Who does IR35 apply to?
Since its introduction into the public sector in 2017, the off-payroll working legislation previously known as the Intermediaries Legislation (better known IR35), has changed the way how many people in the UK work and how they are paid.
As of June 2021, there were over 4 million self-employed workers in the UK (1). Many of whom are contractors, freelancers, self-employed consultants, and independent agency workers who will have been impacted in some way by the changes to IR35, firstly in the public sector, and now since April 2021 in the private sector.
IR35 was originally introduced as a way of curtailing what HMRC perceived to be ‘disguised employment’, a form of tax avoidance which benefited the end client engager who wouldn’t be liable for employment taxes or to provide employment benefits. Self-employed workers also benefited by setting themselves to trade through their own limited companies – often referred to as personal service companies or PSCs - so they could pay little or no National Insurance Contributions and lower income tax, by paying themselves a low salary and then topping up via dividends (2).
However, despite its huge impact on a significant part of the UK’s workforce, many freelance contractors and particularly end clients are still unclear what IR35 actually is and who the off-payroll working legislation actually applies to.
With this in mind, Markel Direct UK has dedicated this blog post to explaining who is affected by IR35 and how each type of self-employed worker, from sole traders and freelancers to contractors and umbrella company workers, is impacted by this tax legislation.
The basics of IR35
IR35 status is determined on a per-engagement basis (per-contract). It is not applied once to your entire limited company then never assessed again. Your IR35 status will need to be assessed every time you begin a new engagement, and in some cases re-assessed should your contract be extended or run for a lengthy duration, or if the working practices of your contract change in any way (3).
From April 2021, the key change regarding IR35 in the private sector is who determines the IR35 status of the engagement. Previously, the IR35 status determination was the responsibility of the contractor, but with some few exceptions, that now shifts to being the responsibility of the end client with the tax liability falling onto the fee payer.
If you are working with a public sector client, or a medium to large private sector client, then those end clients will be responsible for determining the IR35 status of the engagement. There is an onus on these end client engagers to make a decision and, above all, take reasonable care in doing so. If they don’t, then this could mean that your client will be liable for any unpaid taxes.
If they make an incorrect status determination despite taking reasonable care, HMRC’s focus will turn to the fee payer, which is the entity which pays your company. This could be the end client if your company is engaged directly. However, if there is an agency (or more than one) sitting in the contractual chain between the end client and your company, then the agency sitting immediately above your company in the chain – the one which will pay your PSC – will be saddled with the liability – but only if the end client has taken reasonable care in its decision-making process (7). There have been many high-profile news stories of this in the public sector in recent months.
If you are working for a small private sector company as an end client, the position changes. This is because an exemption to IR35 exists for small businesses. As defined by s382(2) of the Companies Act 2006, to be classed as a ‘small business’, an organisation must meet at least two of the following criteria:
• Annual turnover of no more than £10.2 million.
• Balance sheet total of no more than £5.1 million.
• No more than 50 employees (4).
In these circumstances, you, the contractor, retain the responsibility for determining IR35 under the “old” IR35 (Chapter 8 part 2 ITEPA 2003) rules. The same applies if you are engaged by a wholly overseas company with no UK presence.
Does IR35 apply to sole traders?
As we will go on to discuss, most of the talk surrounding IR35 has revolved around how it impacts those who work through their own limited companies. However, can sole traders also be impacted by this ever-evolving legislation?
Well, the simple answer to this question is no - IR35 doesn’t impact sole traders. This is because this legislation only applies to engagements where the person is trading through an intermediary; i.e. their limited company (or partnership), and as a sole trader you do not operate in this way, and thus cannot be caught out by IR35.
However, while IR35 isn’t relevant to sole traders, the principles of determining IR35 are the same for employment status generally. laws around the designation of employment status still do apply, and these can be closely tied to IR35. This is to say, for example, if a client engages a sole trader to provide their services, the client could end up being responsible for any unpaid tax and National Insurance contributions if The same issues around the key status factors of personal service (the right to substitute); the exercising of control over the subcontractor and mutuality of obligations (MOO) need to be considered. As do the in-business factors which the self-employed individual can demonstrate.
If these do not point towards self-employment, then the individual should be treated as an employee. With no intermediary company to take on this role, the individual can only be the employee of the business engaging him or her. Therefore the company receiving the individual’s services would become liable for unpaid Employers’ National Insurance Contributions (plus interest and possibly even a penalty).
The engagement of sole traders rather than contractors and consultants through their own limited companies has been rare in the white collar arena in particular. The engagement of sole traders is perhaps more common in construction and the creative sectors, but neither form of trading is completely exclusive to one industry or sector.
What does IR35 mean for freelancers?
