Are you familiar with IR35? Do you know how HMRC’s rules on your working arrangements could impact you? Are you aware of the imminent changes to IR35 brought about by new government legislation and how these changes might affect you as a contractor? If not, read on…
1. What is IR35?
IR35, also known as the ‘self-employment test’, is the set of HMRC rules for identifying when a contracting worker should not be regarded as an independent contractor but rather as an employee. IR35 applies when you provide a service to a client via an ‘intermediary’ or what HMRC would define as a Personal Service Company (or “PSC”); this would cover, for example, a limited liability company which is a popular choice of contracting route for most of us. PSCs are targets of IR35 legislation as they are the most popular choice of structure for contractors seeking to mitigate (HMRC read: “avoid”) tax and National Insurance by disguising employment as a client/contractor arrangement. If you operate through a PSC, it is of particular importance that you consider your client contracts against IR35 legislation and take appropriate steps to ensure that you will be regarded as a self-employed contractor and not an employee.
2. The effect of failing the threshold test
If under IR35 you are determined to be an employee, you’ll need to pay direct income tax and National Insurance on at least 95% of your PSC’s earnings, allowing up to 5% deductions for expenses, while losing tax efficiency of operating through a limited liability company. This is known as a ‘deemed salary calculation’. Following such a determination by HMRC you would also have to renounce your contractor status and actually become an employee if you wish to continue in your working role at your client!
3. Ensure you’re in safe territory
You are likely to be caught by IR35 if any of the following apply to you:
i) you have typical employee rights;
ii) you are subject to the control of your client as if you were one of their employees;
iii) you are not taking financial risk of your own/responsibility for your limited company.
As a practical matter, the more established your contracting infrastructure is and the larger the variety of clients and contracts you take on, the more likely you are to be regarded as self-employed through your PSC.
In addition to ensuring the above do not apply to you and that your written contracts reflect your working practice (see below), do create a company logo and use this on business cards and letterheads, have a dedicated business line and work remotely/from an office other than your client’s where possible.
4. IR35 and your written contract with your client
Your contract should be ‘IR35 friendly’. Your written agreement with your client can represent strong evidence that you are not in an employment relationship, so it should reflect your working conditions as a contractor accurately. Make sure it includes the following provisions:
*Ensure the client/contractor relationship is clearly described (including a set of defined tasks that comprise your work contract and a finite work period);
*Include a right of substitution clause, such that you can provide another person to carry out the tasks for your client within reason
*Show you are taking some financial risk: Demonstrate you will be taking on your own insurance and if you are providing your client with an indemnity this will bolster the fact that you are taking financial risk;
*State explicitly that you are not an employee: Include general ‘belt and braces’ wording that it is neither your nor the client’s intention to create an employment relationship and that the manner and method of work you conduct is always your own – you are not operating at the direction of the client.
HMRC will typically take an overall view of a contractor’s position to determine whether they will be deemed ‘employed’ under the rules. Make sure that your contract reflects your working practices as a contractor and is not just lip service to a de-facto employer-employee relationship.
5. Proposed Changes to IR35 from April 2017
Draft legislation that is expected to become law from April 2017 targets public sector contractors who work through PSCs and will result in those contractors seeing large reductions in their take-home pay. The new rules prescribe that here a recruiter or recruitment agency pays the PSC, it will be responsible for paying tax and employer’s National Insurance contributions of 13.8% of the PSC contractors it supplies into the public sector, where the PSC contractor falls within IR35 (i.e. the contractor is not genuinely self-employed). In other words, the recruiter will be deemed to be the contractor’s ‘employer’ for tax and NIC purposes. The practical impact of this change is that the responsibility for determining a public sector contractor’s IR35 status will shift from the contractor to the employer that has engaged the contractor. To avoid penalties, employers and recruiters are likely to take a risk-averse approach and deem many contractors to be operating inside IR35, contrary to the belief of the contractors themselves.
While this draft legislation is aimed at public sector contractors, the government is introducing these measures as part of a wider campaign against tax avoidance; commentators are speculating that these measures may soon apply to the private sector as well, even though the government has refused to state whether it intends to do so.
6. Further reading
For a more in-depth description of factors that HMRC considers to determine employee vs. self-employed status, please visit HMRC’s website.
7. If you are unsure…
IR35 is complicated. If you are not sure whether your contracting framework falls on the safe side of IR35 seek specialist advice. If your client has its own accounting, tax or HR team, perhaps have a chat with someone knowledgeable in one of those departments for some free advice before engaging an accountant or tax adviser.
As for the practical shift in determining IR35 status from public sector contractors to employers from April 2017, we advise public sector contractors to carefully re-consider their status and ensure that they have all documentation and evidence necessary to support a determination that they are operating outside IR35. This is even more important now as third parties may be relying on it. Private sector contractors would do as well to reconsider their status and ensure they have supporting evidence.
Note while this blog sets out current thinking on IR35 the law is constantly changing and you should seek specialist legal advice in negotiating and signing your contract to ensure it is IR35 compliant.