IR35, Public and Private Sector off payroll rules can be a minefield. Indeed, when a senior HMRC officer comments that those he trained on IR35 would be competent after three years and understand it after five years, one wonders how many years it might take taxpayers, contractors and general accountants to grasp this area of complex tax law.
Although the government announced a delay to the introduction on 17 March 2020 (due to Covid-19), it’s still important for HR departments to understand the implications and the options available and for HR contractors to understand their options.
Let’s say you are a senior HR Executive who has decided to undertake contracts rather than being an employee. By planning ahead, you can ensure that you are compliant, save tax, and be ready for the changes well ahead of time.
Let look at eleven key areas that contractors need to think about in regards IR35 and the tax implications that are coming. They’ll also be useful to review for HR departments who want to ensure that people undertaking work for their organisation are compliant:
1. Back to Basics
Despite the complexity of the IR35 rules, it is important to note that nearly all IR35 cases go back to the basic principles laid down in a 1968 tax case called ‘Ready Mix Concrete’. In the latest high-profile BBC cases, the Tribunal went through the three key principles of Mutuality of Obligations, Substitution and Control.
So the first thing to do before you throw in the towel and assume you are caught by IR35 is to test your working arrangements against these principles and ask yourself the following questions: Can I send in another person (substitute) to work on my behalf? Can I refuse to work and is my end client obliged to offer me work (mutuality of obligation) and what degree on control is exerted on how I do my work?
2. Release of a new CEST Tool
HMRC has released an enhanced version of the CEST (Check Employment Status for Tax) tool [https://www.gov.uk/guidance/check-employment-status-for-tax]. It is understood that this tool has been rigorously tested against case law and settled cases by the taxman. HMRC promise to stand by the results produced by the tool provided the information entered is accurate. So, if you’re not sure, simply take this test or engage a specialist tax adviser to provide you with formal tax advice on your situation.
3. Tax Implications
Assuming you’ve been properly advised that you’re caught by IR35 or the CEST tool suggest so and you are happy to accept that, then the general tax implication is that you are responsible for paying income tax and National Insurance contributions on an amount called deemed payment.
You will need to calculate this deemed payment on your limited company income for the year.
This means that you deduct your Pay As You Earn (PAYE) salary, a 5% expenses allowance, plus any pension contributions.
What’s left is then treated as if it were the gross cost to the employer (deemed payment). So, let’s say if you have £100,000 income, you pay £10,000 as salaries and pay £10,000 into pensions. And let’s say you’re eligible for the 5% expenses deduction. So, the deemed payment which you will need to apply income tax and NI on will be £75,000.
In practice, if you are certain your contract is caught by IR35, then the simplest solution is to pay out all of your limited company’s income less legitimate expenses and pension contributions as a PAYE salary.
4. Public Sector IR35 and tax implications
Originally, the responsibility for determining IR35 status was placed on the contractor and not the end client. But in 2017, the rules changed for those working with public sector clients (HMRC, NHS, the MOD and the like). Here the responsibility to prove self-employment status shifted from the contractors to the public sector client. Under this rule, where a contractor is caught by IR35, they will be taxed and pay NI as an employee. There is no 5% deduction for expenses under the general IR35 deemed payment tax calculation.
5. Private Sector IR35
Fast forward to April 2020 and we now have another IR35 rule called off-payroll working tax rules. These rules are aimed at big private organisations (see exemptions and further aspects below) and the idea is again to shift the burden of determining the employment status of contractors or workers from the contractor to the private organisation. So, in effect similar to the public sector rule but with some differences including the need for the private sector client to carry out an assessment of the employment status of the worker.
6. Private Sector IR35 tax implications
Under the new rules, the fees paid to the contractor, called the “direct deemed payment” are to be treated as employment income. This means PAYE and employees National Insurance is deducted from that direct deemed payment. Then the entity paying the contractor, which could be the agency or hirer, has to pay their employment taxes on top.
7. HMRC will enquire only if it “suspects” fraud
With the private sector IR35, HMRC has recently announced that it will only use the information it gathers from the new rules to open an enquiry into earlier years if there is reason to suspect fraud or criminal activity. Whilst this will be welcome news for many contractors who are worried that a change in their status stipulated by their private sector client will lead to costly investigation, it is worth bearing in mind that the offence of fraud (or cheating the public revenue) is wide ranging and can catch behaviours including: Withholding PAYE/NI; and failing to disclose income.
In the context of IR35, it is not yet clear how HMRC will view a situation where PAYE/NI were not accounted for and where deemed payment income was not disclosed. With the complex rules around IR35, it is envisaged that a pragmatic approach will be adopted by HMRC.
It is important to first note that the new rules do not apply to all private sector end clients. Those clients qualifying as “small” will fall outside the scope of the new rules. The companies act definition of small company will be used for this purpose. Therefore where the private sector client does not have a turnover of more than £10.2m, balance sheet value of more than £5.1m and employees of more than 50 (remember any two of the three tests will suffice) then it does not have to assess the employment status of its workers.
So, for contractors who are worried about the new IR35 rules, finding out a bit more about your end client might prove a worthwhile exercise.
9. Provision of Assessment Statement and reasons
Under the new rules, the assessment carried out by the private sector end client will be referred to as a “Status Determination Statement” (SDS). The end client will not only be required to provide their assessment to the worker or contractor but also provide the reasons and rationale behind the assessment.
10. Penalties and Mitigation
With the new rules, it is inevitable that disagreements between HMRC and tax-payers would ensue. In the IR35 case of Paya Ltd, HMRC attempted unsuccessfully to argue that there had been “carelessness” in the company’s behaviour, so it (HMRC) could use the longer six-year, rather than four-year limitation period. And, perhaps so that HMRC could charge carelessness penalties.
Where a contractor has sought advice on their IR35 status, any assertion of carelessness should be strongly defended. Where HMRC is minded to levy a penalty and the issue of carelessness cannot be defended, then the suspension of penalties should be considered as a way to reduce your taxes.
11. Options under the private sector IR35
As stated above, some companies are exempt from the new rules so there is always the option of working with these companies and not with the big banks and PLCs. A second option would be simply to accept employment contract(s) with your end client(s). Alternatively, you could choose to work under an umbrella company where they deduct your taxes and pay over to HMRC.
For many contractors, the new rules may sadly spell the end of their limited company. They’ll need to take specialist tax advice to make the most tax efficient decision when making the arrangements.