An Insider’s Guide to IR35 Legislation in 2021

What is IR35?

IR35 is tax legislation introduced by Gordon Brown in 2000, so it’s nothing new. It was designed to close a loophole that could be used by someone who set up a limited company to pay less tax while, effectively, still working for another company as an employee.

A limited company shareholder receives a dividend payment in relation to how many shares they have in the business. The tax on those dividend payments is less than it would be as a regular salary. So, limited company owners pay themselves a salary up to the minimum taxable level then make up the rest of their income in dividend payments.

With a bit of accountancy know-how, a limited company owner can pay minimal tax amounts while maximising their disposable income. It’s all entirely legal and in line with the UK tax laws.

Why was IR35 introduced?

However, it became possible for a contracted worker to create a limited company as the sole director and shareholder then work full-time for another company on a contract basis. They invoiced that company for the hours they’d worked, and the company paid an invoice rather than a wage.

Both parties can benefit from that relationship as the company doesn’t have to pay National Insurance to the worker and isn’t liable for holiday pay, sickness pay, pension contributions etc. They can also terminate the contract without having to follow a redundancy procedure with the associated payments.

The worker benefits by, generally, charging a higher hourly rate than their permanent equivalent on the basis that they bear the risk of sudden unemployment, their own holiday pay, sickness pay etc. And they can pay less tax by taking their income in the form of dividend payments.

The Government believed that workers were leaving companies then returning in the same role but as a limited company contractor. Although that wasn’t illegal, the Government viewed it as a form of tax avoidance and wanted to clamp down on the practice. Hence, the IR35 regulations were born.

How does IR 35 work?

The critical test of whether a worker falls in or out of the IR35 regulations is whether they can be defined as a “deemed employee”. Basically, are they effectively an employee of the business in all but name? 

There are several factors used to determine a worker’s employment status, which can include:

• Right of Substitution – can the worker be substituted with someone else from their limited company, or are they the only person who can perform the required job?
• Right of Control – does the worker control what, how, when, and where the work is done, or does the contracting company specify it?
• Financial Risk – does the worker offer a fixed price for carrying out the work, regardless of how long it actually takes, or do they charge the contracting company a day/hourly rate until the job is done?
• Mutuality of Obligation – this exists in a usual employer/employee relationship where work is expected by the employee, and the employer expects them to do the work issued. If the company has no obligation to provide work or the worker can opt not to do the work, there is no mutuality of obligation, so the worker wouldn’t be a deemed employee.
• Provision of Equipment – does the worker provide their own tools or equipment, or does the contracting company?
• Opportunity to Profit – can the worker use their skill and judgement to profit by completing a fixed-fee job ahead of schedule, or are they paid regularly without any KPIs?
• Integration – how much is the worker integrated into the company? For example, do they have an email address from the contracting company, wear the company uniform, have a specified work area, access all staff areas, etc.?
• Number of Customers – does the worker only provide services to one company or several?

While this is not a definitive list, it’s easy to see how a deemed employee can be determined by looking at all the answers collectively.

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What are the consequences of non-compliance?

If a worker has been operating based on being a limited company, but it’s found that they are a deemed employee, they are liable for all the tax they haven’t paid.

HMRC can extend that period back up to six years, so the financial impact can be massive.

Who determines the employment status?

If the contractor is working for a small business (as defined by the Companies Act), then the responsibility and liability rest with the contractor.

If the contractor works for a public sector company or (as of April 2021) a medium or large private sector company, the responsibility and liability rest with the contracting organisation.

What are the IR35 changes in April 2021?

In April 2017, the rules were extended to public sector companies, which meant that they took responsibility for determining a contractor’s employment status. 

As of April 2021, this responsibility was expanded from the public sector into medium and large private sector companies. The onus rests with the bill-paying company, which could be the end client or a recruitment agency rather than the individual contractor.

Summary

The IR35 tax regulations are a complex topic to understand.

While some elements are clear-cut, others are still open to interpretation, so it’s advisable to take professional advice to determine a worker’s employment status.

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