An IR35 contractor refers to self-employed workers in the UK that provide services to their clients through an intermediary — usually a personal service company (PSC) — but would be classified as an employee if they provided their services directly. Often, these workers are called “disguised” or “deemed” employees.
IR35 is a set of tax laws, which comprise part of the Finance Act. IR35 — properly known as the Intermediaries Legislation — was first enacted in April 2000, to help combat tax avoidance. It ensures self-employed workers that provide their services through an intermediary pay the same taxes and National Insurance contributions as regular employees.
Originally, individual contractors were responsible for determining their employment status and informing the HMRC. In April 2017, the Government introduced the “Off-Payroll Reforms,” which shifted this responsibility from contractors to paying companies in the public sector.
Following the passage of the Finance Act 2020 in July, these changes will be expanded to medium and large companies in the private sector, effective April 6, 2021.
Here are the answers to some common questions about the IR35 contractor rule so you’re fully prepared for the upcoming change, maintain compliance, and keep all of your contractors aligned.
Who does IR35 apply to?
The UK tax law applies to three main groups of stakeholders, according to the HMRC.
- Workers who provide services through an intermediary
- Clients that receive services from a worker through their intermediary
- Agencies that provider workers’ services through their intermediary
If you fall into one of the three categories above, taxes and National Insurance contributions need to be deducted from workers’ fees and paid to the HMRC.
If you aren’t sure if the workers you enlist should be classified as employees or self-employed contractors, the HMRC provides this tool to help you make the right determination.
The chart below can also help provide some clarity.
|Question||Possible IR35||Probably Not IR35|
|Do you have control over what, how, when, and where the contractor completes their work?||Yes – The company decides||No – Contractor decides|
|Are you obligated to offer the contractor work, and are they obligated to complete it?||Yes – The company provides consistent work that the contractor is obliged to do.||No – The company is not expected or obligated to provide work.|
|Is the contractor an essential part of your business?||Yes – The contractor plays a key role in the business’s functioning.||No – The company does not depend on the contractor’s input.|
|Do you provide the contractor the equipment and tools they need to do their work?||Yes – The company provides the equipment.||No – The contractor supplies his or her own equipment.|
|Does the contractor get benefits from the company, such as paid time off, sick leave, or bonuses?||Yes – The company offers benefits to the contractor.||No – The contractor doesn’t get any benefits beyond their wages.|
|Does the contractor have to do their assigned work themselves, or can someone else complete it in their place?||The contractor has to complete the work themselves as a “personal service.”||Someone else can complete the work in his or her place.|
How is the IR35 contractor rule changing?
Currently, public sector companies are responsible for determining the employment status of the independent contractors that they work with and informing them of their decision. For companies in the private sector, it’s up to the workers to determine their employment status for each contract.
However, starting April 6, 2021, medium- and large-size private sector companies will also be responsible for deciding their freelancers’ employment status, and subsequently, whether IR35 applies.
For small private companies, the worker’s intermediary will remain responsible for deciding the worker’s employment status and whether IR35 applies.
If you’re not sure whether your business qualifies as a small company, here are the criteria from HMRC:
- You have annual turnover of no more than £10.2 million.
- Your balance sheet total is at most £5.1 million (balance sheet total refers to the amounts shown as assets in the company’s balance sheet before deducting any liabilities).
- You employ 50 employees or less.
What do companies need to do differently under the updated IR35 contractor rule?
When the update to IR35 goes into effect, public sector companies as well as medium- and large-size private sector companies will need to evaluate and determine the employment status of every contractor who operates through their own intermediary, even if they are provided through an agency.
You are required to document your determination on a Status Determination Statement (SDS), which:
- Clearly explain your determination and the factors you used to come to it
- Must be shared with the worker and the agency you contract with (if applicable)
To keep the process as simple and to avoid issues down the road should an inquiry be made, the HMRC recommends that companies:
- Keep detailed records of the employment status determinations and reasoning, as well as fees paid to each worker
- Create processes to deal with disagreements that may arise between the company and IR35 contractors
- Up-to-date records of your company size so you can readily provide it if requested
The fee-payer (the party paying the worker’s intermediary and usually the lowest party in the labor supply chain) is the one who is responsible for making deductions from the worker’s payments to cover taxes and National Insurance contributions.
What are the consequences of failing to comply with IR35?
If a company incorrectly classifies a contractor as being outside of IR35, HMRC can issue a determination that requires the end hirer to pay all of the unpaid PAYE (pay as you earn) taxes and National Insurance contribution, plus fines and interest.
On top of that, HMRC can issue an additional penalty ranging from 0%-100% of the initial outstanding liability. The severity of the penalty is usually influenced by how cooperative the business is throughout the inquiry, and how much reasonable care they took in the IR35 tax assessment process for all off-payroll workers. If the HMRC concludes that the organization didn’t take reasonable care, a more severe penalty is likely.
On top of financial penalties, not adhering to IR35 can hurt your company’s reputation. Businesses that do not take reasonable care to assess the status of their independent workers and get caught up in inquiries with HMRC will have a harder time attracting top-tier talent.
The combined result of the financial and reputational damage is greater difficulty maintaining a competitive edge, which can hamper speed and hurt business success in more ways than one.
Get ready for the expansion of IR35
With the responsibility for classifying contractors and filing SDS’s now shifting to employers, companies must be prepared for the work involved.
Taking reasonable care and reviewing every individual off-payroll worker’s status can be extraordinarily time-consuming and tedious. However, the risks of not doing this right are huge. For businesses that want to maintain speed and agility as they develop a flexible workforce — and not get bogged down by fees and inquiries — building a solid strategy for managing this work is crucial.