What IR 35 means for contractors
New tax rules for freelancers and self-employed workers in the private sector were designed for implementation in 2020. However, COVID-19 threw a spanner in the works and delayed the rollout.
An entire year has passed, and the government is ready to put the reforms into effect. Therefore, the new tax laws will apply as of April 6th of this year. Amongst those most affected by the change are independent contractors and the firms that hire them. Are you ready for the coming changes?
If not, you are not alone. According to research conducted by EY TaxChat, 6 out of 10 independent contractors are either unaware of the coming changes or do not fully understand them.
“Freelancers and self-employed workers need to do their research and make sure they make the proper arrangements going forward.” Paul Reed – Reed & Co
What is IR35?
The IR35 is the off-payroll rule put into place by HMRC to prevent inequities in the level of tax paid by private contractors. It is essentially a way for the government to plug some taxation loopholes that freelancers have long enjoyed. The treasury is pretty serious about this reform because projections have shown that it will cost the government £1.3bn annually if the new laws are not applied.
The government believes that many independent contractors working through an intermediary should be paying the same tax rate as their directly employed equivalents.
Many workers employed through a Personal Services Company (PSC) have contractual terms essentially identical to fully employed workers. The HMRC designed the reform to apply to those individuals and those individuals only.
The HMRC has identified the following types of intermediaries as ones to which the IR35 may apply:
- The workers’ personal service company. That is the most common form of intermediary under IR35 regulations.
- A personal service company.
- An individual
Keep in mind that IR35 came into effect for the public sector in 2017.
How do I know if IR35 applies to me?
HMRC suggests three tests to conduct for this purpose. Use these to see where you stand.
- Do you determine your hours and the location where you perform your duties? One of the characteristics of freelance and independent work is that you can generally decide on your schedule. The closer your work routine is to an office-bound 9-5 schedule, the more likely it is that IR35 applies to your form of employment.
- Is your employer obligated to provide more work once the current contract is finished or complete the project? Independent contracts are typically temporary and involve little long-term commitment. If there is a level of continued assured cooperation, the HMRC may consider your contract similar to those of fully employed individuals.
- Are you contractually responsible for completing the work personally? IR35 usually does not apply for contracts with a substitute clause, particularly if the contractor is liable for the substitute.
- How big is your employer? The reform is intended for medium and large companies. The rules for small employers will not change, at least not at this stage.
Who is responsible for determining your status?
Make sure you know if the reform applies to you. If it does, the law mandates that Income Tax and National Insurance be deducted directly from fees paid to the contractor and paid to the HMRC. Your employer is also liable for their required National Insurance contributions.
Generally speaking, it is the responsibility of the employer to place you in the correct category. If your client is part of the public sector, they will determine your status vis-à-vis IR35. They are supposed to inform you of their decision. Ensure you receive that information to know what level of taxation they will apply to your income.
The employer will be able to dispute your status if they disagree with the HMRC determination.
Your clients will also be required to submit relevant information to the HMRC. The government will need cooperation to determine the size of the organization and its sector.
Meanwhile, if your client is a private sector firm, your intermediary is responsible for determining your employment status. If they are responsible for more than one of your contracts, they should assess the applicability of IR35 to each separately. Keep in mind that many non-profits and charities are considered private sector entities for taxation purposes.
If you have multiple contracts, keep in mind that IR35 is applied on a contract-by-contract basis. It is not determined according to the characteristics or status of the contractor more generally. Therefore, you may find that the new rules apply to some of your contracts and not others.
Enforcement and penalties
Confused? Most of us are. The government is aware of the uncertainty surrounding the reforms. Therefore, it put together a committee in March 2020, which recommended measures to facilitate a smooth transition to the new tax regime.
To pre-empt and prevent chaos in the first year of IR35 reform applicability, HMRC will not enforce penalties for unintentional lack of compliance. However, by the second year of use, penalties may be applied even for inadvertent misclassification. Therefore, make sure you have the correct status figured out by then.
The HMRC has promised not to launch investigations into previous tax years based on information submitted for IR35. However, this does not apply if they suspect severe fraud or other criminal behaviour.
Also, the law does not apply retrospectively. Therefore, it does not apply to any income you have made thus far. The new IR35 regulations only apply to work executed on April 6th, 2021, or later.
What does IR35 entail?
Unfortunately, a significant consequence of the IR35 tax changes is that many independent contractors will face increased tax bills. In many cases, contractors could lose no less than 20% of their revenue.
Fully-employed individuals pay the basic-rate fork over 20% on income above £50,000 and 12% National Insurance on income up to that amount. However, contractors can allocate their salary and personal company revenue to significantly reduce their income tax and National Insurance payments.
We hope this has clarified the implications of the new IR35 tax regulations. If you are still unsure if these reforms apply to you, use this helpful government tool.