An Overview of Off-Payroll Working Rules (IR35)

Introduction

The off-payroll working rules make sure that a worker (sometimes known as a contractor) pays broadly the same Income Tax (IT) and National Insurance contributions (NICs) as an employee would.

The rules apply if the worker who provides services to a client through their own intermediary would have been an employee if they were providing their services directly to that client.

The rules are commonly known as ‘IR35’.

What is IR35?

In simple terms, IR35 is intended to root out ‘disguised employees’ by looking at what is actually happening in the relationship between the employer and the company, rather than what is being represented at face value. IR35 also means the onus is on the employer if there are discrepancies in taxation etc. Generally, whether or not work falls within IR35 is now for the employer to decide.

With this in mind, IR35 is UK-wide tax legislation which aims to close a loophole in the tax system whereby workers could pay less tax by setting up a limited company (or partnership), than they would if employed.

It is the common term for Chapter 8 Part 2 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA), also known as the Intermediaries Legislation (IR). Specifically, IR35 was the name of the press release from the then Inland Revenue which announced the legislation when introduced in 2000, and has become the common term to refer to this legislation.

Some of the criteria used to determine whether someone is ‘inside’ (i.e. employed for tax purposes) or ‘outside’ IR35 (self-employed for tax purposes) are common sense. Simply put it means: if you act like and are treated like an employee you should be taxed as one. However, there are a lot of grey areas in the legislation and some points which may seem relatively insignificant can have a major impact. Therefore it is always advisable to consult an expert before making any decisions over your IR35 position.

Purpose of IR35

It is essentially tax avoidance legislation designed to tax ‘disguised employment’ at a similar rate to employment.

Who Determines if the Rules Apply?

The person responsible for administering the rules, including determining whether the worker is employed for tax purposes, depends on whether the client is in the public or private sector and whether the client is a small business.

The client is usually responsible for determining the employment status of the worker and if the rules apply. However, the worker’s intermediary is responsible if the worker provides services to a small client outside the public sector. Different rules also apply if the client is entirely based overseas. Read more about off-payroll working for clients.

The off-payroll working rules apply on a contract-by-contract basis. A worker may have some contracts which fall within the off-payroll working rules and some which do not.

Public and Private Sector Reform

On 06 April 2021, new off-payroll working rules were put in place for the private sector. This meant that the IR35 determination process was changed for those engaged to a medium or large client in the private sector. These changes had already been in place for the public sector since 06 April 2017.

Medium and large sized private sector businesses hiring personal service company (PSC) contractors are responsible for determining the IR35 status of their contractors since April 2021. Those workers who fall inside of IR35 are required to have PAYE and National Insurance Contributions (NICs) deducted at source from their income. The ‘fee-payer’ (usually the agency or end client depending on the contractual chain) is responsible for deducting the relevant IT/NICs on behalf of the worker, prior to paying the PSC’s fee.

These changes follow similar rules regarding ‘off-payroll’ workers in the public sector which came into force in 2017. The Autumn Budget 2018 announced that the off-payroll rules in the public sector would be extended to the private sector as of April 2021.

Public Sector Reform

Rules for applying IR35 in the public sector came into force on 06 April 2017, impacting all contractors working for clients who fall under the Freedom of Information Act 2000 (and Freedom of Information (Scotland) Act 2002 for Scotland), such as local authorities, universities, and national service organisations.

Public sector organisations hiring personal service companies (PSCs) are required to check the IR35 status (employment status for tax) of their contracted workers, and ensure the correct IT/NIC is paid.

This means that contractors working with a public sector client are subject to the IR35 assessment provided by their client, and may have tax deducted at source by the fee-payer, or be required to use an umbrella company.

Public sector reform is estimated to have increased overall Exchequer revenues by £250 million in the first 12 months according to a government review of the changes, and was widely considered a test bed for extending the rules to the private sector (as discussed below).

On 6th April 2021, the off-payroll working rules were extended to the private sector. With this came some adjustments which also applied to the public sector (discussed next).

2021 Changes at a Glance

Public sector bodies are now required to supply a Status Determination Statement (SDS) to both the contractor and the next party in the supply chain who will then be responsible to pass the SDS on until it reaches the fee-payer.
Another change was the introduction of a client-led disagreement process.
During the introduction of IR35 reform in the public sector, some organisations initially took a short-sighted approach and applied blanket assessments.
Blanket assessments refers to the practice of applying a usually inside-IR35 status to all contractors, or a large group of contractors, without proper assessment of the individual’s circumstances.
- It is a risk-averse and short-sighted approach which some organisations mistakenly saw as an easy way out of the rules, leading to mass walkouts and delayed projects.
In response to this practice, the need for a way for contractors to disagree with the determination provided was needed.
- Organisations must now consider any disagreements and respond within 45 days, however being at the discretion of the client organisation, the process still falls short of ensuring fairness in the process.

IR35 in the Public Sector (Contractors)

Unless you are providing services to a small company (see below) outside of the public sector, it is no longer your responsibility to determine your IR35 status. Your client must assess your status and provide you with a Status Determination Statement (written confirmation of their decision and reasons for it).

If you are considered inside IR35 (employed for tax purposes), the party which directly pays your fees will become your deemed employer and will deduct IT/NICs before paying you – much like an employer would. In many cases however, an umbrella arrangement would be encouraged or even required instead.

Most businesses will now undertake an indicative assessment before advertising a role, so keep an eye out for outside-IR35 roles that should allow you to work as normal.

