IR35 compliance for end clients

If you’re in charge of hiring contractors sometimes called off-payroll workers) for a public sector body or a medium to large company, you’ll be aware of IR35.

CoComply is a specialist provider of IR35 compliance services. Our job is to keep you on the right side of the HMRC by implementing best practice IR35 process across your organisation so you can confidently engage contractors knowing off-payroll compliance is taken care of.

This article is for people within organisations who have the responsibility for hiring contractors who wish to broaden their knowledge on IR35 compliance.

In three minutes, you’ll find out:

What IR35 is and what it is meant to stop
What the legal definition of a contractor is
Who is responsible for IR35 compliance
What you need to consider in an IR35 compliance test
Whether you should use a template to determine IR35 status
What an employment status determination statement is
What to do if a contractor appeals against your status determination
What the fines are for getting IR35 compliance wrong

For more information on IR35 compliance for end clients, please call +44 (0) 203 051 9792, email [email protected] or fill out the form below.

What is IR35?

The history of IR35 (sometimes called the intermediaries legislation) stretches back decades. In its current form, it’s been with us since the then Inland Revenue introduced it in 1999.

The purpose of IR35 is to stop workers from leaving a job on a Friday only to come back as a contractor the following Monday.

Why did HMRC think IR35 was necessary?

Employees and contractors do not pay the same tax.

Employees pay income tax and National Insurance contributions. Their employers also pay National Insurance Employers’ Contributions and, if applicable, the Apprenticeship Levy.

If an employee earns £100,000 (making no pension contributions), you pay £27,428.40 in income tax and £6,661 in National Insurance. Your employer pays £15,050 in NICs. So, the correct tax take for HMRC from an employee earning this much is £49,139.

The tax rules for contractors are completely different.

Assuming a basic salary of £12,570, the contractor pays corporation tax of £16,512.48. The contractor could draw £70,395.29 in dividends paying £14,158.41 tax on them. There will be a small contactor NIC bill of £522.24. The employer pays no NICs. HMRC receives £31,193 under this arrangement.

The employee would take home £65,960 in the year and the contractor would take £68,806.

Over recent years, the gap has got narrower. Plus, the example we’ve shared above is very simplified.

It’s very rare that a contractor would take out every last penny in this way. They would be more likely to build up cash in their business account over years and then close the company paying 10% tax on the lot by using a Member’s Voluntary Liquidation.

What is a contractor?

Who is a contractor? Strictly speaking, a contractor is an individual who delivers services via a limited company (sometimes called a personal service company) to a client. The limited company is a legal intermediary.

Sometimes there can be more than one intermediary involved in an arrangement, like an umbrella company or a recruitment agency. Please note that contractors taken on via an umbrella company are inside IR35.

Not all contractors use personal service companies. A few are self-employed (unincorporated sole traders or partners) but most work through their own limited company because of the tax advantages.

There are hundreds of thousands of contractors offering services via limited companies in the UK, particularly in the:

IT sector
Transport sector
Engineering sector
Business services sector
Construction sector

Who is responsible for IR35 compliance?

Prior to the recent legislative changes, the determination of a contractor’s status was the contractor’s responsibility. [Related article: The end of IR35 self-determination for most]

Under the revised off-payroll working rules, the following types of organisations are responsible for IR35 compliance:

a medium or large company in the private sector or
public sector organisations

The only exception to this rule is if a contractor is providing services to a small company (generally, companies with a turnover smaller than £10.2m).

Why is ensuring compliance no longer the responsibility of contractors?

For 20 years, contractors got to know the rules on IR35 status. They worked with their clients to make sure that their engagement could be correctly classed as self-employment.

HMRC often disagreed and took thousands of contractors to the First Tier Tribunal as they attempted to prove they were inside IR35 rather than outside. They lost lots of cases.

