IR35 Changes: Employers’ Guide to Off Payroll Working

The IR35 rules, which govern off-payroll working, have undergone significant updates in recent years, shifting responsibilities and increasing compliance requirements for businesses. These changes aim to ensure that individuals working in a similar manner to employees pay broadly the same tax as employees, regardless of their contractor status.

For employers, the changes mean taking on greater responsibility for determining the employment status of contractors and ensuring appropriate deductions for tax and National Insurance contributions. Missteps in compliance can result in financial penalties and reputational damage, making it vital to address IR35 requirements effectively.

A clear grasp of the IR35 rules and the implications for your organisation can help you minimise risks and build stronger relationships with contractors.

 

What is IR35?

 

IR35 refers to a set of tax rules introduced by the UK government in April 2000 to address perceived tax avoidance by individuals providing services through an intermediary, such as a personal service company (PSC), while working in a manner similar to that of an employee. The legislation ensures that those working like employees but through intermediaries pay broadly the same Income Tax and National Insurance contributions as employees.

The rules distinguish between on-payroll and off-payroll working. On-payroll working applies to individuals considered employees for tax purposes, meaning their taxes and National Insurance are deducted at source by the hiring organisation. Off-payroll working refers to those legitimately operating as independent contractors, with responsibility for their tax obligations resting with the individual or their intermediary.

The key objectives of IR35 are to ensure fairness in the tax system, reduce tax avoidance, and create a level playing field between employees and contractors. By addressing inconsistencies in tax treatment, the legislation seeks to ensure that all workers contributing in similar ways are taxed equitably, regardless of their employment arrangements. Employers and contractors must understand these distinctions to ensure compliance and avoid penalties.

 

IR35 reforms

 

The IR35 tax reforms are aimed at reducing tax avoidance and increasing compliance with the existing off-payroll working rules in the private and third sectors, including voluntary and community organisations such as registered charities and self-help groups.

Typically referred to as IR35, the changes were applied first to public sector organisations engaging the services of contractors or off-payroll workers through intermediaries.

Under the extended regime, all medium and large-sized organisations outside of the public sector are now, as with public sector authorities and other public bodies, responsible for determining the IR35 employment status of individuals who work for them through, for example, their own limited company.

The net effect of the ‘IR35 changes 2020’ is that where a determination is made that the IR35 rules do apply, the deemed employer of that individual will be required to deduct the right tax and National Insurance contributions (NICs), instead of the worker’s intermediary deciding what deductions are to be made.

 

IR35 changes in 2021

 

Recent updates to IR35 rules have significantly altered how off-payroll working is managed, particularly in the private sector. The most notable change, introduced in April 2021, shifted the responsibility for determining a contractor’s employment status under IR35 from the contractor’s personal service company to the medium or large business engaging them. This change aligned the private sector rules with those already in place for the public sector since 2017.

Medium and large businesses are now required to assess whether a contractor falls inside or outside IR35. If the contractor is deemed to fall inside IR35, the business is responsible for deducting Income Tax and National Insurance contributions at source, as well as paying the associated employer contributions. This shift has created new administrative responsibilities and increased the importance of accurate status determinations.

For medium and large businesses, the changes mean more scrutiny of contractor arrangements and potential financial consequences for non-compliance. The penalties for incorrect assessments or failure to comply with the rules include liability for unpaid taxes, interest, and fines.

The key milestones in these changes include the introduction of IR35 in 2000, the extension of off-payroll rules to the public sector in 2017, and their implementation in the private sector in April 2021. These developments reflect the government’s ongoing efforts to ensure fairness in taxation and reduce the risk of non-compliance across sectors.

 

Why the off payroll rules have been reformed

 

When engaging the services of contractors and off-payroll workers it is commonplace for businesses to engage with an individual through an intermediary, rather than directly with the worker on a self-employed basis. An intermediary will usually be the worker’s own personal service company (PSC), although it could also be a partnership or a managed service company.

However, the IR35 off-payroll working rules require that where an individual works in the same way as an employee and, but for the PSC would have been regarded as an employee of the engaging business if they had been contracted directly, that individual is liable to pay similar taxes to other employees.

The IR35 rules were introduced back in 2000, based on the rationale that it is only fair that two individuals working similarly for a business pay broadly the same income tax and NICs, even where one of them works through a company.

As such, the aim of the off-payroll working rules is to remove the tax advantages of providing services via a limited company for individuals who are not truly in business on their own account. This essentially means that anyone working like an employee, but operating via an intermediary, will still pay the same or similar tax and NICs as an equivalent employee.

To work out whether the IR35 off-payroll working rules apply, a person or organisation is required to make a decision about whether an individual worker is employed or self-employed for tax purposes. This is typically known as an IR35 employment status determination.

