What is IR35?
IR35 is a tax legislation which came into force in the year 2000. Its purpose was to address and identify individuals who were avoiding having their earnings processed via PAYE by using a corporate entity to achieve a more efficient and lower tax deduction. The legislation allowed HMRC to challenge those people who supplied their services to a client via a company (whether that was a Personal Service Company, Managed Service Company or Composite Company) and who HMRC felt should have been classed as a “disguised employee”. This basically allowed HMRC to pierce the corporate veil from a tax perspective and ensure that they paid tax in the same way as a permanent employee.
IR35 therefore introduced two types of contractors – those that are “Inside IR35” who are deemed to be employees, and who make PAYE deductions from all contract earnings and those that were “Outside IR35” because they provide a genuine service, in business on their own account, with significant financial risk and no mutuality of obligation so they should not be subject to the tax treatment applicable to employees.
This legislation wasn’t as successful as anticipated and was subject to much criticism. It failed to provide a clear test of what an ’employee’ and a ‘genuine business’ actually was, and it also left the legal responsibility for determination up the individual as to whether they fell inside or outside of IR35.
In 2017, HMRC changed its approach, issuing new legislation directed at the public sector and redirecting the legal responsibility for determining the status of a contractor to the end client. This legislation will now be rolled out to the private sector in April 2020.
Why is this important to me?
From April 2020, recruitment agencies and clients will need to work closely together to ensure the correct tax determination of any limited company contractor that is placed on site. This is not a new concept. Since 2014, similar considerations have been in place regarding the self-employed – only those contractors not under (or subject to the right of) supervision, direction and control are eligible to receive a CIS payment.
According to the legislation and guidance, clients must take reasonable care when assessing and classifying whether a limited company contractor falls inside or outside of IR35. Emphasis is also put upon carrying out individual determinations, and avoiding blanket policies. Clients are expected to carry out the determinations and pass these down the chain via their recruitment agencies to the limited company contractor, who has a right to challenge that decision via a complaints procedure.
Penalties and fines will be imposed where the failure to adhere to the legislation has occurred. For example; where a client has failed to use reasonable care to complete a determination leading to an underpayment of tax, the client will face penalties. Where the agency has not made appropriate tax deductions to the limited company contractor’s pay, the agency will face penalties.
Accordingly, both clients and agencies will need to modify internal procedures and upskill staff to be able to correctly identify and apply the new legislation.
Net Temps are already working collaboratively with clients to ensure that procedures are in place for adhering to the new legislation; which also applies where subcontractors are paid directly by clients via limited companies.
Current considerations include; amongst other matters:
- Assessing the contractor population in order to determine the extent of the problem;
- Identifying which staff of the client should be responsible for issuing status decisions and at what stage of the recruitment lifecycle;
- What considerations should form part of the Status Determination;
- Maintaining suitable records
- Looking at the cost implications of the status determinations whether that is inside or outside IR35.
If you are a client or a limited company contractor and wish to find out more about IR35 and its impact, call us on 0115 9400 968. We’re happy to help.