The UK tax law impacting contractor engagements
In the realm of contractor engagements in the United Kingdom, one term that holds significant importance is “IR35.” This tax law has garnered attention and sparked discussions among businesses, contractors, and stakeholders. In this article, we will delve into the intricacies of IR35, examining its purpose, implications, and its impact on the engagement of contractors through personal service companies or other intermediaries. Let’s explore the fundamental aspects of IR35 and gain a comprehensive understanding of its significance in the UK.
What is IR35?
IR35, officially known as the “Intermediaries Legislation,” is a tax law implemented by Her Majesty’s Revenue and Customs (HMRC) in the United Kingdom. Its primary purpose is to determine the tax status of contractors working through intermediaries such as personal service companies (PSCs) or other arrangements.
The legislation aims to tackle the issue of “disguised employment,” wherein individuals who would be deemed employees for tax purposes are engaging in work through intermediaries to benefit from tax advantages. IR35 essentially ensures that contractors who are working in a manner similar to employees are subject to the same tax obligations as employees.
Compliance and penalties
Compliance with IR35 is crucial for both clients and contractors. The client’s assessment of a contractor’s employment status must be accurate and well-documented. Failing to comply with IR35 can result in financial penalties and potential liabilities for unpaid taxes.
Small business exemption
Businesses are exempt from the rules if they are a small company or if they are not UK-based. In both these situations, the contractor remains liable for IR35.
A business is classed as small if it meets two of the following criteria for two consecutive financial years:
- An annual turnover not exceeding £10.2 million
- A total balance sheet of not more than £5.1 million
- An average of no more than 50 employees for the company’s financial year
How does IR35 work
The government introduced IR35 to tackle contractors (and businesses hiring them) who might be taking advantage of the tax efficiency of working through a limited company when they would be otherwise considered employees.
IR35 is mainly an employment status test for tax purposes. The test assesses if a contract points towards employment (inside IR35) or towards self-employment (outside). If the contract is inside, the contractor has to pay income tax and National insurance.
What do I need to do
In advance of April 2021, medium and large businesses will need to assess whether contractors who use personal service companies are in fact workers and employees for IR35 and also for pensions and employment law purposes.
Employers will need to provide a Status Determination Statement (SDS) when assessing the IR35 status of the contractors. A SDS is a complete statement from the client which declares the contractor’s deemed employment status after an IR35 assessment and provides reasons for reaching this conclusion. The contractor can dispute the decision if he or she disagrees with it.
Contractors can use HMRC’s check employment status for tax tool to assist in determining whether or not the off-payroll working rules apply to them.
Status determination
HMRC will use a number of criteria to determine whether a contract is inside or outside IR35.
The main pointers for determining the status are:
- Personal Service/Substitution: Employees cannot send a substitute, so being the only person to offer personal service points towards IR35.
- Supervision, direction and control: The employer controls employees, so the existence of control points towards IR35.
- Mutuality Of Obligation: This refers to the employer’s obligation to give work and the worker’s obligation to complete it. If an element of mutuality of obligation exists, HMRC might argue that the relationship resembles employment, placing the contractor inside IR35.
- Other: Contractors do not get employee benefits (e.g. training courses, holiday/sick pay, staff parties, pension contributions, etc.), they generally work freely (have control of the hours they work) and can usually terminate the contract immediately.
Auto-Enrolment
The (truly) self-employed are excluded from automatic enrolment (AE).
If the contractor’s employment status has been determined as outside IR35, there are no workplace pension duties.
When the contractor’s employment status has been determined as inside IR35 and the individual is not undertaking the work as part of their own business, he might be subject to the Auto-enrolment legislation. If the contractor becomes an employee, AE duties will then apply.
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