What is IR35 and how does it affect your business?

What is IR35?

IR35 describes two sets of tax legislation used to fight tax avoidance by employees and the organizations that hire them in the UK. The legislation is created to tax employees who receive payments from clients via an intermediary (that is, their own limited company).

According to Her Majesty's Revenue and Customs (HMRC), these kind of employees are called "deemed employees". If caught by IR35, they will have to pay National Insurance Contribution (NICs) as if they had employment by an organization in the UK. Understanding the legal challenges when hiring employees is essential as the financial consequences of the IR35 is tremendous.

Who Does the IR35 Impact?

The IR35 affects contractors that operate via an intermediary and the companies they provide services for.

Contractors

The contractors impacted are those who are registered as:

• A limited company
• A personal service company
• A partnership
• An individual

Using one of these business structures has traditionally proved beneficial to contractors for collecting payments and paying less tax. However, the UK government flagged that many people were unfairly taking advantage of this system. Some workers were invoicing companies for their services as contractors while performing as employees.

Any worker that technically meets the criteria of an employee — despite operating as a limited company — will now be classified as a ‘deemed employee.’ This will activate several employers and taxation responsibilities.

Companies

These latest reforms apply to businesses in the Private Sector, following Public Sector reforms in April 2017. Companies that receive the services of a contractor are now responsible for determining the IR35 status of their workers.

This is primarily relevant for medium and large businesses. Small businesses are exempt from the rules as long as they fall within two of the three criteria:

• Have up to £10.2 million turnover
• Up to 50 employees
• Up to £5.1 in gross assets

The IR35 regulations can also impact agencies that provide services through intermediaries.

IR35 rules or Off-payroll working rules

The off-payroll rules are sometimes known as IR35. These rules apply when a worker - usually called contractors provide their services through their limited company or another form of intermediary to their clients.  

These rules affects,

• workers who provide services via intermediaries
• a client or agency who receives services froma worker via their intermediary

What does inside IR35 mean?

Inside IR35 is when a contract worker could legally be defined as an employee by IR35 law. They are inside IR35 and, therefore, subject to the same taxes as an employee. In this case, a company must act in the same way as they do with employees, such as:

• Deduct income taxes at the standard employee rates
• Deduct employee National Insurance Contributions (NICs)
• Pay employer National Insurance Contributions
• Pay an Apprenticeship Levy

What does outside IR35 mean?

A contractor that is correctly defined as a contractor and is not misusing their status to avoid paying certain taxes is deemed outside IR35. They are legally considered self-employed. Thus, they can choose to pay themselves in the way they choose. In this case, they have the right to work through a limited company if this is the most effective way for them to handle liability.

Does a contractor inside IR35 become a full employee?

Yes, if a contractor are 'inside IR35' it means that they are classified as an employee for tax purposes and are subject to Pay As You Earn (PAYE). Contractors inside IR35 are legally required to pay income tax and contribute to National Insurance as listed above. Employers must be aware of this and make the necessary employee and employer deductions.

However, contractors inside IR35 only automatically receive some employee benefits. Currently, the law only refers to taxation. Therefore, employers are not obliged to provide statutory worker rights such as paid leave, worker benefits, etc. While they may not receive employee benefits, contractors maintain their autonomy, controlling when and where they work.

What if the Contractor Rejects the IR35 Status Decision?

What if a company makes an SDS decision, but the contractor disagrees?

Contractors have the right to appeal an SDS decision verbally or in writing within 45 days of it being issued. The company then has a further 45 days to respond. Here a company can maintain its decision and clarify its reasons to the contractor. Alternatively, they can alter and reissue the SDS based on the appeal.

Companies must be careful to respond within the allotted 45 days. Please do so to ensure the company becomes responsible for paying the tax and NICs incurred by the contractor due to the status change.

How to Stay Compliant After IR35 and Still Pay Contractors in the UK

Staying up to date with all UK employment laws is vital to hire, managing, and paying contractors compliantly.

It would help if you understood the following:

• Worker classification
• Employment benefits
• Employment laws
• Payroll practices

Keeping up with unique local laws can be overwhelming if you work with multiple contractors, especially in various countries. That’s why a global employment and payroll platform like Skuad can handle compliance. Skuad can help you legally hire contractors globally, create compliant IR35 contracts, abide by changing employment laws, and track, manage, and make all payments from one platform.

If you work with contractors, the consequences of the IR35 law changes can seem scary and complicated. But this should continue your business from working with UK contractors. These changes aim to change tax loopholes rather than make it more challenging to work with contractors.

Whether you are thinking about working with UK contractors or already are and may be impacted by the IR35 laws, check out how Skuad can help you manage compliance and contractor payroll.

FAQs

What is the full form of IR35?

IR35, also known as the ‘Intermediaries Legislation’ is defined as off-payroll working by HMRC.

What happens inside IR35?

If you fall inside IR35, you are expected to pay the same amount of tax and national insurance that a permanent employee would pay. You are subject to PAYE and should have the correct monthly funds deducted from your pay.

What is the risk of IR35?

If caught by IR35, you have to pay income tax and National Insurance Contributions (NICs) as if you were employed. The financial impact of IR35 is significant. It can reduce your net income by up to 25%, costing the limited company contractor thousands of pounds in additional income tax and NICs.

Does IR35 apply to all companies?

IR35 only applies to personal service companies (PSCs), as such sole traders fall outside the scope of IR35

Does IR35 only apply in the UK?

IR35 only becomes relevant where a worker would be within the charge to UK income tax and National Insurance contributions (NICs). Generally, earnings that a non-UK tax resident worker receives should only fall within the scope of UK income tax if they relate to duties performed in the UK.