IR35 – A Short Guide
Many freelancers and contractors are engaged by businesses through a process called off-payroll working. New IR35 rules could impact contractors and freelancers. This common means of transactional engagement can see a contractor or freelancer engaged through their personal service company (PSC) as opposed to the traditional self-employed recruitment format.
However, HMRC is introducing new tax rules that will place the liability for determining an individual’s tax status, for people who work through PSCs, with the company that engages the individual. This new tax change has become known as IR35 and will come into force from April 2020. This will create a brand-new compliance environment which will add significant costs and challenging compliance thresholds for a range of businesses who significantly rely on flexible PSC-employed talent.
This is a short guide by Prestige Business Management to help businesses understand the challenging changes faced by PSC businesses.
A Little Background – What is a PSC?
A Personal Service Company (PSC) is a single employee/directorship holding individual within a business organisation. The sole purpose of the business is to supply the individual’s services as a business to other businesses. Any revenue generated is paid to the PSC from the company and this is why it is seen as beneficial.
The PSC has many benefits. If you are a contractor, you are singularly protected by limited liability status as a company. There are also beneficial tax savings by operating through a PSC rather than traditional self-employment means. The PSC also allows for greater freedom in how profits can be withdrawn from the PSC company.
From the perspective of businesses engaging PSC companies, the benefits are diverse. For example, they provide for greater flexibility especially within sectors that have fluctuating and ever-changing market dynamics and as such, they provide businesses with on-demand labour needs. This also ties in with another key benefit, they are from an HR perspective “off-books”, this reduces the HR compliance experience and also those operating through a PSC aren’t eligible for employment-based rights like maternity, sickness or holiday pay.
From a technical perspective, the engagement of a PSC contractor also provides a tax saving for the engaging business. This is because you do not deduct tax under the current Pay As You Earn system with a PSC. You also are exempt from paying any employer contributions like NICs. Therefore, recruiting an individual working through a PSC can reduce a company’s overall payroll costs.
The new IR35 rules now mean that tax and national insurance contributions from a PSC-employed contractor need to be regarded as an employee if that PSC is solely engaged with the business directly.
When Is IR35 Applicable?
This new rule only applies when there has been what the HMRC term an “employment relationship” which would be based on the engaging business and the individual employed by the PSC. If there is a genuine relationship – like self-employment or consultancy-based service delivery, then the IR35 does not apply in that context.
The lack of a clear legal definition for the IR35 rule is a problem. How can a business determine whether an individual is either an employee or a contractor? HMRC have generated lots of guidance notes to help businesses. However, these are aimed at larger businesses not small or medium sized enterprises.
HMRC have created the “Check Employment Status for Tax” (CEST) Resource Kit. This is a useful method for understanding the contractor relationship and the established nature of work therein. The CEST Resource, according to the FT, can give incorrect answers to around 15% of business contexts. HMRC is aware of these issues and is re-developing CEST ready for IR35’s April 2020 deadline.
Another issue around the IR35 rules is that if an individual has been engaged through a Personal Service Company who works for the company who has engaged the individual through the PSC in a range of executive roles this could be regarded as office holder and could be a conflict of interest which would mean the individual operating through a PSC could be in breach of the IR35 rules.
How Does IR35 Work In Principle?
If a business within the private sector ‘engages’ a contractor who is employed by a Personal Service Company, the liability in relation to the decision of whether the IR35 rules apply rest with the PSC. However, from April 2017 these rules changed in the public sector who are now responsible for the determination process and the next step is for this responsibility to pass to the private sector.
What Do We Know So Far?
During October 2018’s Autumn Budget, Philip Hammond MP and Chancellor of the Exchequer confirmed to the House of Commons that the IR35 rules currently in place within the public sector would come into force within the realm of the private sector by April 2020.
HMRC has also now confirmed this reality and that there are exemptions for small business and that any and all changes will not create retrospective penalties.
It is believed, that when the new IR35 framework is law, the ‘engaging’ business (or end-client as HMRC denotes) will be liable for the determination of the employment tax status of individuals employed through Personal Service Companies. This will increase the risk for end-client businesses as it will mean increased compliance and greater tax implications. In a range of different scenarios including PSC failure to pay any tax during a tax period, the end-client will always remain liable to unpaid taxes. This will increase the end-client tax risk going forward.
How Can Prestige Business Management Help Contractors with IR35?
Many businesses are starting to act now. This doesn’t mean the end of Personal Service Companies. However, the exposure to greater tax risks and the significant compliance impacts therein does force end-client businesses to re-evaluate their own PSC needs. Some companies are bringing PSC contractors in-house, others are continuing to use PSC whilst others are ending all associations.
Prestige Business Management can help both end-client businesses and contractors/consultants understand the dynamics of IR35 and the impact therein.
HMRC have outlined four key areas in which end-client businesses need to take action. This includes:
- Identifying “Current Engagement with Intermediates… including Personal Service Companies”
- To then put in place “comprehensive” determination processes based on HMRC guidelines to identify the employment status of contractors
- Following the above, end client businesses should review their payroll processes and HR employee mapping in order to identify areas of change
- To keep abreast of IR35 legislative news and developments.
HMRC have been very clear in relation to warning the private sector about the consequences of IR35 on the wider business ecosystem. The consultations have stated clearly that businesses, both the end client and the PSC operator, need to begin reviewing their own processes and compliance dynamics before these rules become law in April 2020.
How Prestige Business Management Can Help You Understand Compliance & Risk Associated With IR35
If both contractors and end clients embark on this “compliance exercise” as soon as possible, there is a pathway towards compliance and even the possibility of minimal impact when the new rules become law. The sooner contractors understand these changes, the sooner end client businesses plan for change, in the end, both parties can create success in the face of such compliance risk.
Prestige Business Management has been following the developments of IR35 for a long time. We have followed the public consultations; we understand the current legislative dynamics and we can help contractors and end clients with compliance issues in the run-up to the April 2020 deadline.
Call us today on 0203 779 2027 to find out more about IR35 compliance and how Prestige Business Management can help you?