What is IR35 and does it apply to you?

The changes in legislation for trade businesses never seem to end. In this guide we take a look at how the new rules on employment called IR35 impact businesses.

Who isn’t impacted by IR35

Let’s start out by saying who won’t be impacted by these recent changes. That way you can save several minutes of your life that you might have spent reading this article!

If you never subcontract for anyone, never use subcontractors and you are always working for end customers, there is nothing to worry about. The IR35 changes won’t have an impact. What a happy place!

If that doesn’t apply, you need to get up to speed with the new rules.

The principles of IR35

IR35 is the law. It aims to make workers who really should be employees to actually be employees. Alternatively, it forces the client to treat them as “deemed employees” that will be taxed exactly like employees.

In the trade, this issue potentially impacts subcontractors who regularly work for contractors. It shouldn’t effect anyone doing work for a variety of end clients.

The way subcontractors have historically avoided becoming employees of contractors at the same time reducing their tax is by creating an intermediary (usually a limited liability company known as a PSC or personal service company) which they own or part own and which charges the contractor. They then get the intermediary to pay them with a mixture of salary and dividends. IR35 only applies when an intermediary is involved.

The reason why contractors and subcontractors take this approach is as follows:

• Everyone pays less tax. Subcontractors take some of their pay as dividends (not subject to national insurance and less income tax) and contractors avoid employer’s NI
• Contractors avoid the hassle and restrictions of having employees

IR35 puts rules in place that disallow having an intermediary under various circumstances outlined below. It only addresses the tax and NI issue.

When IR35 is ruled to apply, workers become “deemed employees” and their tax is handled as though they are actual employees.  This maximises tax for HMRC and the tax is more reliably collected through pay-as-you-earn. Most contractors will insist on actually employing people who fall under IR35 as it is less hassle than deeming them employees.

IR35 doesn’t impact sole traders, who are operating as self-employed persons without an intermediary and don’t get the tax advantages that an intermediary would bring.

Who applies the IR35 rules?

Up until 6 April 2021 the intermediary legally decided on whether IR35 applied, which meant that it was the subcontractor's responsibility. This has now changed and large contractors have to make the decision. If services are provided to a small or medium sized contractor, the intermediary remains responsible.

This is important. The body that makes the decision on IR35 is the one taking the risk of fines and unrecoverable back tax if HMRC decides that they got it wrong.

The actual IR35 rules otherwise didn't change in April 2021.

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The key exemption

Contractors that are small or medium sized businesses and using subcontractors through an intermediary are exempt from being on the hook for IR35. To be exact, that is if any two of the following are true:

• They make less than £10.2m sales per annum
• They have a balance sheet of less than £5.1m
• They have less than 50 employees

The reason for the change in responsibility is that it’s easier for HMRC to chase a relatively small number of larger contractors. Hence the exemption for small and medium sized contractors.

Deciding on the status of the subcontractor

IR35 uses three principles to decide the employment status of a subcontractor:

• Does the contractor control what, how, when and where the subcontractor does the work? Answering "yes" makes IR35 likely to apply.
• Does the subcontractor have the right to send a substitute worker in their place? Answering "no" makes IR35 likely to apply.
• Is the contractor committed to offer work, and is the subcontractor obliged to accept it? Answering "yes" makes IR35 likely to apply.

Expanding on this, to be certain of avoiding IR35, the following should be practised.

The contractor must not:

• Pay for hours, days, weeks or months worked. Rather they should pay by the job
• Provide tools to the subcontractor
• Have a notice period
• Provide the subcontractor with a job title
• Specify the working hours or an overtime rate 

The contractor must:

• Let the subcontractor provide anyone competent to do the work. The subcontractor must be allowed to substitute one suitable person with another
• Allow the subcontractor to control how they deliver their service and manage their own time. There must be no prohibition from taking on other work at the in parallel
• Pay on achieving project milestones or completion rather than for hours done
• Make sure the subcontractor moves to a different contractor on completion of the project and doesn’t always work for the same contractor

Note that HMRC will always look at what happens in practice, not just what is written down. Practice always takes precedence.

Once the contractor determines the subcontractor’s IR35 status, they should issue a "Status Determination Statement" (SDS). This states the subcontractor’s employment status with reasons. The SDS is given to the subcontractor and their intermediary.

Checking IR35 status

HMRC has a service called CEST (Google “HMRC Cest”). There are a series of questions to answer to get HMRC’s advice on IR35 status.

Is there a risk?

If a subcontractor who is deemed to be an employee wasn’t operating under IR35, HMRC will issue an adverse judgement to collect the missing tax and NI from whoever made the determination that IR35 didn’t apply. If it’s the contractor, they are legally prevented from recovering this from the money already paid out. Ouch.

With respect to the change of responsibility in determining IR35 status, HMRC have said that offenders will “not have to pay penalties for inaccuracies in the first 12 months relating to the off-payroll working rules … unless there’s evidence of deliberate non-compliance”. So back tax will be payable, but likely not penalties, until after the end of March 2022.

All of the best!