The UK has recently introduced new legislation to address tax liability loopholes and redefine the relationship between companies and contractors. If your business operates in the UK or employs contractors there, it’s crucial to understand how the new IR35 rules might impact you.
What is IR35?
IR35, also known as the “Intermediaries Legislation,” sets rules for off-payroll working to determine whether a contractor is genuinely self-employed or should be classified as an employee for tax purposes. These rules aim to ensure that contractors pay similar income tax and National Insurance contributions as standard employees.
Key Changes and Implications of IR35
Public and Private Sector Reforms: Initially applied to the public sector, IR35 was extended to the private sector in April 2021. Now, clients—not contractors—are responsible for determining IR35 status, leading to a significant reduction in self-employed contractors and a decrease in earnings for many working under IR35 arrangements.
Misclassification Risks: Misclassifying contractors can lead to severe penalties. Companies must carefully assess working relationships, considering factors like control, substitution, and mutuality of obligation.
Who is Affected by IR35?
IR35 affects both companies and contractors. Contractors who set up a limited company (LC) to receive payments and avoid higher taxes now face stricter scrutiny. The legislation primarily targets medium and large private-sector businesses and all public-sector clients, with exemptions for small businesses meeting specific criteria:
- Annual turnover of less than £10.2 million
- Gross assets of less than £5.1 million
- Fewer than 50 employees
IR35 and Non-UK Companies
Non-UK companies may also fall under IR35 if they engage contractors who provide services in the UK. Contractors with UK tax residency are subject to IR35, while non-resident contractors generally are not. However, the presence of a non-UK client in the UK, such as an office or branch, may necessitate compliance with IR35 rules.
Key Considerations for Compliance
- Status Determination Statement (SDS): Companies must issue an SDS for each contractor, outlining their status under IR35 and the reasoning behind the decision.
- Reasonable Care: Businesses must demonstrate due diligence in determining contractor status, considering whether the contractor has other clients, takes financial risks, and the nature of their work practices.
- Check Employment Status for Tax (CEST): This online tool by HMRC helps businesses determine the tax status of contractors and employees.
Understanding Inside and Outside IR35
- Outside IR35: Contractors are considered self-employed, allowing them to pay themselves a salary, distribute dividends, and pay taxes accordingly.
- Inside IR35: Contractors are treated as employees for tax purposes, requiring companies to deduct income taxes and National Insurance contributions on their behalf.
Impact on Contractors
Contractors found to be inside IR35 must comply with employee tax rules but do not automatically gain employee benefits. Misclassified contractors face penalties, back taxes, and interest payments. Companies must reassess contractor status annually and maintain compliance records.
Staying Compliant with IR35
Navigating IR35 is essential for UK companies and global businesses working with UK contractors. By understanding the legislation and applying thorough compliance checks, businesses can mitigate risks and maintain smooth working relationships with contractors.
