Your IR35 Survival Guide
Everything you need to know, do and say to help you understand IR35
Introduction
April 2021 saw the changes to IR35 rolled out across the Private sector. This guide explains what IR35 is, the recent changes, what the expected impact is on contractors, and what action you can take to protect your contracts and take home pay.
At SG we’ve worked with contractors for more than 20 years and are passionate about supporting the flexible workforce through the upcoming changes. If you have any questions about what you read in this guide, please don’t hesitate to get in touch.
The basics
What is IR35?
IR35 (also known as Intermediaries Legislation) is legislation created to identify individuals falsely establishing limited companies as a means to reduce their national insurance (NI) payments and taxes. This is often referred to as “disguised employment”.
There are a number of rules that aim to determine whether your contract falls inside or outside of IR35. If your contract is ‘inside’ IR35, you will be taxed as if you were a permanent employee – either via your client’s payroll or through an Umbrella Company. If your contract is ‘outside’ the legislation, you will be considered truly “self-employed” and be able to structure your income so as to benefit from the tax efficiencies available through the use of dividend payments.
For this reason, many contractors prefer to work on contracts that are found to be outside of IR35.
How is IR35 status determined?
HMRC have set out three tests that aim to identify whether the contractor is actually working as they would as a permanent employee doing the same job:
Control: How much control do you have over what, when, how and where the services are performed? The more control you have, the more likely you are working outside of IR35
Substitution: Is the work personal to you as the worker or could your Limited Company send someone else to work on this project? If you are able to send a substitute, then you are likely working outside of IR35
Mutuality of obligation: Is the client obliged to offer you work and are you as the worker obliged to accept it?
These rules relate to the way you actually work as well as what’s written in your contract and therefore need to be considered for each new contract you take on, and regularly reviewed. The basic rules are relatively easy to understand but applying them can be far more complex, as can be seen by looking at recent case-law and HMRC investigations. For this reason, some contractor accountants offer an IR35 contract and working practices review service.
Who makes the determination?
Regardless of whether you’re in the Public or Private sector, the end hirer responsible for assessing your IR35 status. They are therefore liable for any fines if they are found to have got it wrong (through an HMRC investigation).
IR35 history – what changed and when?
April 2021 saw a legislative change that shifted responsibility for determining IR35 status in the Private sector from the contractor to the end client, who will then also bear the tax risk if they get it wrong.
The client must assess each assignment with ‘reasonable care’ and provide the contractor with a ‘Status Determination Sheet’ that explains the reasoning behind their decision. It is important to remember that the rules around HOW IR35 status is determined are not changing, just the party responsible for that determination. So if you are currently working on a contract that is genuinely outside of IR35, then this should in theory remain the case after April 2021.
How were the April 2021 changes expected to affect contractors?
Although the rules around status determination didn’t change, the shift in responsibility was likely to lead to a more risk-averse approach, impacting contractors in a number of ways:
Blanket assessments / bans
Sadly we saw some businesses making ‘blanket assessments’ before April 2021, essentially ignoring that the legislation demands they take reasonable care and simply suggesting that all of their contractors are inside IR35. In 2017 very similar rules were introduced to Public Sector organisations and a similar approach of blanket assessments and not using limited company contractors followed. Many contractors either renegotiated their day rates (to compensate for the additional tax) or left and found contracts elsewhere. It wasn’t long before these organisations were forced to reconsider their approach as projects ground to a halt. We expect to see a similar cycle with the Private Sector roll-out although we’d hope that Private Sector businesses would be quicker to realise the knock-on effect of their approach.
CEST
Most end-clients have little (if any) IR35 expertise. They have been told that they can use HMRC’s CEST (Check Employment Status for Tax) online tool, answer a series of questions about the contractor’s engagement and the tool will tell them whether IR35 applies.
The tool has been designed by HMRC and some therefore argue that it is weighted in their favour. It is widely considered to be fundamentally flawed (indeed, HMRC investigations have regularly contradicted their own CEST tool) and yet the decision the tool arrives at will be relied upon by your end client to determine your IR35 status.
Fewer contractor roles available
Some companies made the decision to stop using limited company contractors entirely from April 2021 with the option of leaving the role, going ‘perm’ or using an umbrella company, often the suggested alternatives. We believe this approach is very short sighted – the contracting market exists because those businesses want an agile and flexible workforce in order to deliver their projects. Paying a higher day rate for ‘top talent’ without needing to provide employment benefits is a deliberate commercial strategy. The fact that tax advantages are available for contractors has always been the reward for the associated risks.