In 2017, the UK government changed the off-payroll working rules for those in the public sector engaging workers via PSCs and other intermediaries. The reform shifted responsibility for determining IR35 employment status from the worker’s PSC to the public sector authority or other public body they work for.

As such, all public sector organisations are already responsible for determining the employment status of a contractor or off-payroll worker, and whether the IR35 rules apply to that individual.

However, in the Autumn 2018 budget, the UK government announced that it would be rolling out similar reforms to the private and third sectors, albeit giving businesses time to adjust and prepare. By extending the rules, this would bring these sectors of the economy in line with the public sector changes, ensuring consistency and compliance across the labour market.

Under the current rules, for organisations outside the public sector, it is the individual worker via their PSC or other intermediary, and not the engaging business, that is responsible for making this status determination and, where appropriate, accounting for any tax and NICs.

However, therein lies the problem that has led to reform; namely that the intermediary has essentially been required to self-assess as to whether the rules apply. In consequence, the IR35 rules have been largely ineffective, where it is estimated by HMRC that currently only one in ten people who should comply with the off-payroll working rules within the private sector do so.

 

Impact on Contractors

 

The changes to IR35 rules have significantly affected contractors, particularly those operating through personal service companies. Contractors now rely on the businesses they work for to determine their IR35 status, a shift from the previous system where they were responsible for making their own status assessments. This change can result in uncertainty for contractors, especially if a business deems them to be working inside IR35.

Being assessed as inside IR35 means contractors are taxed as employees, with deductions for Income Tax and National Insurance contributions taken at source. However, they do not receive employment benefits such as sick pay, holiday pay, or pension contributions. This can lead to higher tax liabilities and reduced take-home income, making contracting less financially advantageous for some individuals.

Despite these challenges, many contractors continue to operate through limited companies due to the flexibility and control this structure offers. However, the benefits may be outweighed by the administrative burden and potential financial implications of IR35 compliance. Contractors must weigh the drawbacks, such as reduced income, against the autonomy and professional opportunities that limited companies can provide in a post-IR35 landscape.

 

Impact on Employers

 

The updated IR35 rules place significant responsibilities on businesses engaging contractors. Medium and large companies must assess the IR35 status of contractors they hire and determine whether the working arrangements mean the contractor falls inside or outside IR35. Accurate determinations are crucial, as the hiring organisation becomes liable for tax and National Insurance contributions if a contractor is deemed to be working inside IR35.

Businesses are also required to maintain robust reporting and record-keeping systems to demonstrate compliance. This includes providing contractors with a Status Determination Statement (SDS), outlining the reasons for their IR35 assessment. Clear and thorough documentation helps reduce the risk of disputes and ensures compliance with legal obligations.

Non-compliance can result in significant financial risks, including penalties, liability for unpaid taxes, and reputational damage. Businesses must ensure they have appropriate processes and systems in place to meet their obligations under the updated rules. This may involve investing in training, seeking professional advice, or using tools such as the Check Employment Status for Tax (CEST) tool provided by HMRC.

While the updated IR35 rules create additional administrative responsibilities, adhering to them not only ensures compliance but also fosters stronger, more transparent working relationships with contractors. Businesses that handle these changes effectively can mitigate risks and maintain a flexible, compliant workforce.

 

Which employers are affected by the IR35 changes?

 

The IR35 rules apply to medium or large-sized organisations in the private sector that meet 2 out of the following 3 conditions:

 

• An annual turnover of more than £10.2 million.
• A balance sheet of more than £5.1 million.
• More than 50 employees.

 

The balance sheet total refers to the total amount shown as assets on the balance sheet before deducting any liabilities.

However, a simplified test will apply to businesses with an annual turnover of more than £10.2 million that are not a company, limited liability partnership, unregistered company or overseas company.

Additionally, there are rules that cover connected and associated companies, such that if the parent of a group is classed as medium or large, their subsidiaries will also have to apply the IR35 private sector off-payroll working rules.

If you meet the conditions above, or otherwise fall within the scope of a medium or large-sized organisation, you must start applying the rules when the changes come into force. It is important to bear in mind, however, that the conditions as to size only apply to end-clients, where small-sized fee payers will still be responsible for applying the off-payroll working rules.

It is important to bear in mind that the reforms do not introduce a new tax, but rather they change the way in which tax is collected when a contractor or off-payroll worker falls within the scope of IR35 and is deemed employed for tax purposes. As such, the IR35 private sector changes do not prevent individual contractors from working through their own limited companies, nor do they affect the self-employed who are outside the scope of the rules.

The new off-payroll working rules will only affect people working like employees and through a company, where self-employed people working through a PSC or other intermediary will continue to be taxed as they are now. It is estimated that two-thirds of people currently working through a company are genuinely self-employed and will not be affected by these changes.

