It has been several years since the new rules on IR35 for the private sector were implemented. However, the new legislation has remained a common source of contention among self-employed individuals, contractors and freelancers. Non-compliance with IR35 can result in a heavy fine as well as business disruption. As a result, it is absolutely imperative that contractors who are working with people in the private sector take the necessary steps to ensure that their business falls outside the scope of IR35.
How IR35 Works Today
On 6 April 2021, the UK government implemented reforms to off-payroll working rules (commonly known as IR35) that would affect private businesses that engage workers through intermediaries, such as partnerships, LLCs and Personal Service Companies (PSCs). Initially, it was intended that these changes would take effect a year earlier. However, a deferral was announced to help businesses and individuals suffering from the economic impact of the Covid-19 pandemic and the subsequent lockdown.
Changes rolled out in 2021
Before the IR35 reforms were introduced, it was a contractor’s responsibility to verify their IR35 status. After the recent changes, this task now falls in the hands of their end-client, who must provide a Status Determination Statement (SDS). The SDS will inform the contractor of their IR35 status and the end-client’s reasoning for this determination.
If the end-client decides that the contractor does fall within the scope of IR35, the contractor will be taxed through the Real Time Information (RTI) system, similar to any other employee. The fee-payer (i.e., the individual who is paying the contractor) will deduct PAYE tax and NICs from the contractor’s earnings. A client is designated as a fee-payer if the contractor works directly for them. On the other hand, if the contractor is with an agency, it will be the agency’s responsibility to deduct the taxes.
The new IR35 rules mirror those in the public sector, which were reformed in 2017. However, the private sector rules only apply to medium and large enterprises that liaise with contractors. Any company that fits the description of “small” as set out in the Companies Act 2006 is exempted.
What do these changes mean for the private sector?
Changes to the IR35 rules for the private sector were intended to put a stop to “disguised employment” and encourage businesses and individuals to pay the correct amount of tax. However, many contractors and end-clients believe that the new rules have burdened them with additional obligations.
For contractors and freelancers, an inaccurate IR35 designation from their client could lead to a potential HMRC investigation. The rules can be complex and difficult to interpret, particularly for those who are not well-versed in taxation and legal matters, and failing to demonstrate compliance can result in a heavy fine and a substantial invoice for back taxes.
As for the end-clients, the new IR35 for the private sector requires them to take “reasonable care” when verifying a contractor’s status. If they conduct blanket assessments or file incorrect IR35 determinations, they could be held liable and put on HMRC’s “risk” list. As a consequence of this, some businesses avoid hiring contractors altogether for fear of making expensive mistakes. This in turn results in employment uncertainties for genuine freelancers and self-employed individuals.
The introduction of the new legislation has also incurred additional expenses for private businesses. Some agencies and PSCs representing contractors have begun to charge more to make up for the increase in their tax obligations, forcing end-users to pay more for the services they need.
The IR35 Small Company Exemption
As mentioned earlier, recent changes to IR35 do not apply if the end-client is a small business. A company may qualify for this exemption if it satisfies the following conditions:
- There are no more than 50 employees
- Its annual turnover does not exceed £10.2m
- There is no more than £5.1m on the balance sheet
If a contractor has been hired by a small company, it is still their responsibility to determine their own IR35 status and tax liabilities. However, contractors should note that the exemption will not apply if their agency or limited company is considered to be a small business.
Challenging the End-Client’s SDS
As IR35 rules can be complex, it is difficult to say with certainty that the end-clients will always make accurate IR35 determinations. As such, there is a risk that contractors will be erroneously categorised as falling within the scope of the tax legislation and therefore be penalised as a result. However, the good news is that contractors can appeal a client’s SDS if they disagree with it. The end-client will have 45 days to respond.
As a contractor, it may be well worth your while challenging a client’s SDS if you believe they have got your IR35 status wrong. To be successful, you will need to provide evidence that proves that your work falls outside the scope of IR35. You will also need to set out in writing why the end-client should not misconstrue your engagement as disguised employment.
You can also provide your CEST (Check Employment Status for Tax) results. CEST is a tool developed by the government to help clients make determinations. It identifies an individual’s IR35 status based on how they answer relevant questions.
What Private Businesses and Contractors Must Do to Ensure Compliance
Non-compliance can have both legal and financial ramifications. For this reason, whether you are a contractor or a business owner who engages PSCs, it is important that you take the necessary steps to ensure compliance with IR35 for the private sector.
For business owners
To help ensure you obtain accurate IR35 assessments and that your business complies with the new tax legislation, you should conduct a portfolio analysis to determine:
- The number of PSCs you engage and how you utilise them
- The parts of your business that engage PSCs/contractors
- Their importance to the different areas of your organisation
This vital information will enable you to identify the commercial contracts currently in place and verify whether they are still accurate and fit for purpose.
Although it is possible to challenge an end-client’s SDS if they make an incorrect IR35 determination, there is still a risk that they won’t take any action or alter their status decision. For this reason, it may be better to take a proactive approach to verifying your IR35 status rather than having to deal with a potential problem when it arises.
A comprehensive contract review, a service we offer here at BEB, will allow you to verify your IR35 status in advance. It will also help ensure that your contracts are IR35-friendly and worded appropriately, preventing end-clients from mistaking you as a disguised employee.
As an added bonus, a contract review will enable you to:
- Demonstrate to HMRC that you have taken a “reasonable step” to verify your status
- Ensure compliance with the relevant tax rules
- Obtain evidentiary support should HMRC challenge your IR35 status
A contract review can also be beneficial for end-clients. By allowing legal contract specialists, such as our team at BEB, to examine their contracts with PSCs, they can make accurate IR35 determinations and thus avoid mistakes that could land them in trouble with HMRC further down the line.
Because of their ambiguity, the new IR35 rules for the private sector have made things confusing for contractors and businesses that use their services. This is why it is always a good idea to seek expert advice to ensure compliance. No business wants to run the risk of having to pay a heavy fine or be responsible for significant tax and legal liabilities.
If you are a contractor who needs expert assistance to verify your IR35 status, our team here at BEB Consultancy will be happy to help. We will assess your contracts and work practices to help ensure your business falls outside the scope of IR35. Get in touch with us today!