It’s complex. IR35 has been in place for some sectors for many years. It is now being implemented across all firms in the UK. So, what is it?
IR35 is legislation designed to stop tax avoidance by workers and by firms using workers’ services. It was rolled out to all public sector organisations in 2017. Rebranded ‘Off-Payroll Tax’, it was due to be rolled out to the private sector in April 2020. However, due to the pandemic this was put on hold. It’s now due to be extended to the private sector in April 2021.
Off-Payroll Tax (which we’ll refer to as IR35 for the rest of this blog) is designed to catch suppliers who are really ‘employees’ for tax purposes. These suppliers (contractors or freelancers) are contracted to provide services to a firm, but they work only for that firm. That actually renders them a ‘worker’ or an ‘employee’. This loophole has, until now, allowed firms and suppliers to avoid PAYE and NI contributions. It has also allowed firms using these suppliers to avoid provision of worker basic rights, including paid holiday.
In 2017 we discussed the legal tests that should be undertaken to determine if someone is indeed a contractor or an employee. So, as we asked in our blog, when does a contractor become an employee?
Irrespective of the written contract between a supplier and a firm, HMRC may deem that under the assessment criteria they use, a supplier is a worker or an employee. This creates a ‘notional’ employment contract. We refer to this assessment as the duck test – if it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. If a person looks like a worker, or an employee; then they probably are a worker or an employee.
So, how do you know if the supplier you have working for you is really a ‘notional employee’?
Firstly, you must consider how the service is provided. Is it provided through a limited company, partnership or a not-for profit organisation? These service providers are referred to by HMRC as intermediaries. You may also have heard the term ‘PSC’ (personal service company). Many suppliers set up their own limited company to act as a PSC. They are the only person in the company. They then provide their services as a contractor to one firm through their PSC. It is this tax-avoidance loophole that HMRC wish to close.
Services can be provided in one of two ways: a ‘contract of service’ (an employee) or a ‘contract for services’ (supplier). The criteria discussed below allows the duck test to be applied. A determination of the status of the supplier can then be established. Note that the ultimate determination will be made by HMRC, should it investigate.
Managers (in medium and large firms*) are responsible for determining the status of those who provide services or who work for them. Without clear demarcation between supplier and worker, the firm runs the risk of inadvertently creating an employment contract where a supplier becomes a ‘worker’ or a ‘notional employee’. The firm will then be liable for employer's NI and required to deduct PAYE from the worker. And the worker is eligible for basic rights, including paid holiday.
Determining contract type
The first thing to consider is the type of contract that is in place. How is the contract worded? Is the relationship arms-length, delivering work packages and invoicing on acceptance? Does the relationship suggest a contract for services? Answering ‘yes’ does not mean that the contract is truly a ‘for services’ contract.
There are other things to be considered. For example, can the supplier work for other firms at the same time? Do they work full-time for you? If they are working on your premises and your systems fail what do they do – do you tell them to stay onsite and pay them, or do you tell them to leave without pay? Case law suggests that if they stay and are paid for their downtime, they are likely to be classed as a worker. In this example allowing them to stay suggests a clear mutual obligation to pay them, even if they can’t deliver. Contracts defining an ‘arm’s length agreement’ with specific deliverables, and payment terms will help to show the mutual obligation that both parties have agreed to. When two parties agree a contract of any type, there is a mutual obligation. The issue is how close that mutual obligation is - and does it suggest employment.
Secondly you should look at the way in which the supplier completes the project. Can the supplier send someone else to undertake the work? If not, then the person likely falls under IR35. If, however, a suitably qualified substitute can be sent undertake the work, and the supplier is responsible for paying them, IR35 is unlikely to apply.
Next you should consider what control you have over the supplier. If you tell the person the hours they must work, how to do the job, and you give them a line manager, then you exert control over them. If you move them to a different task outside the scope of the contract, or you implement appraisals the supplier is definitely a worker or an employee. The more control you exert, the less likely that the person is truly a supplier falling outside IR35.
The penultimate consideration concerns the level of risk that the supplier takes. Do they provide their own tools? Do they incur expenses before they are paid? If the work has to be reworked, or takes longer than expected, does the supplier carry the cost? If you answer yes to these questions, then the supplier likely falls outside IR35. On the other hand, if you pay holiday pay, sick pay and other payments normally reserved for workers and employees, then IR35 applies.
Finally, you need to consider how integrated the supplier is with your firm. If the supplier regularly attends internal training, receives all company internal communications and is invited to company social events then they are likely to fall inside IR35.
So, what should you do now?
If you have genuine business-to-business contracts or agreements in place describing a true arms-length relationship, then IR35 likely does not apply. If your suppliers pay themselves as employees in their firms then IR35 likely does not apply. The caveat is that the duck test has been implemented, and status of mutual obligation; substitution; control; financial risk and integration have all been assessed. If anything suggests the supplier could be a worker, then you should investigate further.
HMRC have developed an online tool that you can use to check if IR35 is likely to apply to contracts you have in place – and check employment status for tax. It’s an anonymous service allowing you to answer questions and then print out the results. Whilst HMRC may still determine that a supplier falls under IR35 upon investigation, you will be able to show your determination. And if answered honestly, you are likely to get the most appropriate answer regarding your suppliers. You then need to determine what action, if any, you need to take.
If you need employment or supplier contracts, we can help.
If you need an audit of your contracts, we can help.
*The Government definition of a medium or large firm is one that meets two or more of the following conditions. 1 – an annual turnover of more than £10.2 million. 2 – a balance sheet of more that £5.1 million. 3 – more than 50 employees. Where a private firm does not meet at least two of these criteria the test for IR35 status rests with the supplier.