The latest on IR35: what you need to know

The latest on IR35: what you need to know Share

IR35 is a piece of legislation primarily affecting contract workers, which came into law on 6 April, 2000, though is set to be significantly updated in the coming months. So just what do you as accountants need to know about the law and proposed changes to it? Here’s our handy breakdown:

What is IR35?

If you are self-employed, or you run a business hiring contractors, you will probably have heard about IR35, which aims to make sure contractors pay the right amount of tax and national insurance. It has been designed to stop workers using an intermediary, such as a limited company, when they should be employed directly by the client they are working for and treated as an employee.

If such ‘disguised employers’ are caught by HMRC, the worker will be asked to pay the tax and national insurance due as if they were an employee, which can mean they end up with a significantly bigger tax bill than they were expecting. But how will the legislation work, and who will it affect?

In order to prove someone is outside of IR35, currently a contractor in the private sector needs to show there is no employment relationship (in the public sector it’s up to the employer to prove this). This is done by looking at who controls the work being carried out, and in 2017 HMRC released a tool for employers called the Check Employment Status for Tax (CEST) to assist with this.

What falls outside IR35?

When determining whether someone falls inside or outside IR35, some general factors to consider include:

  • The equipment being used for a job – if someone works from home using their own equipment, they are probably outside of IR35 because an employee would be provided with such things to do their job.
  • Employee benefits including sick pay, holiday entitlement, pension contributions or maternity allowance – these don’t generally apply to contractors.
  • Financial risk – if a worker puts their own money into buying and bearing the running costs of equipment or software needed for a job, there will be little argument that they are self-employed.
  • Self-employed workers are usually paid one-off sums for their work, rather than a salary for ongoing work.
Public sector vs private sector

Reforms for IR35 were introduced for workers in the public sector in 2017, but the roll-out for the private sector is now not expected until April 2020.

This means public authorities are responsible for deciding whether IR35 applies to workers, while at the moment in the private sector it’s up to the contractor to decide this.

If a worker is deemed as being inside IR35 there are several things the public authority needs to do including:

  1. Calculate how much the worker is paid (their net earnings). This calculation must include any VAT due, the costs of materials used by the worker in order for them to work, expenses that would have been deductible from taxable earnings if they were employed, plus national insurance contributions.
  2. Report the information to HMRC through a Full Payment Submission (FPS). The authority can then add the worker to their payroll system and open a PAYE scheme where relevant. A new starter declaration then needs to be sent to HMRC. In most cases the employer needs to fill in the starter declaration C form and the employee will be set up with the tax code BR, but you can find out exactly what kind of declaration is needed here.
  3. Workers will need their own ID to show HMRC which is their primary and secondary employment.
  4. Outline if a worker is an office holder or not. Most self-employed workers are directors of their limited companies and carry out office-holder duties for them. However, if a worker undertakes office-holder duties within an organisation, their income needs to be taxed as employment income and paid through the client’s FPS.
  5. Give the contract end date to HMRC, report any payments made after this date, and send a P45 to the worker.

There are, however, a number of exceptions which need to be taken into account by public authorities. These are not relevant for workers who use intermediary companies and include; student loan payments which employees pay through their own tax return, statutory payments because the worker is not an employee, and workplace pensions.

Private sector reforms

HMRC has revealed that just 10 per cent of intermediaries in the private sector apply existing legislation correctly and the cost of non-compliance is estimated to reach £1.3bn by 2023-24, which is why reforms are being introduced. They are intended to echo what has happened in the public sector and shift the onus of deciding whether an employee falls under IR35 to the employer not the employee.

However, given the complexity of the private sector, and how there is often a long supply chain of employers involved in a work project, HMRC has said it will make it law that a client passes on the status of the employee along the chain, but the specifics of this are, as yet, unclear.

Criticism of IR35

Of course, IR35 has its critics. Lee Murphy, founder of online accounting software Pandle, argues that some workers will now earn a lot less and potentially leave the UK because of it. He says: “Effectively contractors, especially highly skilled IT ones, will be forced to join ‘umbrella companies’ and pay more tax and national insurance.

“For instance, we calculate that a self-employed contractor currently earning £50,000 per year, will typically take home £43,670 after tax, national insurance and other costs. They will now be compelled to go through an umbrella company, meaning their take-home pay will reduce to £37,696 because of increased tax and national insurance costs.”

However, James Poyser chief executive officer of inniAccounts, counters this argument: “Yes, there’s going to be losers, but there’s plenty of people – the majority of the market – who are safely outside IR35, and for them April 2020 is business as usual.”

What comes next

A second consultation into IR35 was opened last week, with a specific focus on how the reforms will work in the private sector.

The consultation closes on May 28 and the initial results are expected to be published in the next Finance Bill which is due out in the summer. These should then be finalised later in the year.

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