What does IR35 stand for and how does it affect your business?
The UK recently passed new laws to fix a tax loophole and change some of the ways workers and companies work together. If you have employees or contractors in the UK, or if your business is based in the UK, you should know how the new IR35 rules could affect your business.
Who is IR35 important to?
Companies that hire contractors and workers themselves are both affected by the IR35 law.
In the past, many contractors in the UK set up a limited business so they could get paid by clients and pay less in taxes. The UK government thought that some of these workers were taking advantage of the tax system by calling themselves contractors when they should have been called employees. Anyone who would be considered a “employee” if the limited company (also called a “personal service company” or “PSC”) didn’t exist is now called a “deemed employee” and must pay employment taxes.
Some small businesses are exempt from the new rules, which mostly affect medium- and large-sized private companies and all sizes of public companies. A small business must meet two of the following requirements to be eligible for the exemption:
less than £10.1 million in sales each year
less than £5.1 million in total assets
Less than 50 people work there.
All companies that don’t meet the criteria for a small business must follow IR35 law.
What does it mean to have to follow IR35 laws?
In the past, it was up to HMRC, the tax body in the UK, to find contractors who took advantage of tax loopholes. Companies that have to follow the new rules for IR35 have to figure out the IR35 state of their own contractors. Small businesses don’t have to follow the rule because they don’t have enough money, but big companies that hire contractors now have to check the IR35 status of their own contract workers.
The IR35 law divides workers into two groups: those who are “outside IR35” and those who are “inside IR35.”
Outside IR35
Contractors who are properly classified as contractors and don’t try to avoid paying all taxes are considered to be “outside IR35.” This means that they are self-employed. They can pay themselves however they think will save them the most money on their taxes. This could include working through a limited business, as long as the arrangement makes sense and isn’t used to avoid paying taxes.
Inside IR35
Contractors who could be called “employees” by IR35 are “inside IR35” and must pay tax at the same rate as an employee in the same tax bracket. Companies that work with workers who fall within IR35 must pay taxes as if the contractor were one of their employees. As a result, the company (the “fee payer”) has to take out National Insurance Contributions (NICs) and income taxes for the contractor. It also has to pay owner NICs and an Apprenticeship Levy.
When IR35 is met, does a freelancer become a full-time worker?
No. If IR35 applies, contractors must pay taxes on their earnings as if they were employees, and their employers must do the same. However, this does not immediately make them full employees. At this time, classification and tax laws are still two different things.Contractors who are “deemed employees” because of IR35 do not automatically get job rights like paid time off and benefits.
When a worker is called a “deemed employee,” what happens?
When a contractor is called a “deemed employee” under IR35, fines happen if the contractor was previously classified outside IR35 and wasn’t paying the right taxes. If IR35 is broken by a contractor (one who is paid through a limited business but should be considered an employee), the contractor must pay all back taxes, interest, and any penalties. HMRC can look into things for up to six years in the past, so fines can be harsh.
If a business that works with freelancers is found to be breaking the law, the business must also pay fines, back taxes, and interest. The UK government said it would stop punishing people who break the rules by accident but take “reasonable care” in 2021. However, it may still punish companies that break the rules on purpose. The government could also publicly shame companies that don’t follow the new rules to get more people to follow them.
Misclassification won’t happen if you use our Contractor Compliance Checklist.
Use this guide to help you decide whether a new hire should be a contractor or an employee.
How does an SDS help a company follow the rules for IR35?
First, companies that fall under IR35 must give each worker a Status Determination Statement (SDS). The SDS goes from the end user or end client (the company getting the service) to the agency (if needed), then to the PSC/limited company, and finally to the individual provider.The SDS must include information about the company’s choice about whether the contractor is inside or outside of IR35, as well as the reasons for the decision and proof that reasonable care was taken when making the decision.
If the contract changes, the company hiring the contractor must make a new SDS to figure out if their connection has changed under IR35.
What happens if the SDS the company makes isn’t what the provider wants?
Contractors can challenge decisions made by SDS by phone or in writing within 45 days of getting the notice. When the company gets the complaint, it has an extra 45 days to reply.
In this case, companies can do one of two things:
Keep the choice and tell the contractor in writing why it was made the way it was.
Make changes to the SDS and make a new one.
If the company doesn’t do what it needs to do within 45 days, it will have to pay the contractor’s taxes and NICs for the change in status.
What does IR35 mean by “reasonable care”?
HMRC wants companies to use SDS to get the information they need to figure out if a worker is inside or outside of IR35.Due diligence can look different, but records like these should be kept:
Does the worker work for anyone else?
Does the contractor take financial risks? Is the PSC/limited company a legal way for the contractor to be represented?
What kind of work does the provider actually do? Are these tasks different from what full-time workers at the company do?
Answering questions like these shows that the company took reasonable steps to follow IR35 rules. Companies must keep these records and write down how they decide who is a worker and why. Companies should never make a “blanket” decision about the standing of all their contractors.
What is Check Employment Status for Tax, or CEST?
The CEST is an online tool made by HMRC. It asks a series of questions to help businesses figure out who is an employee and who is a contractor for tax reasons. You can use this tool as part of “reasonable care.”
On the website of the UK government, businesses can find the CEST.
In this one-hour webinar on managing freelancers, three experts talk about the best ways to work with contractors on your team, such as what to include in a contract, who should own the contract, reviews of contractor status, and more.
After IR35, how to pay workers and stay legal in the UK
With so many brilliant people in the UK, IR35 rules shouldn’t be a reason for them to leave their jobs. The UK is home to workers and employees with a lot of experience in a wide range of fields. These new rules are meant to close a tax loophole, not make it harder to do business in the country.
