Inland Revenue 35 (IR35) regulation aims to reduce tax evasion by independent contractors doing the same work as employees in the UK. Responsibility for establishing employment status currently rests with the employer and not with the employee. Because of this responsibility, it is imperative that employers hiring independent contractors or sole proprietors in the UK understand the legislation and its organizational impact.
This guide will help you understand what IR35 legislation is, if it applies to you, and how you can ensure global compliance with the latest regulations.
Summary
- Overview: What is the IR35 regulation?
- How does IR35 work?
- employee vs. Independent contractor: determination of the difference
- IR35 + Recent Updates Compliance Checklist
Overview: What is the IR35 regulation?
Inland Revenue 35 (IR35) is a set of anti-tax avoidance laws introduced in the UK in 2000 that redefine employment states to eliminate the tax discrepancy between contractors and employees with the same roles and responsibilities.
The IR35 legislation, also known as intermediary legislation or "off-pay rules", is designed to bridge the "alleged work" tax loophole when companies hire contractors to perform employee functions. Preventing thoughtful work also ensures that:
- Companies pay adequate labor taxes for their workforce
- Companies offer employees appropriate benefits
- Contractors pay income tax and social security contributions (NIC)
Originally, it was the contractor's responsibility to determine whether or not their contract fell under IR35, but this proved difficult to enforce. The responsibility for the correct classification of workers now rests with public and private sector employers, increasing the risks for employers of hiring independent contractors in the UK.
How does IR35 work?
IR35 mandates that "suspected" or "masked" employees (contractors who would be classified as employees if they provided services directly to the customer without an intermediary) must pay the same amount of income tax and NIC as employees. Clients (except small private sector firms) who hire workers are responsible for determining:
The employment status of these workers.
If your employment contract is subject to IR35
If HM Revenue and Customs (HMRC) investigates and judges that a deemed employee has been misclassified, it is the employer's responsibility to pay the evaded taxes.
Inside against Outside of IR35: who does IR35 apply to?
IR35 is applicable when a contractor provides its services to a client through an intermediary. The intermediary is usually the limited partnership (or "personal service company") of the contractor, but it could also be a partnership or an individual.
"Inside" and "outside" IR35 are terms that indicate whether the legislation applies to a contract worker or not. IR35 applies to:
Workers who provide services through an intermediary.
Customers who receive services from a worker through his intermediary
Organizations that provide services to workers through their intermediary
If a contract falls under IR35:
Off-pay rules apply and the contractor is considered an employee of the client for tax purposes.
The taxpayer will deduct income tax and NICs from the payment received from the contractor and will also pay the NICs for the employer (which are not deducted from the worker's salary) . The taxpayer is the party that pays for the contractor's personal service business (PSC), regardless of whether it is the client, the agency or another third party.
If a contract is outside of IR35:
The contractor is considered self-employed and operates as his own business.
They can be paid by invoice with no tax deduction and are responsible for managing the taxes of their business]
The contractor does not use a PSC.
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dependent against Classification of independent contractors: seven factors that companies should consider
The IR35 jurisprudence has established a series of occupational tests that employers can use to classify all workers under their jurisdiction. The evaluation criteria include:
- Check
- Replacement
- mutual obligation
- various factors
These tests should be evaluated together to get the clearest picture of someone's occupation, so be careful when making a one-factor decision. Employers should also note that the HMRC evaluates these factors based not only on the written contract but also on actual employment practices, so the "implied" terms can replace the written terms of a contract if the two are not consistent.
1. Check
IR35 for interiors. An individual is an employee if the client controls how and when he performs his responsibilities, as well as what tasks he performs. Potentially outside of IR35. If the individual can check the restrictions around.
2. Replacement
IR35 for interiors. An individual is an employee if the client does not allow him to transfer or substitute responsibilities to another individual. Potentially outside of IR35. If the person can send someone in their place to complete the job, it could be a non-IR35 contractor.
3. Reciprocity of the obligation
IR35 for interiors. An individual is an employee if he is obligated to offer her services and the client is equally obliged to accept those services. Potentially outside of IR35. If the individual has the right to refuse to work, it may be outside of IR35. Four other factors Control, replacement and reciprocity of obligations are the primary considerations in determining job classification, but they do not always paint a complete picture of the situation.
Other factors to consider include:
- The type of contract
- How the individual is paid
- Your level of financial risk.
If they provide the equipment necessary to fulfill their responsibilities
Each of these factors is sufficient to distinguish an internal IR35 contract from an external one. Recent Updates IR35 + Compliance Checklist
In September 2022, the repeal of the IR35 2017 and 2021 updates was announced, potentially transferring the responsibility for classification from employees to contractors. There are currently no changes to the legislation and both updates remain in effect at least until April 2023. The 2017 IR35 reporting reforms shifted responsibility for determining workers' employment status to public sector employers, resulting in a £ 550 million increase in income taxes and NICs.
UK regulators extended classification responsibilities from public sector employers to private sector employers in April 2021, increasing their potential workload. The reform extends the 2017 provisions to the following private sector employers in the UK:
- independent contractors
- employment agencies
- Medium and large companies
The 2021 IR35 updates exempt 1.5 million small private businesses that meet at least two of the following criteria:
- 50 or fewer employees
- Annual turnover not exceeding £ 10.2 million
- Balance totaling £ 5.1 million or less
There are no exemptions for small public sector companies. To make sure you are IR35 compliant, there are a number of dos and don'ts for your business:
Provide State Determination Statements (SDSs) to your workforce.
The SDS is an official form that establishes the status of the worker and provides the rationale behind the determination. Keep an eye on status disputes from contractors or your PSC.
If the status is challenged by the PSCs, employers must review the status decision and respond within 45 days. Any tax liability exposed by the SDS is the employer's responsibility to pay.
HMRC's definition of reasonable care is subjective. An employer needs to consider each situation specifically, paying the right amount of attention to the client's skills, experience and resources. Establish an audit trail for IR35 compliance.
In the case of a compliance audit, it is critical to have evidence of care and due diligence in any classification decision under IR35. Failure to provide evidence can result in your company paying fines for non-compliance.
Do not renounce the liabilities IR35 by deciding not to use the PSCs anymore.
It is not wise to do a comprehensive assessment that ranks all your contractors within IR35, regardless of their individual situations; this is not considered reasonable care. Be sure to discuss the classification with contractors and agencies.
Since contractors and PSCs have the option to challenge the job classification if they feel it is incorrect, talk to them to make sure you have all the information you need. Don't pretend that state disputes don't happen.
A process must be implemented that instructs parties on what to do in the event of a state dispute. Being prepared will ensure you arrive at the moment knowing what to do next and will help you avoid further confusion about the process.
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Hire global talent and stay compliant with an HR partner
Independent contractors invite risks. With the IR35 legislation, companies must expose any worker-employer relationship, intentional or unintentional, and employers face penalties for misclassification of workers.
Navigating the UK recruiting process is difficult, but companies can save time and effort by partnering with Velocity Global's Employer of Record (EoR) and Agent of Record (AoR). With the help of an EoR and AoR solution, employers can compliantly hire talented employees, ensure independent contractor compliance, and build a strong and scalable team.