IR35 - What You Need To Know

Ever since the introduction of PAYE and particularly so in the last twenty years, the rules surrounding what defines “employment” have greatly tightened. This tightening of the definition has been motivated by HMRC’s belief that a loss of tax revenue arises when workers are incorrectly classified as self-employed rather than as employees.

Ensuring that workers are correctly classified remains one of the most contentious issues facing businesses. From April 2020, all public sector and private sector employers will be solely responsible for the classification of the people who carry out work for the benefit of your business. HMRC have said that a failure to correctly classify a worker is likely to lead to financial penalties.

Likewise, contractors themselves are liable for declaring whether the work they carry out for a client falls within or out of the scope of the rules as defined by IR35.

Furthermore, HMRC has adopted a hard line approach to employment status. It regularly takes the workers and the companies they’re contracted to work at to the First Tier Tribunal where its record of success in correctly interpreting IR35 status has recently been thrown into question.

Bearing this in mind, this article will look to navigate a course through the whole employed versus self-employed minefield, paying particular focus on the approach by HMRC – from legislative definitions and compliance, through to disputes and the penalty regimes.

For businesses, understanding the approach of the authorities will help you to implement robust employment status procedures which may limit any potential risks in this area. For contractors themselves, it’s worth taking the time with every contract won to review it for IR35 purposes.

Why did IR35 come about?

Some view that the UK has an overregulated labour market , with employees generally being entitled to a great deal of benefits and employment rights from day one.

Whilst this is good for employees, there is a clear economic impact on employers, with National Insurance, pensions and holiday pay, for example, all increasing the payroll cost of full-time employees. This makes the use of self-employed workers an attractive option.

Why self-employed?

The common misconception is that self-employed staff are cheaper than employed staff. Of course, there is some economic benefit to using contractors including no Employers’ National Insurance, holiday pay, sick or maternity pay, and redundancy. However, for many employers, the primary benefits lie in the flexibility of contracted professionals.

Contractors also benefit from the arrangement, including the freedom to work on the contracts most desired, the significantly higher hourly rate, and more.

The status of workers

The employment status of workers is not a matter of choice nor is it defined by whether a worker has registered with HMRC as an employee or a contractor. Moreover, it is a matter of fact. There are three status tests which HMRC often use as a guide for identifying whether a worker is acting in a self-employed fashion (providing a contract for services) or whether they are to be treated as employees (operating under a contract of service). They are:

• Control
• Personal service
• Basis of payment
  

The control test is usually considered indicative of employment when there exists a level of interference in how a job should be done and by whom.

Self-employed workers generally receive less interference from a contractor and can exert more control over how, where and when a specific job may be carried out.

However, the control test is open to differing views on interpretation, so care must be taken if you are relying on this status test as the sole method for establishing the employment status of workers. In particular, contractors should be looking to evidence instances of :

• Interfering in how a job is done
• Requiring workers to be available
• Specifying what tasks are performed, and in what order

HMRC, following some high-profile legal challenges, now acknowledges that where a worker has the right to provide a substitute worker then this work cannot be under contract of service, i.e. cannot be classed as employment.

HMRC often cite the basis for payment as being a key factor in determining the employment status of workers and a major assumption is that self-employed workers are often paid a set price for a ‘job’ and must absorb any additional costs themselves should this job take longer or involve more work than was initially quoted.

By contrast, employees are typically paid a salary, or on a pro rata basis – for example per hour, week or month. Despite this distinction, there still remains some contention since it is not uncommon for certain self-employed construction workers to be paid by the hour or day. In general, the basis for payment test is held in a better light if factors such as the potential for financial loss or risk – which an employee would never have – are considered as well.

The following bullet points provide a brief summary of the most common employment status indicators:

Employed

• The contractor has the right to control what the worker does, where, when and how – even if this right is not exercised;
• The vast majority of the supplier and equipment needed to do a job is provided by the contractor (with exceptions in some cases where a worker supplies small tools only);
• Worker does not risk his or her money, and there is no possibility of financial loss;
• Worker has no business organisation, i.e. no yard, office, vehicles, staff or bank account;
• Worker is paid by the hour, day, week or month.

Self-employed

• Worker has the right to decide how and when the work is done within an overall deadline;
• Worker has to pay for supplies and equipment needed to fulfil a contract;
• Worker ‘bids’ for a job and must absorb any additional costs;
• Worker has the right to hire additional workers who are paid by him;
• Worker paid a fixed rate for the job regardless of actual time taken or costs to himself incurred.
  