IR35 in the Public Sector (End Clients)

The responsibility for IR35 sits with you as the end client, and you will need to assess your supply chain and where your responsibilities lie within it. If you use any managed services/contracted-out services or have overseas parties in the chain; this can add further complexity to your assessments.

Once you know your obligations, you will need to define your contractor engagement policies and regularly audit your compliance with the legislation. Getting IR35 compliance wrong can cost an organisation a hefty sum. Due to being a test bed for reform, the public sector has seen its fair share of compliance activity.

It was revealed in its 2020/21 accounts that HM Courts & Tribunal Services was made to pay £12.5 million to HMRC as a result of IR35 non-compliance.
The Department for Work and Pensions was hit with a tax liability of £87.9 million after making inaccurate IR35 determinations.
NHS Digital, despite using HMRCs own CEST tool, was hit with a tax liability of £4.3 million after it had set its contractors’ IR35 status incorrectly.

So, as you can see, it is important to get IR35 correct.

Private Sector Reform

Small Clients Exempt

Small private sector businesses are excluded from applying the rules so contractors engaged to a small company will need to assess their own IR35 status. A small company is defined as such which satisfies two or more of the following requirements, as per the Companies Act 2006:

has an aggregate turnover less than £10.2million
has an aggregate balance sheet total less than £6.1million
has less than 50 employees

Status Determination Statements

Hiring organisations are required to provide a ‘status determination statement’ to both the contractor and next party in the chain to be passed to the fee-payer. The ‘status determination statement’ must include both the status decision that was made, as well as the reasoning behind it. Beyond these criteria, HMRC have offered no further guidance as to what this should look like, however we expect to see examples of the key status tests and the manner in which the decision was made e.g. if CEST (Check Employment Status for Tax) was used.

Client-led Disagreement Process

The introduction of a “client-led status disagreement process” now means that the client must respond to any dispute within 45 days, with both the decision and reasoning. Whilst this provides a contractor with the opportunity to present evidence against a determination, it ultimately removes a contractor’s ability to appeal via ADR or to a tax tribunal.

Obligation-based Liability

Liability as the fee-payer is dependent on the meeting of obligations e.g. until such time as the client provides an appropriate status determination statement, the client will be deemed the fee-payer and therefore liable.

Off-Payroll Rules in Practice

Despite numerous reports of businesses banning the use of contractors, or blanket applying an inside IR35 status (particularly in the finance sector), experience suggests that end clients, recruitment agencies, and businesses generally began taking the time to be fair and pragmatic in their response to the changes implemented in April 2021. There are some slight differences in the processes taken.

What Impact has IR35 reform had on Contractors?

Impact	Consideration(s)
Roles are now advertised with a preliminary status	1. In both the public sector and private sector, agencies and clients advertise roles with an expected IR35 status.
Clients assess your status	1. Before commencing the contract, your client will assess your status. 2. Reasonable care must be taken in this assessment. 3. Clients will usually utilise HMRC’s CEST tool (see above) or a third party. 4. In some circumstances however, the status will be determined on limited factors such as the role as opposed to you as an individual.
Clients provide you with a status determination statement	1. Before commencing the contract, end clients must provide you with a ‘status determination statement’, which says whether or not they believe IR35 applies as well as why. 2. This will also be passed along the supply chain to the fee-payer. 3. Until such time as your client provides this to you, the client will be considered to have failed in their obligations and will therefore be liable.
If inside IR35, the fee-payer will make any necessary deductions	1. Upon receiving the determination statement, if the result is that you are inside IR35 (considered employed for tax purposes), your fee-payer (usually recruitment agency) will become your ‘deemed employer’ and will be required to deduct the relevant tax and national insurance contributions before paying you. 2. Some recruitment agencies may choose not to engage in this manner and instead require contractors to engage via an umbrella company or alternative arrangement. 3. They should discuss this with you at the outset

Rights and Obligations

For agencies/hiring organisations: taking steps to understand the contractor workforce from an IR35 perspective is imperative to help you understand the various processes and responsibilities.
For contractors: It is important to understand your rights and obligations under the rules.

Steps to Take

As with the public sector reform, the responsibility for determining tax status is passed on to the end client if an individual is engaging with a medium or large sized business, and inside IR35 determinations place the individual onto their or the agency’s payroll; If an individual is engaging with a small business (only applies to the private sector) then this process remains with the contractor themselves. In some instances, the agency-end client will only accept contractors operating through umbrella companies or other trading styles. This lack of control puts contractors in a difficult position for ‘what to do’.

Open up a Dialogue with Your Agency/End-Client	1. Understanding their intentions is the first step. 2. Your tax status is no longer your responsibility, so speaking with your end user/agency is the best way of determining what will happen and how it will happen.
Encourage Your End-Client/Agency to a Third Party (if using one)	1. The compliance management system put in place requires the end client and agency to be on board with the process, which means whilst it would provide a fair and pragmatic solution to the reform, you can not use it without your client and agency including it into their processes for implementing the rules. 2. A number of agencies/clients who work with for the public sector have been referred to a third party by their contractors, so encouraging them to speak to the third party may help you in the long run.
Check Your Status	1. Whilst some third parties do not recommend using the CEST tool in general (due to clear biases and purposefully neglected key status tests), it is likely to be the first port of call for many end clients. 2. Using this tool will give you a heads up of what your result will or expect to be (remember that you may have differing opinions on how some of the questions are answered). 3. You may also want to have an independent IR35 contract review completed for the same reasons.

If you are engaged to a small business (outside the public sector) you remain responsible for your IR35 status, meaning you continue to determine your own status as normal with no changes.