What’s the impact if a contract is deemed inside IR35?
If your contract is considered inside IR35, your future invoices will be subject to tax and National Insurance as if you were employed by your end client. Whilst it varies depending on the circumstances, for most this will mean 20-30% additional tax liability, which will be deducted at source – with you receiving the net amount.
How to challenge a client over an IR35 status determination
If you find yourself with an end-client who has either blanket assessed all contractors as inside IR35 or carries out an individual assessment but incorrectly arrives at an inside IR35 conclusion, there are steps you can take, with a ‘client-led disagreement’ process part of the legislation:
- Request the ‘Status Determination Sheet’ (SDS) that each business is required to provide.
- If you have a contractor accountant that offers an IR35 SDS review service (at SG we do – at no additional cost), send it to them with a copy of your latest contract for a review.
- They’ll help you identify specific working practices that can be either used as evidence or put in place to help your case. i.e. it helps to have actually used a substitute in your work to prove that substitution is a reality rather than just a clause in the contract.
- Alternatively, run your details through the CEST tool yourself. Whilst we acknowledge that the tool is flawed, for many contractors it will still arrive at an outside IR35 decision.
- Provide the evidence to your end-client and the ‘client-led disagreement’ process should begin. HMRC have said that they will stand by the decision of the CEST tool provided the answers given are factually correct. So for many, an outside of IR35 decision should be enough to reassure the end-client.
- There is no further guidance yet on a formal process, however the end client will have 45 days to respond to your appeal.
What to do if a client refuses to reconsider an incorrect assessment
If you are working with a client that will no longer engage with limited companies from April onwards then your choices are likely to be leave, accept permanent employment, use an umbrella company, or contract through your Limited Company.
Leave (and contract elsewhere through your Limited Company)
Seeking contracts with more reasonable clients was the route taken by many Public Sector contractors in similar situations in 2017. This mass migration of talent instigated a change of approach for many clients who lost time on valuable projects.
Accept permanent employment
You will need to assess your situation, the market and any offer on the table; if you are offered a fantastic package to join as permanent member of staff then you may decide to accept! However, it is likely that the package will represent a significant reduction in your income so that will need to be viewed against the positives of employment benefits.
Contract through an umbrella company
Depending on the offer (and now may be the time to negotiate a higher day rate), you could choose to use an umbrella for the contract in order to pay the tax and national insurance due. Working with a contractor accountant (like SG Accounting) that offers the use of an umbrella at an additional monthly charge whilst keeping your Limited Company running will allow you to swap between your existing Limited Company and umbrella depending on the contract and offers the level of flexibility that many contractors will now need.
Any decision to close your Limited Company should be considered very carefully as you may lose some tax benefits of closing your company (Entrepreneurs Relief) if you were to open a new company within 2 years. It may be prudent to keep your Limited Company open whilst the dust settles post-April 2021 and to allow you to consider your longer term plans and options.
Contract through your Limited Company
If your end client agrees, you can continue the contract through your Limited Company, as long as you pay the relevant taxes and NI contributions. This may prove more straightforward for you if you do not have access to an umbrella solution, especially if you think that the client decision may be reversed.
There are other benefits of contracting through your Limited Company; for example, you will be able to continue making pension contributions through your Limited Company (assuming you have the available profits to do so) and take dividends once your salary has been accounted for. Also (although this is likely to change in April, in line with the Public Sector), you can currently claim back 5% of income generated by your contract to cover the cost of running a company. You contractor accountant will be able to advise on all of these points and any changes that affect you.
Caution should be exercised in accepting an inside IR35 decision from an existing client where you have previously operated outside of IR35. HMRC have said that they ‘have no plans’ to open retrospective enquiries into prior years but HMRC’s behaviour recently suggests this shouldn’t be relied upon.
Summary
At SG we have always been behind the concept of any genuine IR35 reform that would correctly tax those working in the same way as employees. However, by pushing the burden onto UK businesses, who typically have no expertise with IR35 and then telling them they’ll pay the tax liability if they get it wrong, we can expect a very risk averse approach from some end-clients. Contractors shouldn’t allow that approach to cost them 20-30% of their income unfairly.
It is important to remember that these new rules do not change how IR35 should be assessed nor do they supersede the 50 years of case law on employment vs self-employment. If your contract is genuinely outside of IR35, it is very likely that will still be the case after April 2021. Don’t allow your client to decide otherwise without following the process set out in the legislation.
If you need help with this, ensure that you are working with an expert Contractor Accountant like SG.