IR35 is designed to prevent workers from avoiding tax by operating as contractors. If a contractor operates via their own limited company, but is otherwise treated the same as their client’s employees, they are considered to be ‘inside IR35’ and will need to make additional tax payments.
From April 2021, private sector employers will be held responsible for determining whether IR35 applies to any contractor they hire – which would require them to treat the contractor as an employee for tax purposes.
Are you inside or outside IR35?
IR35 was introduced because of the way employees are treated differently from contractors. With an employee, an employer must provide a workplace pension, paid holiday, sick pay, other benefits (perhaps) and pay employer’s National Insurance contributions. A contractor, on the other hand, is paid a flat fee and has very little employment rights.
The vast majority of contractors operate as limited companies, however, operating as a company doesn’t prevent a contractor from being an employee in all but name which is where IR35 becomes applicable.
IR35 creates a double problem, affecting both contractors and the businesses that want to use them. If a business is afraid that any contractor it hires might be considered an employee by HMRC, it may not risk hiring them at all. In this case, both the business and the contractor lose out.
How to check IR35 employment status?
HMRC offers an online tool, Check Employment Status for Tax (CEST) that you can use to use as a general guide to employment status.
Mutually of Obligation Test
One of the key deficiencies of the CEST tool is that it does not factor in ‘Mutuality of Obligation’ (MoO). Mutuality of Obligation is one of the defining characteristics of employment, in that the employee has certain obligations towards the employer, and vice versa. Many of these obligations do not apply to contractors (e.g. the contractor can choose where and how to deliver the work, and can delegate it to an associate if necessary; while the client is not obliged to offer the contractor more work). MoO has been a decisive factor in a number of recent IR35 tribunals, which is another reason why the CEST tool is still only a rough guide.
Not falling foul of IR35
From April 2021 it will be employers’ responsibility to determine whether a worker is an employee or a contractor for tax purposes. You will have to issue a Status Determination Statement to your contractors, which makes their IR35 status clear (inside or outside the rules) and explains why. As long as you support your decision with sufficient evidence and file the appropriate tax documents, you should avoid any penalties.
In summary, employers should:
- Review all your relationships with contractors and/or consultants
- Make sure your terms of engagement are clear and accurate
- Provide contractors with their Status Determination Statement
- Consider changing some contractors into employees if they fall within IR35 and if this is a more practical solution for you both
If you would like to discuss IR35 and your business, please get in touch with our Employment Solicitor Sasha Brine by calling 07475069698.