Equally, the changes to the off-payroll working rules do not affect the smallest 1.5 million businesses in the UK. As such, small-sized private sector businesses will not have to decide the employment status of their contractor or off-payroll workers, where this will remain the responsibility of the worker’s intermediary.

 

Complying with the IR35 private sector rules

 

All medium and large-sized organisations outside of the public sector will be responsible for deciding the IR35 employment status of contractors and off-payroll workers for tax purposes. This involves carrying out an assessment for each and every contract you agree with an agency or individual worker via their PSC. In particular, you will need to undertake the following steps:

 

• Make your determination as to the worker’s employment status
• Provide reasons for the determination to the worker and the person or organisation you contract with
• Retain detailed records of any employment status determination, including the reasons for the decision and fees paid
• Put in place clear processes to deal with any disagreements that arise from your determination.

 

 

How to determine an individual’s employment status

 

There is no precise legal test to determine whether an individual should be treated as employed for tax purposes, rather the test is based on a number of different factors. However, HMRC has put in place various measures to help businesses and other organisations get their status determinations right.

This includes, in some cases, one-to-one support and direct communications, as well as workshops, online learning and an enhanced online tool. The ‘Check Employment Status for Tax’ (CEST) tool has been specifically designed to help organisations determine whether the off-payroll working rules apply.

Having undertaken your assessment, you must provide the worker and the agency, or other organisation you contract with, your determination, regardless of whether or not your determination shows that the IR35 off-payroll working rules will apply. This is known as a ‘Status Determination Statement’ (SDS).

Further, the SDS must not only set out the decision made as to the individual’s deemed employment status, but also the rationale for reaching this conclusion. You will also remain liable for any tax and NICs until you tell the worker, and whomever you contract with, of your determination and the reasons for it.

It is important to bear in mind that if you make a status determination that an engagement falls outside IR35, you must ensure that reasonable care was taken during the decision-making process and that the determination itself is reasonable. Any failure to exercise reasonable care will invalidate your decision and make you liable for any unpaid taxes.

If the sub-contractor is considered to be a worker, the organisation will be responsible for the tax and national insurance contributions

Further, where an engagement falls within the off-payroll working rules, the organisation, agency or other third party responsible for paying the worker’s company will also become responsible for deducting any tax and NICs by way of Pay As You Earn (PAYE), in addition to any employer NICs. As such, the contractor business will be taxed at source exactly as if it were an employee.

Ultimately, this means that the responsibility for undertaking employment status assessments will become the responsibility of the business or body using the services of the contractor or off-payroll worker, ie; the ‘end-client’, whilst the responsibility for operating PAYE and paying employer NICs will be that of the entity paying the PSC, ie; the ‘fee payer’.

 

Retaining records of your determination

 

As an affected medium or large-sized organisation, the new IR35 private sector changes will potentially expose you to significant tax implications. As such, it is vital that you keep clear and accurate records of your IR35 employment status determinations and your reasons for reaching those decisions.

In the event that you determine that the contractor or off-payroll worker is employed for tax purposes, your business, or the agency through which the contractor has been hired through, will be required to pay the necessary tax and NICs before paying the contractor.

If, on the other hand, you determine that the individual is self-employed, they will remain responsible for meeting their own tax obligations. The new rules will not apply where there is a genuine self-employment or consultant relationship.

 

Dealing with disagreements over a determination

 

In circumstances where the contractor or off-payroll worker, or the agency paying the worker’s intermediary, disagrees with the determination you have reached, you will need to have a process in place for dealing with disagreements.

In particular, as part of your status disagreement process, you should:

 

• Reconsider the employment status determination based on the reasons given to you for disagreeing with your original determination, including any further information provided
• Decide whether to maintain the original determination if you feel it is correct and give reasons why or, alternatively, provide a new determination where you agree that it was wrong
• Retain a record of your decision and the reasons for this, as well as records of the representations made to you by the worker or agency paying their intermediary.

 

You will be required to provide a response within 45 days of receiving notification that the worker and/or agency disagrees with your IR35 employment status determination. In the interim, you should continue to apply the rules in line with your original determination.

Any failure to review your decision and provide a reasoned response within 45 days will result in you, rather than the worker or any agency, assuming responsibility for the worker’s IR35 tax and NIC liability.

 

Can PSCs still be used under the new IR35 changes?

 

Notwithstanding the shift in responsibility for determining the IR35 employment status, thereby making the hiring of contractors and off-payroll workers less attractive to medium to large businesses that IR35 applies to, the new regime will not stop anyone working through an intermediary if that suits them, or from businesses engaging with individuals who continue to work through a PSC.

