For many freelancers, IR35 sounds like another jargon term that has no relevance to them and there is a concerning lack of awareness of IR35 and how it will affect the freelance contractor sector.
No matter what industry you’re in, if you are a contractor or freelancer working under a limited company, this legislation is something that could affect you. In order to avoid fines, it is important that you understand IR35 and what action you need to take to protect your income and your autonomy.
What is IR35?
IR35, also known as disguised employment or off-payroll working rules is legislation that was introduced in the Finance Act of 2000 by the government.
The name itself was coined from the press release reference (Inland Revenue 35) issued by the Inland Revenue before it became known as Her Majesty’s Revenue & Customs (HMRC).
The Intermediaries Legislation was created to ensure that workers and employers pay the right amount of employment taxes, with the intention of eliminating any differences between employed workers and self-employed individuals carrying out similar work. It typically affects contractors’ providing services through an intermediary such as a Personal Service Company (PSC).
There are situations where contractors and freelancers are working under a limited company but are receiving benefits or being in some way treated as an employee. There may be minor ways in which you’re being treated as an employee without even realising, such as being given managerial responsibilities, having to run your work decisions by someone in the company or being paid a regular monthly wage.
An employed worker pays more income tax and National Insurance than a self-employed contractor does when working through an intermediary. The taxes of an employed worker are paid by the employer, before they receive their wage, at 13.8% – Employers National Insurance (NI) – for each employee plus tax. If you are self-employed you have the responsibility to pay this yourself.
Using a tax efficient combination of salary and dividends, self-employed workers are able to build up a profit from their limited company. This is often done by the contractor paying themselves a minimum wage salary followed by paying themselves a dividend at the end of their tax year from their limited company’s profits.
IR35 aims to improve equality, so that those contractors who are being treated as employees pay the same amount of tax as employees.
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What are the consequences of IR35 for freelance contractors?
If HMRC run an investigation and find that you are in some way being treated as an employee, you could face hefty penalties, regardless of whether you were doing so intentionally or unintentionally.
HMRC consider a range of factors before coming to a final decision. There are a range of points to consider which we will discuss in more detail in this article.
Why is it relevant now?
On 6th April 2020, the legislation is being amended so that the end-client (the client you’re freelancing for) is responsible for determining your employment status and whether you’re working inside IR35 or outside IR35.
This update will also lead to investigations being carried out by HMRC and could result in tax penalties if you are deemed to be working inside IR35 but have paid tax based on working outside IR35.
Rules on who decides the IR35 status of an assignment were introduced for the public sector in April 2017. These rules are now being applied to the private sector.
Until April 5th 2020, the PSC will still be responsible for determining their IR35 status for assignments. From April 6th 2020, the end-client will be responsible for this and for issuing a Status Determination Statement, which is a report that:
- Declares a contractor’s deemed employment status following an IR35 assessment
- Provides reasons for reaching the deemed employment status conclusion
Private sector end-clients who are considered to be small, will not be affected by the changes, if they meet two of the following criteria:
– Annual turnover less than £10.2 million
– Balance sheet total less than £5.1 million
– Less than 50 employees
The government has included clauses in the legislation to ensure medium or large organisations do not create small subsidiary companies to procure services from PSCs. The legislation applies to the parent company based on the aggregate amount of turnover and aggregate amount of the balance total of all connected companies.
There is no small business exemption for the public sector so the legislation will apply to all organisations procuring the services of PSCs in the public sector.
How could IR35 negatively impact freelancers and contractors?
Clients may panic under the legislative pressure and put contractors inside of IR35 to avoid any potential backlash. The knock-on effect of this is that contractors will be taxed at a similar rate to permanent employees without receiving all the benefits of a permanent member of staff – such as holiday pay, maternity pay, sickness pay etc and could therefore be out of pocket.
Many organisations in industries like construction, offshore oil and gas, IT, and the financial sector have already started to make substantial changes to the structure of their workforce, due to the private sector IR35 reforms.
What is inside IR35?
If as a freelance contractor, you are deemed to be working inside IR35 by benefitting from one or more of the same benefits as an employed (PAYE) member of staff, then you will likely be deemed as an employee. This means you have to pay the same taxes and NIC as an employee and your end-client should be responsible for those.
