With two months until the changes to IR35 come into force, all medium to large companies in the private sector need to determine the tax status of their contractors, or risk facing financial liabilities.
In an effort by HMRC to reduce tax avoidance, 6 April 2020 will see the responsibility for IR35 compliance shift from the personal service companies ('PSCs') via which many contractors operate and onto the companies which engage or pay them.
The changes to IR35 require the engaging company to provide the contractor with a Status Determination Statement setting out the reasons why the company engaging them considers that they are, for IR35 (tax) purposes, an employee or a contractor. All companies that meet two of the following three criteria will be subject to the new rules:
- An annual turnover of more than £10.2 million
- A balance sheet total of more than £5.1 million, and/or
- More than 50 employees
UK subsidiaries where the parent company meets two of the above criteria will also be subject to the new IR35 rules. The draft legislation points to this including UK subsidiaries of parent companies incorporated outside of the UK which meet the above criteria. If you are unsure whether your company may be subject to the new IR35 rules, please contact one of our team members (details below).
Failure to comply with this requirement (or to take "reasonable care" when making a Status Determination Statement) will see the contractor's tax and NIC (National Insurance Contributions) liabilities become the engaging company's responsibility.
Quick Recap: What is IR35?
IR35 is the name given to the UK tax rules which cover off-payroll working. The rules are designed to regulate individuals who provide services through a personal service company ("PSC").
A contractor will fall out of the scope of IR35 if the day-to-day working relationship between them and their client reflects that they are genuinely working independently.
Conversely, a contractor will fall within the scope of IR35 if their working relationship is considered to amount to a de facto employment relationship. Factors that could indicate such a relationship may include the client exercising a high level of control over the contractor or the contractor being unable to elect a substitute.
Being out of the scope of IR35 means a contractor's PSC will continue to receive their fees gross (i.e. without deduction of tax or NI) from the company making the payment. The PSC is then responsible for any relevant tax deductions (typically the contractor may take a modest salary and otherwise receive dividends, on which NICs are not payable).
Being in the scope of IR35 means that a contractor is a deemed employee for tax purposes and should be paid through the payroll, with deductions for PAYE and employee NI being the responsibility of the company paying the PSC. That company will also have to account for employer NI and any apprenticeship levy, but will not have to cover statutory payments, repayments or pension auto-enrolment.
Not all IR35 cases are simple, however. In some cases, third parties will form part of the contractual chain between the engaging company and the PSC. Where a company benefits from the services of a PSC but does not engage them directly (instead doing so via a third party), it is still the company benefiting from the services which must make a Status Determination Statement and provide this to the third party.
There is scope within the new IR35 rules for outstanding PAYE and NI liabilities to be passed along the contractual chain where one party has been negligent in applying the rules. This includes a company benefitting from the services of a contractor not making a valid Status Determination Statement.
On this basis, it is essential that companies which benefit from the services provided by a PSC, as well as companies which engage PSCs directly, understand when and how to make Status Determination Statements.
What is a Status Determination Statement?
From 6 April 2020, providing a Status Determination Statement
(SDS) to contractors is a new requirement for private sector
companies which fall within the scope of IR35.
An SDS must set out whether the engaging company considers its contractors to be, for tax purposes, either employees or contractors, as well as its reasons for making this determination.
When making an SDS, "reasonable care" requirement means that the company must carry out a specific assessment in respect of each contractor it engages, taking into account the contractual relationship between the parties and the day-to-day reality of the role they are performing.
The government has confirmed that a Status Determination Statement issued before 6 April 2020 is valid under the new rules, provided it contains the reasons for the determination.
We therefore strongly advise that all engaging companies prepare for the changes to IR35 in advance of 6 April 2020 by providing Status Determination Statements as soon as practicable.
What steps should engaging companies take?
Private sector companies to which the rules will apply should begin actively preparing for the changes to IR35 well in advance of 6 April 2020 by:
- Analysing day-to-day working relationships with contractors operating via their own PSC's and considering whether these suggest they are employees or contractors for tax purposes
- Beginning a consultation process with contractors to ensure they understand the changes to IR35 and the potential impact it will have on their role
- Where appropriate, arranging for contractual documentation including consultancy agreements and employment contracts to be redrafted to reflect the true nature of a contractor status
- Considering whether to redesign job roles to bring contractors in or out of scope of IR35
- Providing a Status Determination Statement for each contractor operating via their own PSC, and
- Anticipating likely challenges from contractors as to the determination that has been made. Engaging companies must respond to challenges from within 45 days or will be responsible for the contractor's tax liability under IR35
If your in-house expertise is scarce, it is advisable to engage a third-party expert who will be able to provide guidance and advice, template documents or partial or complete outsourced support.
They should be able to assist with:
- Auditing contractors who operate via their own PSC's
- Preparing Status Determination Statements
- Redesigning job roles to bring in or out of the scope of IR35
- Drafting or redrafting contractual documentation
- Supporting payroll teams with adding PSC payments to existing payrolls or setting up specific contractor payrolls where appropriate;
- Advising on challenges from contractors or employment agencies regarding IR35 status
- Negotiating contractual terms on your behalf, and
- Providing general IR35 guidance to meet your specific needs
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.