IR35 Tax Reform: Guidance for businesses using contractors
HMRC’s changes to the IR35 tax legislation for contractors employed by private firms, through an intermediary such as a personal service company (PSC), come into force on 6th April 2020. This will shift the tax assessment and liability away from the individual contractor to the client, so if your business employs contractors you need to be prepared.
The changes to the off-payroll working rules are designed to stamp out tax avoidance and National Insurance contribution manipulation by contractors who are to all intents and purposes an employee of a company – a ‘disguised’ employee – but are benefiting from the lower taxation rates afforded to businesses.
The reforms mandate that, as the firm responsible for contracting the individual, you will determine whether a role falls inside or outside IR35. Specifically, you will be required by law to assess every individual contractor’s tax status and issue what is known as a Status Determination Statement (SDS) for every engagement undertaken.
The first step is to audit your contractor base to assess the specific tax status of every contractor paid through an intermediary. Get it wrong and the liability for any unpaid tax and National Insurance contributions could fall at your firm’s door.
Assessing someone’s employment status can be difficult. HMRC’s Check Employment Status for Tax (CEST) tool might help, but the results are often inconclusive. However, it is due to be updated ahead of the April deadline.
The following four pointers should help:
- Mutuality of obligation: If the contractor has to accept work and the client is obliged to provide it, then the individual is likely to be categorised as on-payroll by HMRC.
- Part and parcel: Contractors who are embedded within the company structure, for example with line management responsibility, are likely to be viewed as employees.
- Supervision and control: This is a more nuanced area, but the general rule is that if a contractor agreement sets out terms such as mandated working hours, it is likely that the individual will be regarded as an employee for tax purposes.
- Substitution: If the role allows the contractor to send a substitute in their place and at their own cost when they are unable to work, then they will typically fall outside IR35.
Following the audit, you will need to allocate every contractor to one of the following categories:
Genuine independent contractor: A genuine independent contractor using a PSC and placed outside IR35 will continue to be paid the gross amount due for their services. If there is any uncertainty, your firm could choose to purchase insurance to mitigate the risk of having to pay out large sums in unpaid tax down the line.
On-payroll contractor: For contractors falling inside IR35, your firm will be responsible for ensuring that the correct levels of income tax and National Insurance contributions are deducted at source.
Deemed model: This gives you the flexibility to treat genuine independent contractors operating as a PSC as inside IR35 for specific client engagements.
Umbrella: If a lot of your firm’s assignments fall inside IR35, you could set up an umbrella services company that will withhold all taxes due by contractors, while extending some of the PAYE benefits to them – for example, health insurance, pension scheme, health club membership. This approach could help to alleviate some of the financial impact of the IR35 reforms.
Statement of Work (SOW) solution: This is an option for any assignment that can be implemented using milestone and deliverable-based outcomes. In this scenario, the agency becomes the end user, but will still face the same tests if it uses contractors. There are a number of potential pitfalls with this model and it will also likely be far more time-consuming – and therefore expensive – to administer.
In summary, you will need to get in touch with all of your contractors ahead of the April 2020 deadline to confirm their IR35 status. You will need to:
- Create an employment status determination statement;
- Clarify or adjust any contractual terms;
- Adjust the method of remuneration, where applicable.
As part of your communication, it is worth recommending that contractors seek independent tax advice prior to 6th April 2020 to ensure they are fully informed.