Whilst this summary is by no means exhaustive, it should prove a useful checklist to ensure to use when considering your businesses future compliance.

HMRC enforcement

HMRC routinely investigate independent contractors, and in the past, has enjoyed a degree of success from conducting investigations into independent contractors.

Historically HMRC committed significant resources to policing employment status – more status inspectors, extra compliance teams, as well as extensive investment in online resources that can allow rapid cross-checking of businesses and red flag potential compliance risks; all as part of a wide-ranging compliance strategy to bridge the tax gap.

Given the rise in the number of self-employed and gig economy workers in the UK and HMRC’s belief that much of the key to closing the “tax gap” lies in getting the self-employed to pay the correct tax, it’s no surprise that HMRC is redoubling its efforts in this area.

There have been some high-profile cases either brought by HMRC or contractors arguing that the people contracted to perform a service (Uber taxi drivers, multi-drop parcel delivery drivers, and so on) are in fact employees and not self-employed. Do not be surprised to read of HMRC pressing for new investigatory powers to crack down on this further together with a government drive to further define what an “employee” actually is.

Against this backdrop, it is important to understand and manage the status of workers, both for now and for the future.

For employers, if you are unlucky enough to fall foul of an Employer Compliance Review then the first thing you should do is to have a quick look over any invoices you have from self-employed subcontractors. HMRC, in particular, will generally review these invoices as a first step of any compliance review, and typically look for the invoice to have some or all of the following characteristics:

• Show the worker’s home address
• Have consecutive numbering
• Contain narrative that indicates ‘labour only’
• The shown bank account is a personal bank account
• The frequency of the invoices being issued: are they weekly, which could be problematic, or are they for a complete job?
  

Of course, invoices in this format are not indicative of employment or self-employment; however, if the invoices from your subcontractors are similar to this, then you should expect HMRC to investigate further. Similarly, it is highly likely HMRC will investigate any payments to individuals that have no supporting invoice.

For contractors, specifying in as much detail as possible why you are billing for your time is part of an overall defence against IR35, the basis of which is a contract. When examining your terms and conditions of supply, HMRC are likely to use the following benchmarks to decide IR35 compliance:

• Who sets your working days and hours?
• Are you paid by the hour, week, or the month regardless of how well you’ve done in that time?
• Do you control where they work or do you?
• Are you forbidden or restricted from providing labour to someone else? (especially to your client’s competitors)
• Is your client able to “sack” you?
• Do your clients have key performance indicators which measure and evaluate your output?
• Is your client able to take disciplinary action against you if you do not start on or complete the work they’ve set out for you?
• When your client sets a task, is it only you who can do it? (that is, you can’t contract the work out themselves to someone else)
• Does your client provide you with the tools, equipment and/or data that you use to do your work?
• Is your client obliged to provide you with work and are you obligated to make yourself available to do it?
  

The more your contract and your actions can demonstrate independence, the more robust your response to challenge can be.

What happens if I get it wrong?

For the contracting businesses, it is important to get the employment status right as you are required to make a declaration each month. This means that you will be vulnerable to any subsequent compliance check, with a potential risk for penalties which could reach £3,000 per month, not to mention having to be liable for unpaid taxes or National Insurance.

For contractors who have declared themselves outside IR35 but who are later found to be in it, there is a strong likelihood that HMRC will investigate all other recent contracts for non-compliance. You will need to calculate what your deemed employment payment is and then make a payment for that among. HMRC have an IR35 deemed payment calculator tool here.

HMRC does provide an online Employment Status Indicator (ESI) that contractors can use to reassure themselves on the status of their workers. It is anonymous, but the resulting report can be printed and retained on file as a method of defence against any future HMRC query into the employment status of the worker(s) in question.

Public sector contracts and private sector contracts

IR35 reforms covering contractor engagement with the public sector were introduced in 2017. Whereas previously contractors would declare their own IR35 compliance prior to the reforms, now it is the responsibility of the client to decide on IR35 status.

Many public sector clients err on the side of caution and declare their engagement with their contractors as within the scope of IR35 to avoid the fines and penalties discussed earlier in this article. Should a contractor be deemed as within the scope of IR35, either by the client or through self-declaration, the public sector body needs to:

• calculate a deemed payment for the contractor;
• inform HMRC;
• issue the contractor with a worker ID number;
• report any office holding duties or not (office holding duties will be classified as employment income);
• send a P45 to the contractor upon the ending on the contract.
  

The same reforms will be introduced to the private sector from April 2020.

To discuss your circumstances and clarify your tax affairs, contact us today.