Large and medium-sized organisations need to understand the impact of the changes to off-payroll working rules, which have extended to the private sector.
Since April 2021, firms that engage private sector contractors are responsible for deciding if the IR35 rules should apply and for deducting income tax and national insurance. Prior to these changes, contractors who operated through their own personal service company (PSC) had these responsibilities. The extension of the off-payroll working rules made it the responsibility of the organisation engaging the contractors. HMRC predicts this measure affects thousands of individuals and businesses in the private sector.
Companies that engage off-payroll workers are impacted by these rules unless they are classified as a small company. A company is deemed ‘small’ if it meets two of the following criteria for two consecutive years: annual turnover of less than £10.2 million, a balance sheet of less than £5.1 million, or fewer than 50 employees. The rules that determine who is or isn’t within IR35 remain unchanged; however, who is legally responsible for applying them has shifted.
Aims and controversy
IR35 was introduced to address tax avoidance where workers supplied services through an intermediary. It was designed to target self-employed workers who were essentially being treated as employees but were not taxed as such. The goal is to prevent off-payroll services from being used to avoid taxes.
The off-payroll working rules were extended to the public sector in 2017 and have created challenges for organisations. Many have faced difficulties replacing contractors who were deemed inside IR35, resulting in project delays or cost increases. Businesses in the private sector face similar challenges as they implement these changes.
Recent inconsistencies
HMRC recently encountered issues with applying the rules to certain PSCs. For example, HMRC mistakenly targeted 1,500 PSCs that supplied services to GlaxoSmithKline (GSK), citing incorrect rules regarding payroll frequency and contract structure. These inconsistencies highlight the challenges businesses face when adapting to the IR35 rules.
Key considerations for contractors
Contractors need to consider several factors to determine whether they should operate inside or outside of IR35. These factors include:
1. Mutuality of obligation
Employees and employers must sign contracts that require the employer to provide work and the employee to accept it. Contractors, on the other hand, are not obligated to accept work. This distinction is key in determining if a contractor falls within IR35.
2. Substitution
Contractors should ensure that they have the right to substitute another person for their work if necessary. A genuine right of substitution can help demonstrate that a contractor is working as a business, not as an employee.
3. Proving self-employment
Contractors should be able to prove they are self-employed. This can be demonstrated by bringing their own tools and equipment, working for multiple clients, or assuming financial risk.
4. Checking employment status
HMRC’s ‘Check Employment Status for Tax’ (CEST) tool is designed to help determine if a contract is inside or outside of IR35. However, it has received criticism for not considering the mutuality of obligation, which is crucial for the determination. HMRC is working on enhancing the tool, but contractors should ensure their contracts are in order.
5. Expenses Allowance
Contractors working inside IR35 are still allowed to claim 5% of their gross annual income for administrative expenses, including items such as office equipment, accountancy services, and training.
Options to prepare for IR35
Contractors in the private sector who fall within IR35 should start preparing for the tax implications now. It’s crucial to assess whether the contractor will be considered inside or outside IR35 by working with an accountant or legal professional. If it’s determined that a contractor will be inside IR35, it may be worth considering switching to permanent employment or closing the PSC and using an umbrella company.
If you are a private-sector contractor impacted by IR35, contact our tax advisers for advice on managing the changes and reducing tax liabilities.
Talk to us about IR35 in the private sector on 0161 761 5231 or email theteam@horsfield-smith.co.uk.
