What is IR35?
The ‘IR35’ rules have been in existence for many years and are designed to prevent the avoidance of tax and national insurance contributions (NICs) through the use of personal service companies (PSCs) and partnerships. The ‘off payroll working’ regulations were introduced to essentially increase the enforcement of the IR35 rules. The ‘off payroll working’ regulations were first introduced in April 2017 for services supplied to the public sector and then later expanded to the private sector in April 2021.
The regulations apply where individuals provide their personal services via an ‘intermediary’ to the ‘fee-paying business’. An intermediary may be another individual, a partnership, an unincorporated association or a company. The most common structure is a worker providing their services via their own company (PSC) which is the term used in this article to summarise the rules which will apply to all intermediaries.
What is the effect of IR35?
If determined that the rules apply, this will mean:
- the fee-paying business will calculate a ‘deemed payment’ based on the fees that the PSC has charged for the services of the individual worker
- generally, the entity that pays the PSC for the services must first deduct PAYE and employee National Insurance contributions (NICs) as if the deemed payment is a salary paid to an employee
- the fee-paying business will have to pay to HMRC not only the PAYE and NICs deducted from the deemed payment but also any employer NICs on the deemed payment
- the net amount received by the PSC can be passed onto the individual without paying any further PAYE and NICs.
The practical effect of these rules is that the individual worker no longer benefits from the potential tax advantages of receiving such income via their own company.
The businesses to whom the PSC provides a service may look to renegotiate their contracts due to their increased cost of employer NICs.
Who will decide if the IR35 rules apply?
The onus is on the fee-paying business to form an opinion as to whether the individual worker would be regarded as an employee of the business if the personal services of the individual worker were provided under a contract directly between that individual and fee-paying business. This is the same kind of employment status test based on case law that businesses and agencies must consider when they hire staff directly.
HMRC has a Check Employment Status Tool (CEST) to help businesses decide the status of individuals that provide personal services to them. HMRC have previously stated that the tool is ‘able to determine employment status in 85% of cases’, which also means it is not correct in 15% of cases. Many commentators consider the accuracy of the tool to be much lower.
For reasons which are explained below, the fee-paying business may be tempted to make a finding of ‘employment’ status, particularly if the CEST indicates employment.
The Employment Status Service tool can be accessed at www.gov.uk/guidance/check-employment-status-for-tax.
Why were these rules introduced?
In the past, PSC / individual worker made the decision as to whether they fell within the definition of off-payroll worker or not, with many viewing the risk of being ‘caught’ by IR35 worth taking, given that the benefits of company profits being paid out under a ‘low salary, balance as dividends’ regime
far outweighed the burden of paying PAYE and NICs. However, the new legislation shifts the responsibility and any risks of non-compliance on to the fee-paying business that is receiving the services of the individual worker. If the fee-paying business decides the new rules do not apply, they face the possibility of a protracted dispute with HMRC. If the Tribunal decides against the fee-paying business, they will have to pay over PAYE and NICs to HMRC, having already paid the gross fees to the PSC.
What is the tax effect on the Individual worker?
The important point to appreciate is that the individual worker will be treated in tax terms as an employee of the fee-paying business, with P60’s etc. being issued that show gross pay and deductions for PAYE and NIC. The individual worker will need to declare the amounts reported on Form P60 (or P45) as an employment on the employment pages of their self assessment tax return.
The other important point to appreciate is that the PSC actually receives the income from the fee-paying business, not the individual worker personally. Tax legislation has special rules that enable this income to be drawn from the PSC tax efficiently.
What procedures does the PSC need to follow if deemed payments are received?
To avoid the same income being taxed twice, the PSC will deduct the amount of the payment it receives, as well as the PAYE/employee NICs costs incurred, from its taxable income.
If you have any queries, please do not hesitate to contact Tim Adcock.
Written October 2019 (Updated June 2023)