The original IR35 rules
The contractor tax known as IR35 (named after an Inland Revenue publication) has existed since April 2000 – see Sch.12 Finance Act 2000. Under this tax a PSC contractor, whose deployed individual provides personal services to the hirer, is responsible for assessing ’employment status’ under the engagement arrangements, and for paying tax due where there is ‘deemed employment’.
‘Deemed employment’ arises if there would be an employment relationship (between the hirer and the individual) were it not for the existence of the company and any agency involved. This does not mean there is actual employment, simply that there is a ‘deemed employment relationship’ for tax purposes.
A ‘deemed employment’ relationship is determined by considering the law around employment status – a notoriously challenging area that involves assessment of the intended arrangements and contracts as well as the working practices during the engagement.
The rule extends to contractors operating through partnerships.
HMRC may reach a conclusion that is different from the contractor’s opinion even if supported by legal advice. Liability follows the outcome as to who is correct, ultimately determined by a Tax tribunal or higher court. HMRC provides an online tool – check employment status for tax (CEST) – to assist with assessment but in common with all other online tools, this cannot review the contracts nor monitor working practices.
Where there is a deemed employment relationship the PSC must account to HMRC for employment taxes on 95% of the income earned by the PSC from that relationship, there being a 5% top slice exemption to allow for administration expenses.
Public authority IR35 rules
Applicable since April 2017, responsibility for paying the IR35 tax shifted away from the PSC contractor wherever the hirer is a public authority – see Chapter 10 Part 2 ITEPA 2003. HMRC refers to these contractors as ‘off payroll’. Although these rules are often referred to as public sector IR35 rules, note that as defined a public authority does not include all public sector operations.
Where a qualifying contractor (normally a PSC) provides services to a public authority and there is a deemed employment relationship (as described under ‘the original IR35 rules’), the public authority hirer is liable to pay PAYE and NICs as if the PSC (not the individual) were an employee of the authority. If a business (normally an employment business) is involved in supplying the PSC and paying the contractor (referred to in the legislation as ‘the Fee Payer’), that business is obliged to pay the PAYE and NICs as if it were the employer of the PSC.
So under these rules IR35 tax liability changed. The party responsible for the assessment of deemed employment status under the IR35 rules switched to the hirer and the Fee Payer, with the hirer responsible for informing the Fee Payer of its conclusion. The contractor had no formal right of appeal to the hirer or the Fee Payer.
Under the 2017 rules where there is a deemed employment relationship the liable party (Fee Payer or hirer) is required to account for PAYE and NICs to HMRC on 100% of the contractor invoice (net of VAT) for services provided, employer NICs being due from the liable party (i.e. cannot be deducted from the payment to the contractor company). The PSC is paid by the Fee Payer net plus the VAT amount and excluded expenses. This results in the PSC losing the 5% top slice exemption allowed under the original rules.
Change to IR35 rules from April 2021
Further changes are set to apply to all the IR35 rules from 6th April 2021. The private sector will be subject to the same rules in principle as the public sector rules summarised above, although small companies are excluded.
The new proposed rules retain the main principles of the public sector rules, but with some key alterations. These will apply to the hiring of ‘off payroll’ contractors by hiring businesses whether private or public sector, the main impact being the extension to the private sector. Hiring businesses that are defined as ‘small’ are excluded from scope of these new rules, and in those cases the original IR35 rules will continue to apply.
So as with the 2017 rules, liability and responsibility will shift away from the contractor. Where there is a deemed employment relationship the liable party (Fee Payer or hirer) is required to account for PAYE and NICs on 100% of the contractor invoice (net of VAT) for services provided, employer NICs being due from the liable party (i.e. cannot be deducted from the payment to the contractor company). The hirer remains responsible for determining IR35 status and the rules contain more detail on the timing for reporting information and steps to be taken for IR35 status assessment with liability transfers up a chain of supply in the event of non compliance. There are also rules allowing contractors to challenge a hirer’s status assessment, requiring the hirer to set up a process.
The change of IR35 rules set for April 2021 were initially planned to apply from April 2020, but delayed due to the pandemic.