IR35: All change for businesses and freelance workers

This article, by our tax experts Sarah Cardew and Anamika Pandey, first appeared in Estates Gazette.

The IR35 regime applies to individuals who, if they did not use an intermediary (such as a personal services company), would be categorised as employees of their clients.

The effect of IR35 is to collect the same amount of income tax and national insurance contributions as would have been paid if an individual had been employed directly by the client.

IR35 applies on an engagement-by-engagement basis, hence the underlying arrangements in relation to each client must be assessed individually.

How does this affect the real estate sector?

In comparison with other countries, the UK real estate sector – and in particular the construction sector – has a much higher reliance on its self-employed workforce.

A common approach by these workers is to set up a simple “one man band” limited company (so they own most, or all, of the shares as director of the limited company), categorised as a personal services company (PSC) by the tax authorities.

Working through a PSC provides certain tax advantages to the individuals, as well as the businesses that engage them. Individuals can invoice their clients for their services via the PSC and then take some – or all – of the earnings as dividends (which are subject to a much lower rate of tax than salary).

This also comes with the added advantage that they do not need to pay national insurance contributions on a large part of their income. The ownership of the PSC can also be split between family members – this enables them to place the income of the PSC in lower tax bands.

Many businesses prefer to engage workers through PSCs, as this means the businesses have lower – or no – employment responsibilities, thereby making freelance a more flexible resource.

Work arrangements via a PSC are also a useful way to protect intellectual property rights.

IR35 basics and reforms

Under the IR35 legislation, when an individual provides services to a client through a PSC, income tax and national insurance contribution liabilities can fall on the PSC if the individual would have been regarded as an employee of the client, had the individual not contracted through the PSC or any other intermediary, like a partnership or an LLP.

In April 2017, the IR35 rules changed for the public sector. Under the changed rules, public sector engagers became responsible for determining the employment status of their freelancers operating through PSCs. If, as per their evaluation, an individual would have been regarded as an employee of the business, disregarding any PSC used as an intermediary, the public sector engager must operate PAYE, and pay employer’s national insurance contributions.

In the 2018 Budget, the chancellor announced that he would extend the IR35 reforms in the public sector to the private sector from 6 April 2020. However, they will not apply to small businesses. In the case of small businesses engaging freelancers through PSCs, the PSC will remain liable for applying the IR35 rules.

Determining the employment status

In order to decide if IR35 applies to a contract, it is important to establish what the underlying employment status is between the worker and the engager. While an individual’s employment status can only be finally determined by a court or a tribunal (based on a subjective review, rather than objective review, of the contractual terms) on a case-by-case basis, a typical indicator of being inside IR35 is that the individual works under the engager’s direction, control or supervision, is required to perform the work personally, or does not take any commercial risk while performing his duties. HMRC has also published an online tool to help determine the status of the PSC.

It is worth mentioning that there has been a recent ruling in the case of MCDM Ltd v The Commissioners for HM Revenue & Customs [2018] UKFTT 201 (TC). In this case, a contractor in the construction industry successfully appealed an HMRC ruling that he was an employee, with the First-tier Tribunal finding that he was not an employee for IR35 purposes.

The tribunal noted “we find that the nature of the payment arrangements, a flat rate per day with no notice period and no entitlement to any employee benefits are inconsistent with employment”.

Given the vagueness, speculative nature and complexity of the IR35 regime, this decision has been welcomed by business and tax advisers equally.

Private sector businesses which engage third-party professional services, and other freelancers that are supplied via PSCs in the construction and real estate sector, are likely to be hit by IR35. Although the new legislation will not come into force until April 2020, now is the time to consider the potential impact so that you have sufficient time to introduce any changes required to manage your PAYE compliance effectively and efficiently.

Brace for impact

Businesses should assess their existing contractual arrangements, and evaluate the risks of any of their workers being treated as an employee.

The main risks being associated with the additional costs of their workforce (employer’s national insurance contributions, the Apprenticeship Levy, rights to holiday, pensions, etc) will need to be considered in evaluating the revised rates of the worker.

Similarly, many freelancers will need to review the benefits of continuing to work in a self-employed capacity.

Also, as the April 2020 proposed reforms could drastically increase costs for private sector businesses and have a significant impact on their operating models, it is extremely important to ensure that the IR35 reforms stay high on the agenda of the business’s key decision-makers.

Sarah Cardew is a tax partner and Anamika Pandey is a solicitor at Irwin Mitchell LLP