IR35: How this could affect you and your company

Understanding the Implications of IR35 for Company Directors

IR35, also referred to as the Intermediaries Legislation was initially enacted in April 2000 as a government initiative to curb tax avoidance. The legislation was built on the idea that independent contractors could evade tax obligations by operating through an intermediary, such as their own limited company, rather than being classified as employees under the PAYE scheme.

Some individuals choose to work through recruitment agencies or umbrella companies that handle salary and tax payments. HMRC questioned the employment status in cases where extended contracts were in place or when contractors were viewed as ‘disguised employees.’

 

What is ‘disguised employment?’

When an individual transitions from being an employee on a Friday to working as a contractor on a Monday, performing the same tasks but with reduced tax obligations, it is termed as ‘disguised employment.’

This practice is advantageous for the former employer as they are relieved from making Employers’ National Insurance contributions and providing employment benefits or rights to the contractor.

The introduction of IR35 legislation aimed to detect disguised employees by implementing a test for employment status. If a contractor doesn’t pass this test, they may be categorised as ‘inside IR35’ and would be required to pay tax and National Insurance contributions as if they were an employee.

 

Testing for employment status

Although HMRC has recently introduced a new tool for determining employment status, several aspects of a contract can indicate whether a contractor is employed or self-employed. These include:

• Control: Do you have control over your work hours and the way the work is done?
• Right of substitution: Can you appoint someone else to do the work if you’re unavailable? Would you be responsible for paying the substitute and covering any training costs?
• Mutuality of obligation: Is there an obligation for your client to offer work or for you to accept work if offered?
• Employment rights: Does the contract mention employment rights like holiday or sick pay?

Other considerations include whether you provide the necessary equipment for the contract, such as computer or video editing hardware, the level of financial risk you bear, and the ‘length of engagement.’

To be considered self-employed, it’s essential to avoid being perceived as an integral part of your client’s company. This involves refraining from using a security pass alongside your client’s employees or even using the staff canteen, as these actions could work against you in an IR35 tax investigation.

In summary, IR35 assesses an overall perspective of your working practices. For instance, if a contract specifies that the personal service company can send another person in your place to perform the work, demonstrating the ‘right of substitution,’ and when all other factors are considered, it may indicate that IR35 does not apply.

 

Changes to IR35 legislation in 2017

The government points to a combination of intricate IR35 rules that are challenging to comprehend and substantial non-compliance, estimated at £440 million annually, as the rationale for altering IR35 legislation in the 2017 Budget.

HMRC contends that in numerous cases, without the existence of a limited company acting as an intermediary, directors would be classified as employees of their clients.

Traditionally, the responsibility for determining the applicability of IR35 rules and ensuring correct tax payment rested with the contractor. However, as of April this year, this responsibility shifted to the end-client for those working exclusively in the public sector.

Despite the introduction of the new online Employment Status Service Tool by HMRC, uncertainties persist when deciding whether IR35 applies. The tool poses queries about various contract aspects, such as the right of substitution, and the public sector client has 31 days to determine a contractor’s employment status.

 

What does this mean for company directors?

This new process poses a risk to company directors operating their personal service companies, as public bodies might be inclined to categorise contractors as ‘within IR35’ to avoid making an incorrect decision.

Beyond the substantial loss of earnings for company directors falling under IR35, there is concern that this could trigger an HMRC investigation into previous contracts spanning several years.

When a contractor is deemed ‘inside IR35’ and subject to the legislation, HMRC reviews each contract, subtracts the tax already paid from what an employee would have paid through PAYE, and retroactively applies this tax charge to the contractor.

Read More:

• Understanding IR35, CEST, and the new April 2020 rules
• IR35: How the Public and Private Sector reforms affect contractors
• IR35
• Dedicated advice for freelancers and contractors

 

How IR35 rules lead to company insolvency

This process can lead to significant financial challenges in many cases and may readily result in insolvency for the personal service company concerned. HMRC has the authority to review contracts for at least six years to determine if contractors or company directors fall under IR35 rules. 

The prospect of enduring reduced income, especially for personal service companies primarily serving clients in the public sector, is indeed concerning. If HMRC also applies IR35 to past contracts that have already been completed, this combination could lead to a spiral into debt that is challenging to overcome.

Even if you are confident that IR35 does not apply to your working situation, HMRC can still initiate an investigation, causing disruption and expenses. Intermediaries Legislation is a highly intricate area, and the guidance of an IR35 specialist is essential to anticipate tax investigations and assist in managing them if you become a target.

If you are uncertain about the applicability of IR35 rules or are facing scrutiny from HMRC, Vanguard Insolvency can provide assistance. We offer guidance on the new ‘off-payroll’ IR35 regulations and seek clarity in this particularly complex aspect of self-employment. Contact our experts to arrange a same-day meeting at one of our offices.