HMRC then decided it would be better to go for the end-clients (fee payer) for two reasons:

To close the perceived tax loophole being exploited by contractors operating as disguised employees
IR35 is reportedly worth an estimated £1.4 billion to the treasury

HMRC’s bet was that the precautionary principle would kick in. Rather than take the risk that someone may be outside IR35 and get the weighty cost of defending themselves against the taxman and enormous fines, they’d just declare everyone inside IR35.

Either way, HMRC would get more revenue.

IR35 Status Determinations

You need to perform a thorough IR35 determination on every contractor.

You must take reasonable care when determining status or you’ll face steep fines for IR35 non-compliance.

When determining an individual’s employment status, you must accurately reflect and account for a number of different key factors to ensure compliance including but not limited to:

Do they provide services personally? If your contractor has to provide services directly themselves and they can’t send in someone else to do it, this is indicative of a disguised employee.
Other clients. If you don’t permit a contractor to work for different organisations while working for yours, HMRC would argue that your contractor should be on your standard payroll.
Further work. If you don’t ask your contractor to do work not covered by the contract you’ve both agreed to, this is an indication that your working arrangement with them is inside IR35.
Sick pay and holiday pay. If you do not pay contractors sick pay or holiday pay, this suggests that, for tax purposes, this contractor is outside IR35.
Financial risk. If your contractor makes a mistake and they are liable to pay to rectify that mistake on their own account, this is evidence that your arrangement with them is outside IR35 as is having professional indemnity insurance and public liability insurance.

Should we use an outside IR35 contract template?

You can download an outside IR35 contract template from a number of different websites.

The problem with IR35 contract templates is that, to be confident that they’re filled in accurately, you need the due diligence an IR35 specialist like CoComply or an employment law solicitor would bring.

There is a significant body of case law governing the employment status of off-payroll workers. The reasoning behind judgements given is technical and complicated. Even a watertight outside IR35 compliant contract might not be enough if the daily working realities of your contractors vary from what they’ve agreed to in their contract.

The employment status determination statement

In IR35, you are the end client. That’s because your organisation directly benefits from the services provided by a contractor’s personal service company.

The fee payer is the organisation which pays the personal service company. If you recruit contractors directly, you are both the end client and the fee payer.

If you employ a recruiter to find your contractors and they pay contractors rather than you, you are the end client and they are the fee payer.

You must send a copy of the determination statement to every party in the contractual chain.

Can contractors challenge status determination statements?

One fear many contractors had was that employers would take fright and declare all contractors within IR35 regardless of individual working practices.

They were right to feel this way. There is a lot of evidence to suggest this is what happened.

Contactors can lodge an IR35 status determination appeal if they disagree with your assessment.

They are more likely to do so if you use the CEST tool, download an IR35 compliance template or issue blanket compliance or role-based compliance statements.

Most contractors write to their employers to request a reassessment. Make sure that you keep all relevant correspondence with your contractor before, during and after a dispute.

You are under no obligation to change your assessment nor obtain third-party contract reviews. You have 45 days to respond to your contactor. Contactors can appeal a determination until the day they receive their final payment from you (or the fee payer).

The financial penalties for getting employment status determinations wrong

If your contractors are found to be working inside IR35 where you had previously declared them outside IR35, you’ll have a make a “deemed payment” to HMRC.

The value of the payment will be the relevant tax and National Insurance contributions you would have deducted and paid but didn’t. You make this payment generally at the end of the tax year.

You will likely also pay a penalty on top, the severity of which is determined by whether your error was through carelessness, dishonesty or negligence.

Turn the new off-payroll working rules to your advantage

Running an IR35-compliant payroll is difficult. It’s been difficult for many public and private sector organisations to adapt to the change.

But the new off-payroll working rules do present an opportunity to attract the most talented contractors to your business. CoComply works with companies and public sector bodies to create a compliant environment in which the contractors you chose can be declared outside IR35.

This not only saves your business money but, because contractors don’t have to pay income tax or National Insurance nor have an umbrella company dipping into their pay, they’re more likely to choose to work with you.

For more information on IR35 compliance for end clients please call +44 (0) 203 051 9792, email [email protected] or fill out the form below.