What does IR35 stand for and how does it affect your business?
The UK recently passed new laws to fix a tax loophole and change some of the ways workers and companies work together. If you have employees or contractors in the UK, or if your business is based in the UK, you should know how the new IR35 rules could affect your business.
Who is IR35 important to?
Companies that hire contractors and workers themselves are both affected by the IR35 law.
In the past, many contractors in the UK set up a limited business so they could get paid by clients and pay less in taxes. The UK government thought that some of these workers were taking advantage of the tax system by calling themselves contractors when they should have been called employees. Anyone who would be considered a “employee” if the limited company (also called a “personal service company” or “PSC”) didn’t exist is now called a “deemed employee” and must pay employment taxes.
Some small businesses are exempt from the new rules, which mostly affect medium- and large-sized private companies and all sizes of public companies. A small business must meet two of the following requirements to be eligible for the exemption:
less than £10.1 million in sales each year
less than £5.1 million in total assets
Less than 50 people work there.
All companies that don’t meet the criteria for a small business must follow IR35 law.
What does it mean to have to follow IR35 laws?
In the past, it was up to HMRC, the tax body in the UK, to find contractors who took advantage of tax loopholes. Companies that have to follow the new rules for IR35 have to figure out the IR35 state of their own contractors. Small businesses don’t have to follow the rule because they don’t have enough money, but big companies that hire contractors now have to check the IR35 status of their own contract workers.
The IR35 law divides workers into two groups: those who are “outside IR35” and those who are “inside IR35.”
Outside IR35
Contractors who are properly classified as contractors and don’t try to avoid paying all taxes are considered to be “outside IR35.” This means that they are self-employed. They can pay themselves however they think will save them the most money on their taxes. This could include working through a limited business, as long as the arrangement makes sense and isn’t used to avoid paying taxes.
Inside IR35
Contractors who could be called “employees” by IR35 are “inside IR35” and must pay tax at the same rate as an employee in the same tax bracket. Companies that work with workers who fall within IR35 must pay taxes as if the contractor were one of their employees. As a result, the company (the “fee payer”) has to take out National Insurance Contributions (NICs) and income taxes for the contractor. It also has to pay owner NICs and an Apprenticeship Levy.
When IR35 is met, does a freelancer become a full-time worker?
No. If IR35 applies, contractors must pay taxes on their earnings as if they were employees, and their employers must do the same. However, this does not immediately make them full employees. At this time, classification and tax laws are still two different things.Contractors who are “deemed employees” because of IR35 do not automatically get job rights like paid time off and benefits.
When a worker is called a “deemed employee,” what happens?
When a contractor is called a “deemed employee” under IR35, fines happen if the contractor was previously classified outside IR35 and wasn’t paying the right taxes. If IR35 is broken by a contractor (one who is paid through a limited business but should be considered an employee), the contractor must pay all back taxes, interest, and any penalties. HMRC can look into things for up to six years in the past, so fines can be harsh.
If a business that works with freelancers is found to be breaking the law, the business must also pay fines, back taxes, and interest. The UK government said it would stop punishing people who break the rules by accident but take “reasonable care” in 2021. However, it may still punish companies that break the rules on purpose. The government could also publicly shame companies that don’t follow the new rules to get more people to follow them.
Misclassification won’t happen if you use our Contractor Compliance Checklist.
Use this guide to help you decide whether a new hire should be a contractor or an employee.
How does an SDS help a company follow the rules for IR35?
First, companies that fall under IR35 must give each worker a Status Determination Statement (SDS). The SDS goes from the end user or end client (the company getting the service) to the agency (if needed), then to the PSC/limited company, and finally to the individual provider.The SDS must include information about the company’s choice about whether the contractor is inside or outside of IR35, as well as the reasons for the decision and proof that reasonable care was taken when making the decision.
If the contract changes, the company hiring the contractor must make a new SDS to figure out if their connection has changed under IR35.
What happens if the SDS the company makes isn’t what the provider wants?
Contractors can challenge decisions made by SDS by phone or in writing within 45 days of getting the notice. When the company gets the complaint, it has an extra 45 days to reply.
In this case, companies can do one of two things:
Keep the choice and tell the contractor in writing why it was made the way it was.
Make changes to the SDS and make a new one.
If the company doesn’t do what it needs to do within 45 days, it will have to pay the contractor’s taxes and NICs for the change in status.
What does IR35 mean by “reasonable care”?
HMRC wants companies to use SDS to get the information they need to figure out if a worker is inside or outside of IR35.Due diligence can look different, but records like these should be kept:
Does the worker work for anyone else?
Does the contractor take financial risks? Is the PSC/limited company a legal way for the contractor to be represented?
What kind of work does the provider actually do? Are these tasks different from what full-time workers at the company do?
Answering questions like these shows that the company took reasonable steps to follow IR35 rules. Companies must keep these records and write down how they decide who is a worker and why. Companies should never make a “blanket” decision about the standing of all their contractors.
What is Check Employment Status for Tax, or CEST?
The CEST is an online tool made by HMRC. It asks a series of questions to help businesses figure out who is an employee and who is a contractor for tax reasons. You can use this tool as part of “reasonable care.”
On the website of the UK government, businesses can find the CEST.
In this one-hour webinar on managing freelancers, three experts talk about the best ways to work with contractors on your team, such as what to include in a contract, who should own the contract, reviews of contractor status, and more.
After IR35, how to pay workers and stay legal in the UK
With so many brilliant people in the UK, IR35 rules shouldn’t be a reason for them to leave their jobs. The UK is home to workers and employees with a lot of experience in a wide range of fields. These new rules are meant to close a tax loophole, not make it harder to do business in the country.