sector companies. However, all of this is set to change from April 2020.
What is IR35 About?
The IR35 rules were introduced by HMRC to address a particular type of tax avoidance that applied to contractors. A contractor normally works with an organisation via a limited company or a personal services company (PSC). The business contracts with the limited company or PSC and the company suppliers the contractor who is normally the sole employee of the company. This has implications for the amount of tax and national insurance that the contractor pays. They pay much less tax and national insurance than if they were employed directly by the target business. HMRC deems people working in this type of situation a ‘disguised employee’. They are effectively working directly for the target business but because of the nature of the contracts, they are an ‘independent contractor’ and pay a lot less tax.
What is set to Change?
The IR35 rules currently mean that the responsibility for determining whether they are a true contractor or a disguised employee fall on the contractor themselves. (Unless they are working in the public sector). However, from April 2020 the responsibility will fall on the contracting business to determine whether they are getting a true contractor or the person is, in fact, a disguised employee. If it is found that companies are ‘harbouring’ these disguised employees then HMRC will levy fines and demands for back payment of tax on both the hiring company and the individual. This is because the hiring company will not have been making employers national insurance contributions properly either.
What does this mean for Companies?
This means that if you are hiring a contractor and they are determined to be inside IR35 then you must pay them in the same way that you would pay an employee and this means that you must make deductions for PAYE and National Insurance exactly as you would for a direct employee. This will apply to most private sector businesses from April 2020, though some smaller businesses are excluded to help ease the administrative burden that this would cause such companies. The deductions made by the businesses for PAYE and national insurance must be given the HMRC in the same way that they do for all other employees.
What does it mean to be Inside IR35 and Outside IR35?
If a contractor is deemed to be inside IR35 then they are classed as a disguised employee and this means that they are subject to PAYE. They have to pay the correct amount of tax and national insurance deducted from their paycheque. If a contractor is investigated and found to be inside IR35 when they have claimed to be outside then they could face a penalty charge to cover the cost of unpaid tax and national insurance. If a contract is outside IR35 this means that they are operating legitimately as a limited company and therefore it is their responsibility to determine if they are paying the right amount of tax.
How is it determined if you are inside or outside of IR35?
HMRC will look at several different factors when it comes to deciding about IR35 qualification. There are no hard and fast rules as every situation is unique, however, there are some general guidelines.
These, of course, and not exclusively what HMRC will look at when it comes to determining whether they are inside or outside of IR35. They will also look at things like equipment provided, expenses, location of working, all sorts of things in making their determination. They will look at what benefits the contractor gets from the hiring company. If they get things like sickness benefit, maternity leave and other things like that, this would tend to suggest they are an employee rather than a contractor.
Some Examples to Illustrate
You are a specialist Business Intelligence Contractor. You are contracted by a company to provide improvements to their business intelligence systems for 12 months. You are given a desk in the company office, with a computer and everything you need. You are expected to attend every day, and you need to request time off for leave during this period. You are paid a ‘fee’ every month.
In this situation, you are a disguised employee and you would fall inside IR35 and be liable to pay PAYE and NI contributions each month.
IT Contractor 2
You are a specialist Business Intelligence Contractor. You are contracted by a company to deliver a data warehouse for its new CRM system. It is expected that the work will take 12 months to complete. You are expected to ‘work from home’ but attend meetings on-site when required to provide status updates. You use your own computer from home and you can set your own working hours as you see fit. You have a fixed fee set for the work which will be paid when the work is completed. Though you can get interim payments at certain points in the project.
In this situation, you will likely be classed as being outside of IR35.
Book Keeper Contractor
You are a qualified bookkeeper. You are contracted by a small company (less than 10 employees) to provide ‘day-to-day’ bookkeeping services for them. You are provided with a laptop and software by the company though you can ‘work from home’. You are also supplied with a company mobile phone for calls. You are expected to be available between 9 and 5, Monday to Friday to provide work for the company. The contract is ‘on-going’ and you are paid a fixed rate per week.
In this situation, you are likely a disguised employee, however, due to the size of the company the responsibility for making that determination rests solely with the contractor.
Book Keeper Contractor 2
You are a qualified bookkeeper. You are contracted by a small company to provide ‘day-to-day’ bookkeeping services for them. The amount of work you get from them is roughly 8 hours per week. You work from home using your own computer and software. Due to the level of work, you also have several other clients that you work for. You have your own office in your home and you have your own phones. You work between 9 and 5, Monday to Friday providing work for different companies. The work you do each day is determined by your own priorities and scheduling. The contract is ‘on-going’ and you bill them monthly for work done.
In this situation, you are operating as an independent business and therefore are almost certainly outside of IR35.
What do Businesses Need to Do if a Contractor Falls within IR35?
If you think that your contractor would fall within IR35 then you need to start preparations now before the rules change in April 2020. You need to calculate a ‘deemed payment’ for the contractor. This is a rate of pay that incorporates deductions for tax and national insurance. When making this calculation there are a few things that you need to take into account. You need to make deductions for any VAT that would be due. You also need to take off any monies that are paid for materials or expenses that are used by the worker to provide the service. All of these would be deductible if the were an employee so they need to take these into account. The company would then need to report the contractor to HMRC using a full payment submission in the same way that they would with a regular employee. They are then able to add them to their payroll system and can enrol them in an existing PAYE scheme or create a new one just for this ‘employee’
The other things that a company needs to do are to provide the worker with a unique worker ID that can be shown to HMRC, this is similar to an employee number. Most contractors will hold office positions within their limited company. e.g. as a director. However, if the contractor also holds an official position within the hiring company then this is classed as being employed directly by the company and the income from this will need to be taxed as employee income. When a contract for a contractor who was inside IR35 comes to an end then the hiring company will need to notify HMRC of the end of the contract and will also need to issue the contractor with a P45 detailing the payments that have been made. Several exceptions exist for contractors that are inside IR35 over regular employees and these are things like student loan payments and other statutory payments as these need to be made from the contractor’s tax returns rather than by the hiring company.
HMRC has brought in these changes as they believe that currently, only around 10% of companies apply the rules correctly. This is believed to cost HMRC around £1.3Billion per year in lost revenue. The rules were extended to shift responsibility onto public sector organisations in April 2017 and this has been quite successful. However, there are added challenges when it comes to private sector clients. This is most notable when there is a long supply chain of contractors and sub-contractors and sub-sub-contractors. It is not yet determined where ultimate responsibility will lie, however it may come down to the nature of each contract and who passes on information. These reforms have not been received well as it is believed that contractors fill a significant role when it comes to IT skills shortage in particular. The average contractor will find that their income is significantly reduced if they fall foul of IR35. This may well lead to an exodus of contractors from the market leading to a skills shortage. Ultimately it all comes down to how contractors have organised their contracts and their tax affairs. HMRC argue that is only about targeting workers who already should be inside IR35 and are avoiding it. It is true though that if you are outside of IR35 and will remain outside of IR35 then these changes will have absolutely no effect on them so they have nothing to worry about. However, for companies that employ contractors now is the time to start checking on their statuses and how you pay them.