The use of a PSC can still be beneficial to both the individual contractor and the business looking to engage their services. In particular, the limited liability status of a company will protect the worker from any potential claims against them, whilst for businesses, the use of PSCs provide increased flexibility, especially where it operates in a sector with fluctuating labour demands.

By engaging with contractors through PSCs, this can also create significant costs savings for organisations, where these workers will not accrue any statutory employment rights, such as an entitlement to sickness and holiday pay, simply by virtue of them providing a service.

In other words, although the individual worker impacted by the new measures may have to pay tax like an employee, their employment status will not change, so they will not receive the rights and benefits that go with employment.

 

Need assistance?

 

DavidsonMorris’ employment lawyers are on hand to support employers with determining employment status, and reviewing and updating employment documentation and processes to ensure compliance with the IR35 requirements. Contact us for advice.

 

IR35 FAQs

 

What is IR35?

IR35 is a set of tax rules aimed at preventing tax avoidance by individuals working as contractors through intermediaries, such as personal service companies, while operating in a way similar to employees.

 

What are the recent IR35 changes?

Since April 2021, the responsibility for determining a contractor’s IR35 status shifted to medium and large businesses in the private sector. This means the hiring company, not the contractor, must assess whether the contractor is working inside or outside IR35.

 

What does ‘inside IR35’ mean?

Being inside IR35 means the contractor is considered an employee for tax purposes. The business hiring them must deduct Income Tax and National Insurance contributions at source.

 

What does ‘outside IR35’ mean?

Being outside IR35 means the contractor is considered genuinely self-employed. They are responsible for managing their own tax and National Insurance contributions.

 

Who is responsible for IR35 compliance?

Medium and large businesses are responsible for determining IR35 status for contractors they hire. Contractors working with small businesses retain this responsibility themselves.

 

What are the risks of non-compliance for businesses?

Non-compliance can lead to penalties, liability for unpaid taxes, and reputational damage. Businesses must ensure accurate IR35 assessments and proper record-keeping.

 

How do IR35 changes affect contractors?

Contractors assessed as inside IR35 may face reduced take-home pay due to higher tax liabilities but do not receive employee benefits, such as holiday pay or pensions.

 

What tools can businesses use to assess IR35 status?

HMRC provides the Check Employment Status for Tax (CEST) tool to help businesses determine IR35 status. However, businesses should also seek professional advice if needed.

 

Do IR35 rules apply to all businesses?

IR35 rules apply to medium and large businesses in the private sector. Small businesses are exempt, meaning contractors must assess their own IR35 status when working with them.

 

Can contractors challenge their IR35 status?

Contractors can dispute their IR35 status if they believe the assessment is incorrect. Businesses must have a process in place to handle these disputes.

 

Glossary

Term	Definition
IR35	A set of tax rules introduced to ensure that individuals working through intermediaries pay the correct Income Tax and National Insurance contributions.
Off-Payroll Working	A working arrangement where an individual provides services to a client through an intermediary, such as a personal service company.
Inside IR35	When a contractor is deemed to be working as an employee for tax purposes, requiring Income Tax and National Insurance contributions to be deducted at source.
Outside IR35	When a contractor is deemed genuinely self-employed and is responsible for managing their own tax and National Insurance contributions.
Personal Service Company (PSC)	A limited company set up by an individual to provide services to clients, commonly used by contractors.
Status Determination Statement (SDS)	A document provided by the hiring organisation explaining the contractor’s IR35 status and the reasons for the determination.
CEST Tool	The Check Employment Status for Tax tool provided by HMRC to help businesses assess a contractor’s IR35 status.
Medium or Large Business	Defined under IR35 rules as a company meeting two or more criteria: annual turnover of more than £10.2 million, a balance sheet total of more than £5.1 million, or more than 50 employees.
Small Business	A business that does not meet the criteria for a medium or large business and is exempt from making IR35 status determinations.
Employment Status	The classification of a worker as either an employee, self-employed, or falling inside IR35 for tax purposes.
HMRC	Her Majesty’s Revenue and Customs, the UK government department responsible for tax collection and enforcement.
Income Tax	A tax on an individual’s earnings, which must be deducted at source for contractors inside IR35.
National Insurance Contributions (NICs)	Payments made by employees, employers, and self-employed individuals to fund state benefits such as pensions and healthcare.
Tax Avoidance	The legal use of loopholes in tax rules to minimise tax liability, which IR35 aims to reduce for contractors misclassified as self-employed.
Compliance	The process of adhering to IR35 regulations, including accurate status assessments and proper record-keeping.
Penalties	Financial or legal consequences imposed on businesses or contractors for failing to comply with IR35 rules.
Contractor	An individual providing services to a business or client on a temporary basis, often through a PSC or as a freelancer.
Tax Liability	The total amount of tax an individual or organisation is legally required to pay.