IR35 – A simple breakdown

If you run a business using associates and contractors these changes will affect you.

If you are a contractor with a personal service company (PSC) i.e.; Ltd company, this will affect you too and you will need to understand how the legislation works and apply best practice in order to ensure it doesn’t apply to you – which simply put, means you’ll need to meet HMRC’s definition of self-employment.

Failure to meet the definition will mean you cannot claim business costs against tax bills, or avoid full national insurance payments, nor will you be able to pay yourself a lower wage, which you then top up with dividends – as was previously allowed.

In a nutshell, if IR35 applies, the liability to operate PAYE & National insurance Contributions (NIC) will fall onto the fee-payer, rather than the person or PSC providing the worker.

When does IR35 apply?

This depends on the answer to a theoretical question: if the limited company did not exist, would the relationship between the end client and the worker be that of employer and employee? If the relationship between the end client and the worker would be that of employer and employee, then IR35 applies to that contract. However, if the relationship between the end client and the worker would be that of true self-employment, then IR35 does not apply to that contract.

Common components that indicate self-employment include that as a contractor you:

• have control over what work you do and how you do it;
• can delegate the work to someone else, rather than carrying out the work yourself;
• are responsible for providing your own equipment; and
• can work for more than one client.

How does IR35 work currently?

Currently, in the private sector, the PSC decides for itself whether IR35 applies.

If IR35 applies, the PSC is responsible for applying PAYE & NICs to the ‘deemed direct payments’ received under the contract including the liability for employer’s NICs.

The ‘deemed direct payment’ is effectively a minimum salary that must be processed by the PSC – which prevents the shareholder extracting the money in the form of dividends.

Why the need for change?

HMRC estimate that only 10% of individuals working as contractors apply the rules correctly, costing the Treasury hundreds of millions of pounds in lost tax revenues every year. In the meantime, the cost of non-compliance with the off-payroll working rules in the private sector is growing rapidly.

The government want to take action by implementing new rules to address this issue and to secure funds that could otherwise be spent on vital public services.

Am I inside or outside IR35?

If you’re found to fall inside IR35, you’re expected to pay the same amount of tax and national insurance as is paid by a permanent employee. Within the public sector, the agency or hiring body will deduct national insurance and income tax from your pay each month at source.

If you’re working outside IR35, and operating legitimately as a contractor, being paid by your limited company and doing so outside of the IR35 rules, you are responsible for ensuring you pay the right amount of national insurance and tax on the money that you receive for work you undertake.

Ultimately, an individual’s employment status can be interpreted by HMRC, or an Employment Tribunal, on the basis of the facts of the case. Whatever the ‘Agreement’ in place, the risk that an employer-employee relationship for employment law or tax purposes may still exist. The reality of arrangements relating to the work and the true agreement of the parties are key.

What happens if I don’t comply with IR35 rules for 2021?

HMRC are committed to ensuring there is no advantage for clients who engage contractors through intermediaries/PSCs and who do not comply with the new rules. Organisations and individuals found to be non-compliant will risk fines and substantial tax bills.