A Guide to IR35 Legislation every Small UK Business should read

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IR35 legislation relates to contractors and the relationship they have with the businesses to which they provide their services. The legislation was enacted in an attempt to establish whether or not contractors were engaging in a genuine business to business relationship, or if there was a case of ‘disguised employment.’

Before IR35

Prior to IR35, most contractors worked as self-employed individuals, until an HMRC rule change in the 1980s made recruitment agencies liable for unpaid tax that came about from these relationships. As you may imagine, recruitment companies simply ceased to work with any self-employed contractors, refusing to entertain any risk of liability for the unpaid tax.

As recruitment companies were not under any obligation to cover tax shortfalls when dealing with limited companies, contractors quickly established their own limited companies. This new way of working offered its own benefits to contractors and in maximising their own returns, HMRC found that tax revenues weren’t what they might have been.

The solution to this was IR35, which was brought into effect in the year 2000. HMRC suggested that IR35 was required to ensure that workers were protected and that businesses stepped up to their responsibilities towards their employees.

If it Looks like a Duck

The old saying that if something looks like a duck and quacks like a duck it must be a duck applies when working under IR35 legislation. If the relationship between a contractor and a business appears to be akin to a more traditional employee and employer relationship, then according to HMRC, it will be treated as such. 

In broad terms, income tax for individuals deemed to be employed under IR35 legislation will be collected under PAYE rules, except for a 5% allowance which is paid to cover operating expenses for a limited company. The only other expenses allowable are those that an employee would reasonably be allowed to claim, such as mileage or laundering of work uniform. 

The reasoning behind this is to ensure that would-be contractors think carefully before incorporating as a limited company and if their relationship with a client is one of disguised employment, the tax implications disincentivise this.

Rule Changes

Under current rules, contractors who offer services to organisations within the public sector are to be informed by these organisations as to their employment status. As such, the organisation must decide whether or not the contractor is an employee and must have tax deducted from their pay under PAYE rules, or whether they are a bona fide self-employed contractor, looking after their own tax.

Within the private sector, the intermediary working with the contractor must decide on the employment status for each and every contract undertaken by a contractor. In considering the private sector, this also includes third sector organisations, for example, some charities.

At the start of the next tax year in April 2020, these rules will be applied slightly differently.

Whilst public sector organisations will still make decisions as to the employment status of their contractors, medium and large private sector enterprises will now need to make these decisions themselves. 

For smaller private sector clients, intermediaries will still be responsible for making the judgement as to the worker’s employment status.

As per the HMRC guidelines, whether a company is classed as a medium or large enterprise relate closely to the small companies’ regime. In short, if two or more of the following conditions are met, a company is classed as medium or large:

Turnover is more than £10.2 million annually The balance sheet total is greater than £5.1 million The company has more than 50 employees

Companies that are currently small may find that their circumstances change over time. If a company is expanding and meets these conditions for more than 2 consecutive years, the rules for deciding the employment status of a worker must be then followed from the beginning of the tax year following the close of the filing period in which the conditions have been met.

When a Judgement is made

When an organisation has come to a decision regarding the employment status of a worker, they must inform both the contractor and their intermediary of the outcome. 

Workers can, of course, disagree with judgments made regarding their employment status and make an appeal. If this happens, it is the organisation’s responsibility to consider the reasons for the disagreement, decide whether or not to change the determination and explain the reasoning either way. It must keep records as to the decisions made, in addition to any appeals made by workers. 

If you’re unsure about whether your workforce is subject to the changes in IR35 legislation, it’s important to get in touch with a trusted chartered accountant, who can help you get compliant and avoid any nasty surprises from HMRC in the future.