IR35’s still hot on the lips of contractors and employers alike. And probably because there remains a certain amount of confusion around the topic.
After Covid-19 delaying the planned rollout of IR35 into the public sector in 2020, the legislation finally came into effect a year later in April 2021.
Despite IR35 coming into force some time ago now, we know from speaking to our clients and contractors that there’s still some uncertainty surrounding understanding and responsibilities.
We also know it can feel like a minefield! So, to clear a few things up, here’s our guide to IR35 and what it means for you.
What is IR35?
Let’s take it back to basics. We’ve been discussing IR35 for so long now, it’s good to refresh what it’s all about…
IR35 is a legislation put into force by the government to stop tax avoidance by companies and individuals through disguising contractors as employees. It focusses on ensuring contractors aren’t benefitting from things that PAYE employees would normally enjoy, including things like the use of company equipment, petrol allowance, insurances, or company social events, such as lunches or Christmas parties.
History of IR35
Despite the recent hype, IR35 is nothing new. It was originally announced in a press release by the Inland Revenue back in 1999 and was brought in to prevent self-employed individuals from working in the same way as traditional employees whilst still reaping the associated tax benefits.
These initial rules were imposed on the public sector but the more recent changes to the legislation that came into force in 2021 were extended to the private sector too. Now, it’s the responsibility of both contractors and those hiring them to ensure IR35 regulations are being adhered to.
IR35 - what do I need to do?
Action needs to be taken by both contractors and employers under the new legislation. Hefty fines can be enforced on both parties should a contractor sit within IR35 and continue to be treated as a PAYE employee.
For employers, the first step should be (if you’ve not already done so) to carry out an audit of your current contractors to determine whether they sit inside or outside of IR35. The government encourages people to use its CEST tool. The tool’s certainly a great starting point but has been hit by some hard criticism for not covering all bases. Our advice therefore is to use it alongside common sense and your own checklist for determining whether contractors are deemed to be inside of outside of the legislation.
If your contractors sit outside of IR35, i.e., you’re clearly hiring them on a contract/freelance basis that cannot be confused with them being a PAYE employee, then you need do no more.
For any contractors who sit inside of IR35, i.e., there could be some overlap in the way they and your PAYE employees work, you should notify them of your determination and put a plan of action into place as to how you will engage with them going forwards.
DATS has various solutions for if your contractors fall inside IR35. But, in short, the options include transferring them to a PAYE or umbrella, drawing up a statement of work, devising a plan for outsourcing individual packages of work or turning your contract role into a permanent one.
It’s worth noting that HMRC can go back as far as 20 years when carrying out an IR35 investigation should they suspect deliberate tax avoidance. If on the other hand they feel honest mistakes have been made, they will go back as far as around four years. So, make sure whether you’re an employer or a contractor, you’re doing all you can to follow the guidelines.
Exceptions to IR35
As with most regulations there are some exceptions, and in the case of IR35 the rules do not apply to small companies. A small company, as defined by HMRC, must fall into at least two of the following three categories
1.Have less than 50 employees
2.Have a turnover of less than £10.2m
3.Make a net profit of less that £5.1m
Ways to clearly define a contractor from an employee
Whether employer or contractor, there are a number of things both parties can work on together to ensure a contractor is clearly defined as such and can continue to sit outside of IR35.
These include:
-Ensuring contractors are using their own equipment - specialist tools, vehicles, laptops, mobile phones, etc.
-Checking that contractors are working under their own insurance policy (as opposed to yours).
-Having a sign-in book for contractors, as opposed to an employee key card/fob.
-Making sure contractors are covering their own mileage costs, petrol expenses etc.
-Treating contractors differently to employees when it comes to corporate gatherings or social events. You can still invite them to attend but to comply with IR35 they should not be benefitting from food/drinks/activities on the company and should cover their own bills.
-Paying invoices monthly that lay out varying hours, rather than encouraging long term, rolling contracts for set hours each month.
Impacts of IR35 - an example
When determined as ‘inside’ IR35, a Limited Company’s or self-employed contractor’s net earnings could reduce by 25-30%. Most hirers won’t have the budget to offset this reduction in pay, so it’s often contractors that will take the hit. To overcome the impacts of IR35, sometimes they’ll choose to engage an umbrella company, while others will become PAYE contractors through an agency, meaning a new rate and contract to suit.
To illustrate this in monetary terms, imagine a contractor had been earning a gross rate of £50 per hour. Having previously been paid in full to their Limited Company, the gross rate must now be recalculated and employment costs such as NI (National Insurance) and pension contributions deducted. Here’s an example:
·Rate of £50 per hour
·Minus 13.8% National Insurance (£5.91)
·Minus 3% pension contribution (£1.28)
·Equals new rate of £42.81 per hour
That’s all before the worker’s own personal tax, NI and pension contributions have been deducted so it’s clear to see how contractors’ rates can significantly drop if found to be inside IR35.
On top of this, employers also need to consider holiday time. So, the new gross rate of £42.81 must further be broken down into a basic hourly rate and an hourly holiday rate. Holiday rates will of course vary from company to company, but as the minimum is 20 days plus 8 bank holidays, we’ll use 28 days to continue our explanation:
£42.81 would equate to:
·£38.20 per hour (basic rate), and;
·£4.61 per hour (holiday rate)
Earning both amounts for every hour worked, a contractor can choose to accrue holiday pay over time so they can be paid during holiday periods, or they can choose to be paid both amounts at the same time and receive no money whilst taking holiday.
Note that this example is based on a candidate choosing a PAYE route to comply with IR35. Other options include using an umbrella company where processes and associated benefits may differ. If opting for the umbrella route, we advise contractors to ensure they’re working with a reputable company, ideally FCSA qualified. The umbrella market remains unregulated and HMRC can still impose fines on workers whose umbrella company has processed payments incorrectly.
DATS has put together an approved supplier list of FCSA umbrella companies that have passed our rigorous due diligence tests. Contact us should you need information or guidance on selecting an umbrella company and we’ll happily help.
In summary, IR35’s here to stay and if you’re not on top of it the alternative is risking large fines and in extreme circumstances, even fraud charges. Remember, responsibility now falls to both contractors and those hiring them, so it’s important that all parties are collaborating to ensure work is being carried out in line with HMRC’s guidelines.
If you’re an employer who uses contractors and are still unsure about how to get the ball rolling on IR35, or to ensure a system for ongoing compliance, get in touch. At DATS Recruitment, we’re experts on hiring both permanent and contract staff and are working with companies like yours every day to ensure they’re growing legally and ethically in ways that work for them. From advice on carrying out contractor audits, to helping you find new contractors outside of the legislation, or solutions for existing contractors who fall inside, we’re here to help make the process simpler.