What is outside of IR35?
If you’re outside of IR35, that’s ideal. It means you have the right amount of autonomy to be classed as a freelance contractor and are not being treated like a permanent worker, or disguised employee. In this case, you are responsible for paying your own taxes and national insurance contributions.
Check whether you are inside or outside of IR35
One way of checking your IR35 status is via the HMRC Check of Employment Status Tool (CEST).
Here are some other areas for you to consider:
Control, supervision and direction
What degree of control does your client have over what, how, when and where you complete your working day? If an end-client exercises control over how you perform the work you are contracted to complete, that leaves you at risk of being placed inside IR35.
This could be checking the work you have completed before allowing you to move onto another task. It could also mean working around stringent procedures and completing your tasks in the way that the hiring manager likes things done. The hiring manager may also try to move you from one task to another as priorities in the company change. In these cases, a freelancer loses their autonomy.
Overall, if you do not personally have control over your working day, you could find yourself working inside IR35.
Are you required to carry the work out yourself? If the answer is yes, then this is an indication that you are working inside IR35.
The right of substitution is a key determining factor for IR35 status. This means that when working for your end-client, you should, if necessary, be able to supply the end-client with someone else to complete the task – a substitute.
If investigated by HMRC, you will need to prove that the client you’re working for does not want you to personally deliver the services you have been contracted for.
You should be able to send a substitute with the relevant skills and qualifications to successfully deliver the services required as detailed in the contract. If your client does not accept the right of substitution and insists on you completing the work, that contradicts the purpose of hiring the contractor’s limited company, if they want the individual only.
HMRC’s perspective on this would be that the contractor should be employed directly by the end-client and taxed in the same way as an employee.
Make sure you have the substitute clause in your contract
- If you are writing the contract, make sure you include the substitute clause.
- As well as including it in the paper contract, make sure you mention it verbally to the end-client.
- If the end-client is writing the contract, make sure they include this.
- If they haven’t included it, it might just be because they’re not aware of it. Make sure you mention it to them.
- If they don’t want to include it, it means you will likely be working inside IR35.
Mutuality of Obligation (MOO)
Is your client obliged to provide you work and are you obliged to complete it?
If you are paid weekly or monthly for your contract, you are likely to be viewed as working inside IR35. The reason for this, is that this type of relationship is typically what you would expect from a permanent employee. This is one of the key indicators towards determining your type of employment.
As a freelancer or contractor, once a project is complete, you should be free to move on to another client or alternatively you could be offered a new contract by the existing client.
Existing private sector contracts
It’s important for you to take steps towards understanding the IR35 status of your existing assignments through reviews of each contract and working practices.
When you enter into new contracts or continue with existing contracts after April 2020 you as a freelancer need to ask what your client is doing to provide you with a Status Determination Statement (SDS). If you do not agree with the outcome of the SDS, you can complete the Status Disagreement Process.
If you are in any doubt about the compliance of your contract/s, then it is a good idea to have your contract/s expertly reviewed. Call our team on 0333 321 1403 for details about IR35 Contract Reviews.
The benefits of working under an umbrella company
Where an agency is involved in the labour supply chain and is the fee-payer, the agency is responsible for deduction and payment of all employment taxes. This is what umbrella companies do. While you are still contracting, the umbrella company will provide you with full-time employment rights such as holiday pay, maternity pay, sickness pay, pensions and so on. They will also provide HR functions and the usual employment benefits.
While you are still contracting, you are an employee of the umbrella company. The umbrella company is paid by the client you’re working for. They will then pay you and deduct any taxes and national insurance.
This provides contractors with the stability and advantages of being employed while still also giving them the flexibility to work on contracts with a range of clients.
Book an IR35 contract review for your peace of mind
If you feel over faced and unsure of whether you fall inside or outside IR35, seeking professional advice will put your mind at ease. A contract review service will provide you with a clear explanation of your status in the eyes of HMRC and will help to clarify whether you fall inside or outside IR35.
During the review, the clauses in your contract will be checked for compliance and to verify whether your working practices follow the terms and conditions outlined in your contract.
For further information or to book a Contract Review, call our friendly award-winning team on 0333 321 1403 today.