What are the IR35 changes and why do they matter?
IR35 is tax legislation which was introduced to address a particular kind of tax avoidance…and the law is changing in April 2020.
Where do they apply?
The IR35 changes apply where individuals supply their services through a ‘personal service company’ (a PSC) – one of the advantages is to avoid paying as much income tax and national insurance by paying themselves dividends rather than a salary – in reality, the individuals involved may work in a very similar way to any other employees.
Small organisations will be exempt, minimising administrative burdens for the vast majority of engagers, and HMRC will provide support and guidance to medium and large organisations ahead of implementation.
During a 12-month period, a business is deemed to be a ‘small’ company if it meets 2 or more of the following criteria:
- Turnover – not more than £10.2 million
- Balance sheet total – not more than 5.1 million
- Number of employees – no more than 50
What are the changes?
The Government has published draft legislation which means that, with effect from April 2020, medium and large companies in the private sector which contract with PSC’s will be directly responsible for determining the appropriate tax regime to apply to the arrangement, and ultimately, ensure income tax and national insurance are properly categorised and accounted for through PAYE.
Currently the responsibility for making that assessment and (where deemed employee status applies) for deducting PAYE and employees’ NI contributions and paying employers’ NI falls on the PSC.
The change is simply a shift in responsibility for determining whether, for tax purposes, the nature of the engagement is that of deemed employment, or self-employment. The changes are formulated as amendments to Income Tax (Earnings and Pensions) Act 2003 (the ‘statutory provisions’).
How does an employer make that determination?
It’s complicated and technical…
The statutory provisions require an employer take reasonable care in making the assessment, known as the ‘Status Determination’ and HMRC has provided a helpful online tool – the CEST (Check Employment Status for Tax) test. The CEST has been around for some time and in the process of being upgraded.
The statutory provisions require the end user inform the worker and the fee payer of the Status Determination. The worker can challenge the determination. There is not a specific time frame for making the challenge but, if one is raised, the end user has to reply to the challenge within 45 days but there is no further appeal.
The wider implications of the changes
The CEST tool is equally applicable is assessing self-employed status for direct engagements and so all end users, whether or not they are small companies outside the statutory provisions would be well advised to use the tool to assess whether direct freelance engagements qualify for self-employed status for tax.
If the CEST tool or other reasonable assessment suggests deemed employee status, an employer needs to consider what that means for employment law purposes. It is the case that the assessment of tax for tax status is separate to the assessment of status for employment law purposes, but it is almost impossible to draw any clear distinction based on the case law.
Therefore, in the majority of cases where deemed employee status is determined, the employer would be sensible to offer a direct employee contract instead, although there are exceptions as follows:
- The end user could continue to engage with the PSC. This would involve payrolling the PSC and may include VAT having to be paid – a complicated business that many payroll systems may not be able to support. The advantage is that responsibility for holiday pay and the like continue to rest with the PSC and the individual does not get employment rights with the end user.
- There may be occasions where a ‘worker’ contract may be appropriate (for example where there is no ongoing/fixed expectation of work). It is possible that there may even be occasions where it is still credible to treat the contractor as an independent contractor with no employment rights, but it is difficult to envisage such circumstances.
- It may also be possible to legitimately restructure the arrangement so that it is an outsourced service which is not caught by IR35 (HMRC has not yet but is apparently intending to issue guidance to bring some clarity on the dividing line between an outsourced service and a contract for labour within IR35). It is however likely to be an essential part of that arrangement that the end user does not require specific named personnel.