The objective of the IR35 legislation is to assess whether or not freelancers and contractors who provide their services to third party organisations through their own limited company should be considered ‘genuine freelancers/contractors’ Or are they operating as a ‘disguised employee’ to reap the tax benefits of being paid through their limited company. HMRC’s argument is that two people undertaking the same work should not be taxed on a different basis.
paying tax under different regimes Therefore, the purpose of the off-payroll working legislation – and indeed IR35 when it was first brought in – is to ensure that the same amount of tax is being paid for the engagement of both workers, should the relationship not reflect genuine self-employment.
How does IR35 affect contractors?
Contractors and freelancers working through their own limited company enjoy several tax efficiencies over employees. They are able to claim their home to site travel because their company is sending them to a different place of business; whereas for an employee this is their commute. All the expenses that are associated with running a business are also tax deductible and critically, the ability to remunerate via low salary and dividends, reduces both the tax and NI burden for the contractor.
As workers of this kind typically do not receive employee benefits such as sick and holiday pay, as they are not a full-time employee of any one company, these tax efficiencies – plus the fact that they tend to have higher day rates than the salary of their employed counterparts – are seen as the reward for taking the risks associated with being in business.
Genuine independent contractors are described as being ‘outside IR35’ and can be paid gross; i.e. paid based on the invoice they issue. Those who are inside IR35 (often referred to as ‘caught by IR35’) should be paid in the same way as employees are with tax and National Insurance Contributions being deducted at source by the fee payer.
If as a contractor or freelancer, you have become accustomed to being remunerated on the basis of your engagements being ‘outside IR35’, for this position to change can have a massive impact on your finances. Net income can be reduced by as much as 25 percent (5) and under certain circumstances, HMRC can go back as far as six years to evaluate the contracts you have worked on. This could result in you owing hundreds of thousands of pounds in backdated tax if you have been falsely treating your engagements as being outside of IR35 when that was not a contractor working through the case.
On the other hand, if you are a limited company contractor and have been assessed as outside IR35, you can continue operating as normal. This means your company is paid a gross amount for your services from which you can pay yourself a salary and draw the remainder of income out as dividends. In this scenario, you also remain responsible for paying your own taxes.
Does IR35 apply to umbrella companies?
Umbrella companies used to be a means of engaging contractors/freelancers who do not have their own limited company and that is still the case now. However, since the introduction of IR35, many engagements run through umbrella companies because the contractor doesn’t want to use their company for an engagement deemed inside IR35 or the end client is one which will not sanction the use of PSCs in order to avoid engaging with the off payroll working legislation. When working through an umbrella the individual is an employee of that umbrella and so all their income should have PAYE deducted from it as would be the case for any other employee.
Many contractors switched to Umbrellas after public sector IR35 was introduced in 2017, as it became clear that contractors operating through their own limited company who were determined to be working inside IR35 would be impacted as follows:
- If they couldn’t negotiate a better day rate, it would be reduced by a deduction for employers’ NICs.
- The amount remaining would be taxed under PAYE, which means their take home pay would be significantly impacted.
- An engagement which is inside IR35 means that you cannot claim your home to site travel, e.g.: like an employee, they could not claim their commute – meaning these costs would now come out of their take home pay.
- The 5% notional allowance for expenses would be removed for any engagement deemed inside IR35 where the fee payer was responsible for the tax deductions.
This means that once a PSC presented an invoice, all of the amount would be accounted for as in the form of net pay or deductions. A whole tax year on this basis would leave the contractor with no profit, no loss, and nothing to set expenses off against, meaning there would be little point in continuing to trade through their limited company.
Consequently, many contractors opted to join umbrella companies. Although many private sector contractors already work via umbrella companies, it is thought thousands more will now follow. Working for an umbrella company means that you are technically an employee of that company, but what you must remember is that if the end client or agency has agreed a day rate with the umbrella for your services, that is NOT the amount you will be paid.
The umbrella will make the following deductions from that day rate:
• An amount for the provision of its services
• Apprenticeship levy if applicable
• Employers’ National insurance
These are not deductions from your pay, but the cost of employing you.
From your gross pay, you will have income tax and employee’s national Insurance deducted in the same way as any other employee.(6)
Umbrella companies have always existed because engagers and agencies did not want people on their payroll, but were happy to pay a limited company for its services. With the advent of the off-payroll changes, there has been considerable growth in the use of umbrella companies. As the individuals are employees, IR35 is not applicable. However, be wary of any umbrella company which is not deducting taxes in the usual manner. If it is offering loans or some kind of ‘hybrid’ payment model, you should take tax advice because if it doesn’t work, then you will be the one liable for any unpaid tax.
Markel Direct offers a range of solutions for freelance contractors including Legal Expenses Insurance and an IR35 Contract Review service.
Please contact 0330 433 2135 for further details and a quote or click here for a quick online quote in as little as 90 seconds.
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