From 6 April 2020, the off-payroll working rules (IR35) will be extended to the private sector. In this article, partner Jill Springbett answers some FAQs about the new IR35 rules from the point of view of the end client.
What are the IR35 rules?
The off-payroll working rules (IR35) apply to individuals who provide their services to clients through an intermediary, usually a personal service company (“PSC”), on engagements where they could be regarded employees of the clients if they provided their services directly. IR35 requires the PSC to pay broadly the same amounts of tax and national insurance that the client would pay if the individual were employed by it.
What is the main change to IR35 coming into effect on 6 April 2020?
Since 6 April 2000, contractors who provide services to clients through a PSC have been responsible for deciding if the IR35 rules apply (thereby making them deemed employees). If they decided the rules applied, the PSC would have to do an IR35 computation and account to HMRC for PAYE on their fees. HMRC estimates that compliance by PSCs has been as low as 10%.
Since 6 April 2017, where the client is a public authority, the client rather than the contractor has been responsible for deciding if IR35 applies. From 6 April 2020, this will be extended to the private sector. However, it will only apply to medium or large private sector clients, and there is an exemption for ‘small’ businesses.
How do you determine if you are a ‘small’ business for the purposes of the rules?
Whether a business is ‘small’ is defined in a similar way to that in the Companies Act 2006 for financial reporting. In brief, ‘small’ companies are ones with two or more of:
- an annual turnover of less than £10.2m,
- a balance sheet total of less than £5.1m, and
- fewer than 50 employees.
If you as the end client meet two or more of these criteria, the PSC remains responsible for determining the IR35 status of a contract, and the new rules don’t apply to you.
A simplified test also applies to non-corporate clients and considers annual turnover. You must apply the rules if you have an annual turnover of more than £10.2m and are not:
- a company
- a limited liability partnership
- an unregistered company
- an overseas company
If the parent of a group is medium or large, their subsidiaries will also have to apply the rules.
How will you determine whether the off-payroll working rules apply i.e. whether a contractor is “inside IR35” or “outside IR35”?
As the client, if the rules apply, you will now be responsible for determining if the rules apply to a contract. To do this, you can refer to HMRC guidance and its check employment status for tax (CEST) tool, which can be found here.
If the off-payrolling rules apply, you must issue a status determination statement (SDS) to the party with whom you have contracted (the PSC) and the contractor. You also need to set up a disagreements process to deal with any objections that the contractor may have about your determination.
What are your tax obligations if the contractor is inside IR35?
If you determine that a contractor with whom you have contracted is within IR35 (and hence a deemed employee), income tax, class 1 national insurance and apprenticeship levy (if relevant) must be accounted for via payroll on the fees paid to the PSC by the party who has contracted with the PSC (called the “fee-payer”) (NB, the fee-payer may be an agency rather than the end client.) The contractor is responsible for providing the fee-payer with the information they need to do this.
The fee-payer will at the outset withhold tax at the basic rate of 20%, although this is likely to change once HMRC issues a more accurate code.
If the fee invoice includes VAT or allowable expenses (i.e. allowable if the contractor was a direct employee), these will be payable without deduction of PAYE.
Who bears the cost of secondary (employer’s) national insurance (and apprenticeship levy)?
Is it the PSC, the end client, the fee-payer or someone else? This will depend on the terms of the contract under which the contractor is engaged. It is most likely to be the end client. Class 1 secondary (employer’s) national insurance accounted for by the fee-payer must not be passed to the PSC unless this is allowed under the contract.
How are the fees that are subject to PAYE treated in the hands of the contractor?
These are treated as if they were income of the contractor, and the contractor should include the deemed employment income on their self-assessment tax return. This income is treated as non-taxable in the hands of the PSC for corporation tax to avoid double taxation. The PSC can pay to the contractor (as salary or dividends) the fees on which PAYE has been paid, and these fees are tax free in the contractor’s hands.
What should you as a client do to prepare for the IR35 changes?
HMRC has issued guidance to businesses affected by the new rules (ie those which are not ‘small’) and recommends that they should:
- Review their current workforce, (including people engaged through agencies), to identify people supplying services through PSCs.
- Determine if the off-payroll rules apply to any contracts that extend beyond 6 April 2020.
- Discuss with contractors whether the off-payroll rules apply to them.
- Put in place processes to determine if the rules apply to engagements after 6 April 2020.
There is no doubt the change in the rules places more administrative responsibility on end clients. Some clients may adopt a risk-free approach and treat all contractor assignments as falling with IR35. This could lead to contractors seeing a reduction in their income if they are unable to agree an increase in their fee to offset the PAYE deduction taken at source. A recent article in the Financial Times suggests that this could lead to contractors increasing their day rates by up to 25%.
What should you do if you have further queries?
The above is a broad summary of the new rules, and we will be looking at the rules in more depth in future articles. In the meantime, if you have any queries about the new IR35 rules, please do not hesitate to contact Jill Springbett.
Warning: The above is merely general guidance and should not be relied upon as formal advice. The advice we give to each client will depend on their specific circumstances. We suggest you take professional advice before taking any action in relation to the issues discussed above.