IR35 and Off-Payroll Tax Blog

IR35 and Off-Payroll Tax

The above are two groups of tax legislation specifically created to deal with tax avoidance by workers, and the businesses using them, who are supplying their services to clients via an intermediary, such as a limited company, but who would otherwise be an employee in the absence of that intermediary.

The workers described above will be deemed employees by HMRC. Indeed, if they are designated IR35 by HMRC, they will have to pay income tax and National Insurance Contributions as if they were employed. This can be quite painful, - reducing the worker’s net income by up to 25%, and increasing the costs to the hiring business and any intermediary.

IR35 has been heavily criticised by many parties and is being replaced by the new ‘Off Payroll Tax’ which will be reaching the private sector in April 2020.

Genuine contractors, freelancers, and consultants in business on their own accounts should be ok, but really should understand the legislation to best protect themselves.

Likewise, the hiring businesses should be prepared and implement appropriate hiring procedures and policies.

So what is IR35 and the new Off-Payroll Tax?

They are actually separate provisions but have been mentioned in the same breath.

They both contain the concept of "deemed employment". The Off-Payroll provisions introduce a different set of tax treatment, meaning that firms will now have to assess the contractor’s status, but, more importantly, pay employment taxes in addition to the fees paid to the contractor. This new tax is now widely referred to as the "Off-Payroll Tax".

IR35 was primarily brought in to address the ‘deemed employment’ issue. This is where businesses hire workers on a self-employed basis (usually through an intermediary), rather than on an employment contract.

Clearly this arrangement has financial benefits in that the hiring business saves on costs as they do not have to pay employers’ National Insurance and the worker attracts no employment rights or benefits.

The Deemed Employment Test

This test is relevant to both IR35 and Off-Payroll. We are not seeking to minimise the complexity behind the issue. The HMRC position will (where appropriate as far as it is concerned) be to categorise contractors as employees. This situation is therefore interpreted by employment legislation and relevant case law. Accordingly, historic employment tests are applied.

The HMRC can basically ignore the existence and contents of the written agreement between the client and the worker, looking at the actual working relationship in order to come to a conclusion.

HMRC (or any tribunal) therefore decides whether there is an implied/deemed/notional employment contract in place.

As mentioned, this may be complex, and a knowledge of employment law is desirable. However, most businesses and workers are not experts, so perhaps expert advice should be sought.

IR35 basically uses three main principles to decide on the status of the worker’s employment. These are known as the principal ‘tests of employment’ and are as follows;

Control
What exactly is the extent of control which the business has over the worker in terms of hours/location/duties/role/completion of tasks etc.

Substitution
Can the worker be substituted or is the worker’s own appearance and services provided crucial to the work?

Obligation reciprocity
Is the business obliged to offer work to the worker? Does the worker have to accept this work, or can it be rejected?

Other aspects come into play such as investment by the worker, risk, equipment provided by the worker etc. but the essence seems to be on of flexibility and freedom as much as anything else.

All circumstances will be taken into account, and the test is one of ‘balance of probabilities’. If it is thought that the worker is really an employee, then IR35 applies.

For example therefore, if a worker doesn’t personally have to turn up and can send someone else instead, then IR35 is unlikely to apply.

If caught under the Off-Payroll provisions

The fees paid to the worker (the "direct deemed payment") will be treated as employment income - which means just like a salary. This means PAYE and employees NI is deducted from that deemed salary. Then the fee-payer, which could be the agency or hirer, has to pay their employment taxes on top - these cannot lawfully be deducted from the contractor’s fees.

How can IR35 be avoided by firms and contractors?

There is no guaranteed way, but it might be an idea to introduce flexibility into the contractor agreement but only if such flexibility suits the business needs of the hiring company?

John Davies

17th February 2020

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