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IR35
Background
The IR35 rules affect contractors that operate via their own companies. The key question with IR35 is whether a ‘deemed employment’ relationship exists. More specifically the question is whether in the absence of the contractor’s company would the contractor have been classed as an employee of the end client under ‘employment status’ case law. If a deemed employment relationship exists, then the contractor’s company falls within IR35 and is subject to an adverse tax regime.
The April 2021 Private Sector Reforms
The private sector reforms in April 2021 broadly followed the public sector reforms introduced in April 2017. The basics of IR35 were unchanged by the reforms, namely if no deemed employment exists then the contractor will continue to be Outside IR35. What changed with the reforms was who was responsible for determining whether a deemed employment relationship exists. Previously the responsibility belonged with the contractor’s company. Following the reforms the responsibility rests with the end client.
This is significant because of the PAYE and Class 1 NIC tax liabilities that the end client is exposed to when they make an incorrect decision. A cautious end client who is in a strong negotiating position is therefore more likely to make an Inside IR35 decision without any compensating increase in contract rates.
There is an important exception for smaller end client companies. If the end client company qualifies as a small company under the companies act, then the private sector reforms do not apply, and the tax risk of an incorrect decision is with the contractor’s company.
Responsibilities along the Supply Chain
Under the reforms the end client has a responsibility to share its employment status decision with the parties in the supply chain. Where an Inside IR35 decision is given the agency paying the contractor’s company is responsible for deducting PAYE and Class 1 NIC. In the event HMRC is unable to collect the amounts due, the liability is passed to the party that failed to fulfil its obligations, with the eventual default being that the end client would be liable.
Disagreements with Decisions on Status
The process for handling status disagreements is operated by the end client. In practice there is little that can be done if the contractor does not agree with the decision. An option available to a contractor that does not agree with a status decision is to make a claim for a tax repayment in his self assessment tax return along with a full disclosure as to the reason. This would almost certainly result in an enquiry from HMRC into the tax return.
HMRC’s Online Status Tool ‘CEST’
HMRC’s online tool for determining employment status is known as ‘CEST‘. HMRC undertake not to challenge an Outside IR35 verdict from CEST providing that the information given is correct. While a favourable CEST verdict would obviously be very helpful to a contractor, there will always be some uncertainty as HMRC could take the view that the information entered is not correct.
The accounting and tax profession have widely criticised the tool for failing to take account of existing employment status case law and failing to reflect the complex nature of the private sector.
Reports and Supporting Evidence
Contractors working via their own companies with private sector end clients should avoid agencies and end clients that have poor reputations on IR35 compliance and contractual matters. Contractors operating Outside IR35 should have a CEST report and/or a 3rd party specialist report supporting the Outside IR35 case, and retain supporting evidence. These reports, along with supporting evidence, are very important if the end client qualifies as a small company under the companies act.
Employment Rights
An Inside IR35 decision, of itself, does not result in any employment rights being granted to the contractor.
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Director - Ian Blackwood CA CTA