Off payroll working and IR35 – a short guide

The main points

The off payroll working rules (IR35) are designed to ensure that individuals who work like employees through their own limited company (also often called a ‘personal service company’ or ‘PSC’) or other intermediaries pay similar income tax and national insurance as those who are directly employed.

The rules first changed in April 2017 and at that time they only applied to the public sector.  Since 6 April 2021, the rules now apply to medium or large sized organisations in the private sector as well. All private sector clients with a UK connection who are not defined as small and who engage workers via an intermediary will be caught by these rules.

This impacts on two groups of our clients:

  1. Any individual who is contracting via a 3rd party to another entity “the worker” or
  2. A business engaging with an intermediary to engage temporary or contract staff “the client” or “fee payer”

What is a small company? 

A large or medium sized organisation is defined as ‘not small’. The definition of small is:

  • A corporate body will always be small for its first year of operation.
  • A corporate body will be small if it meets two of the following three criteria:
    • Turnover £10.2 million or less
    • Balance sheet of £5.1 million or less
    • 50 employees or less
  • Any other undertaking or person (essentially not a corporate body) need only meet the requirement of turnover being £10.2 million or less.

There are rules to apply the test to joint undertakings and members of a group to prevent groups from having a ‘small’ company specifically for the purposes of these rules while associated with medium or large businesses.

Where the rules apply

For the rules to apply there needs to be an intermediary between the worker and the fee paying client. The intermediary is often a personal service company, but services can also be provided via a partnership, another individual or entity.

Identifying contracts within the rules

The responsibility for IR35 lies with the contractor/worker if:

  • a worker provides services to a client in the private sector which is classed as a small company under the Companies Act 2006

The responsibility for IR35 lies with the end client/fee-payer if:

  • a worker provides services to a client in the public sector
  • a worker provides services to a client in the private sector which is classed as a medium or large company under the Companies Act 2006 from 6th April 2021

Obligations of the client/fee payer

Request to confirm size

The client has an obligation to respond to a request to confirm whether they are a medium or large organisation. A request can be made by the worker or the person contracting with the client and a response must be provided within 45 days.

Check employment status

The client/fee payer must decide whether a worker would be regarded as its employee if there was no intermediary entity between them. To do this, the client should apply the employment status tests to the engagement in question.

HMRC has a Check Employment Status for Tax (“CEST”) online tool which can be used to determine whether a particular contract to provide services to a client comes within the scope of these rules. HMRC states on the site that it will stand by the result given by the test unless a compliance check finds the information provided is not accurate. It can therefore be useful to run the check for each individual falling within the rules and to save the results on file to support the treatment of any payments. Please be aware that it is possible for the test to provide an inconclusive outcome in some cases.

When considering overall IR35 compliance for the entire engagement, it truly is a mixture of different factors, not simply the written terms. The worker should ensure that any contract proven to be outside of IR35 also matches the working practices of that engagement. So, if the contract says the worker is expected to provide their own equipment for the services, they should make sure that they are not using any client equipment during the provision of the services. This is because when determining IR35 status, the working practices are seen to hold more weight or are also referred to as the reality of the engagement.

The main factors which are used in the determination of IR35 status are listed below.  We will not go into full detail here but we would be pleased to advise further on any of these areas as case law is already developing.

  • Office holders – IR35 automatically applies to “office holders”, i.e., those who take on a management role in a client’s business.
  • Right of substitution/personal service – consider whether the situation is that of a self-employed contractor entering into a contract to provide a service rather than personal skills and whether he should be able to provide a substitute or engage a helper to provide the service. An employee on the other hand, would have to provide their services personally.
  • Control – for IR35 not to apply, can the worker demonstrate that you have complete autonomy over the way the services are provided.
  • Mutuality of Obligation – what this means is that an employer will try to make sure that their employees have a continuous supply of work and will also expect the employees to carry out the work when they require. A truly self-employed individual will do the work they are being contracted to do and will finish with no expectation of further work.
  • Financial risk – consider if any worker is really in business on their own account, do they provide your own equipment, hire their own people, indemnify the client against losses or defective work by having their own insurances and licences and so on.
  • Holding oneself out as part of the organisation - Contractors should not be on any internal lists of employees or have business cards showing their client’s name and, crucially, must not be entitled to any benefits offered to the client’s own staff, i.e. bonuses, pensions, and use of facilities such as a gym.

Communicate employment status

The client/fee payer must notify the intermediary of the result of the employment status check (the notification is called the ‘status determination statement’ (SDS)). This must be done by the latest of two dates; the date the contract is entered into, or the date that services under the contract start to be performed. The intermediary or the worker can ask for an explanation of the decision and the client must provide an explanation in writing within 31 days.

The CEST output can be used as an SDS. It is required that reasonable care is taken to reach the determination. Where the client has not given the SDS to the worker, the client will be deemed to be the fee payer and therefore take on the responsibilities of the fee payer and operating PAYE.

Once the SDS has been issued

Status disagreement process

The client is required to lead the status disagreement process where either the worker or the fee payer disagrees with the status decision made in the SDS.

Firstly, the worker or fee payer must make a ‘representation’ to the client.

The client must respond within 45 days to either inform them that its determination was correct or that it has made a new determination and the previous determination is withdrawn. If it decides that the original determination was correct, it must provide reasons.

If the client does not meet these obligations within 45 days of receipt of the ‘representation’, then they will be treated as the fee payer and take on all the responsibilities of the fee payer (ie operation of PAYE) until they comply.

Payment of fees by the client/fee payer

It is important to note that the SDS relates to tax withholdings only the worker does not become an employee as a question of fact. This means that responsibility for any statutory payments which could be due to the worker, such as statutory sick pay or statutory maternity pay, are not due from the client/fee payer but will be due from the intermediary.

If the SDS is that the worker should be treated as an employee then they should be included in the company’s payroll to:

  • calculate the deemed direct payment to account for employment taxes and National Insurance contributions associated with the contract
  • deduct those taxes and employee National Insurance contributions from the payment to a worker’s intermediary
  • pay employer National Insurance contributions
  • report to HMRC through Real Time Information the Income Tax and National Insurance contributions deducted
  • use the ‘off-payroll worker subject to the rules’ indicator in PAYE Real Time Information 
  • apply the Apprenticeship Levy and calculate any payments necessary

Implications for the intermediary

Once the contract is in place and services are being supplied, the intermediary will receive payment as the net amount of invoices issued after deduction of tax and NIC. The tax and NIC will be operated in relation to the individual worker, using their PAYE code, despite the payment going to the intermediary.

Where the intermediary is a company, it is these net amounts (excluding VAT) that it should include in its turnover for corporation tax purposes.

Implications for the worker

When the worker comes to complete their self-assessment tax return they should include the total of the deemed payments, tax and NIC deducted on the employment pages, with the fee payer being recorded as the ‘employer’.

Compliance

In the first year of the application of the rules to the private sector (2021/22), penalties will only be charged where there is evidence of deliberate non-compliance.

HMRC have introduced Targeted Anti Avoidance Rules (TAAR) in order to discourage avoidance behaviour.

 

Useful resources:

HMRC IR35 resources index:

https://www.gov.uk/topic/business-tax/ir35

HMRC Check Employment status for tax tool: 

https://www.gov.uk/guidance/check-employment-status-for-tax

HMRC Employment status guidance:

https://www.gov.uk/hmrc-internal-manuals/employment-status-manual/esm11000