IR35 UK: Legislations Explained

For companies in the UK, the responsibility of classifying workers remains. The latest decision around the region’s off-payroll working rules (IR35) is that businesses will still need to decide whether a contractor is really an employee or not, pay the tax, and where appropriate, contribute towards the worker’s national insurance.

Historically, contractors were in charge of determining whether they would be taxed as an individuals or as a company. In 2020, the IR35 dictated that the business (or client) would need to determine the worker’s correct tax status. For many businesses, that meant and still means they’re at risk of misclassification and the consequences that come with it.

Knowing the legislation around IR35 tax changes will help companies legally protect themselves and understand how much resources they can and need to devote to classifying workers. We’ll take you through the IR35 legislation, what it means, what it looks like in practice, and how it can impact your business.

Let’s start with the basics.

What is IR35 UK?

IR35 is a set of tax laws that determine whether a worker is an employee or a self-employed contractor.

These off-payroll rules were created to ensure individuals working like employees—but through their own company (often referred to as a personal service company or PSC)—pay the same income tax and national insurance as employees.

IR35 effects the way all companies in the UK operate from how they use resources to avoiding liabilities.

Does IR35 Apply to Non-UK Companies?

Do non-UK companies need to worry about IR35? The bottom line is yes. IR35 applies to non-UK companies in certain circumstances. IR35 creates off-payroll working rules for contractors servicing entities in the UK, regardless of their nationality or the employer’s location.
Contractors who are UK tax residents are included under IR35 and medium- or large-sized companies must classify them as either contractors or employees. If non-UK contractors work in the UK and do not have tax residency, they are not subject to IR35.
An additional layer to IR35 UK is reciprocal agreements (RAs) between the UK and other countries. Each contract has specific parameters, but workers in the UK must usually pay social security in their client’s country and maintain national insurance for a certain amount of years.
If a non-UK private-sector client works with contractors or has an office or branch, the company could be subject to IR35 rules and abide by its tax obligations.
Non-UK companies must follow the relevant tax laws and regulations when doing business in the UK, to avoid penalties and legal issues related to IR35.

Who do the IR35 rules apply to?

The IR35 rules apply to workers providing their services through an intermediary and clients who receive services from workers through their intermediary.

Agencies – recruitment agencies for contractors can also be obligated to follow these rules. Responsibility for deciding whether IR35 applies to the contract depends on the size of the client.

Public authorities and medium and large-size companies outside the public sector are also responsible for deciding whether contractors fall inside IR35 or not. Medium or large-size businesses must provide contractors with an employment status determination and the reasoning behind it.
IR35 only applies to limited companies. It usually doesn’t apply to umbrella companies, for instance, a business a recruitment agency uses to pay temporary workers.

Who is exempt from IR35?

Small businesses are exempt from IR35. If a small business hires a contractor, the contractor must determine whether they fall inside IR35.

For a company to be considered a small business, it must have two or more of the following:

• Annual turnover of no more than £10.2 million
• A balance sheet of no more than £5.1 million
• No more than 50 employees

What does it mean to be subject to IR35 legislation?

HMRC once identified contractors exploiting tax loopholes, but under IR35, companies became responsible for classifying the IR35 status of their contractors. This doesn’t apply to small businesses due to their limited resources, but large companies must identify the IR35 status of their contract workforces.
IR35 legislation categorizes contractors as “outside IR35” or “inside IR35” for tax treatment purposes. Outside IR35 means the contractor is considered a business and their pay as employment income.
Contractors classified as “inside IR35” are considered full-time employees for tax purposes. They pay the same income taxes and contribute equal National Insurance Contributions (NICs) as an employee on payroll. The company deducts taxes and contributions from their pay.

What if a contractor is termed a “deemed employee”?

When a contractor is a “deemed employee” under IR35, they will face penalties especially if they were classified outside IR35 beforehand and not paying the right taxes. A contractor violating IR35 must pay all missing back taxes, interest, and any penalties. HMRC can investigate at least six years back, leading to severe penalties.
Businesses working with contractors must also pay penalties and back taxes with interest if they’re in violation. The UK government may also publicly criticize companies that don’t comply.

The Impacts of IR35 on Businesses

The biggest implication of the off-payroll working rules (IR35 legislation) is that businesses will continue determining worker’s employment status for tax purposes. Businesses will need to provide a ‘Status Determination Statement’ which explains their decision (we’ll get to this a little later on).

IR35 UK will have a direct impact on you if you’re:

• A client who receives services from a worker through an intermediary
• An agency that provides workers’ services through their intermediary
• In the public sector
• A medium or large-sized business outside of the public sector

This covers most businesses in the UK, which means if you misclassify an individual’s employment status, you’ll need to pay unpaid tax and penalties or lose benefits. To protect you and your business from fines or penalties, you first need to determine whether you qualify as inside IR35 or outside IR35.

What Does Inside IR35 Mean?

Being inside IR35 means your contract with the individual falls under the off-payroll working rules and His Majesty’s Revenue and Customs (HMRC) declares the worker as an employee for tax purposes.

If your contract with a professional is inside IR35, the worker will need to pay income tax and National Insurance Contributions just as regular employees do. The individual is also subject to Pay As You Earn (PAYE) and will have a certain amount of funds deducted from their pay each month.

As a business working with someone inside IR35, you’ll need to match the national insurance payment to the government and will be responsible if those payments aren’t correct.

What Does Outside IR35 Mean?

If the individual working doing business with your company is outside IR35, it means HMRC considers them self-employed.
In this instance, the worker will work on defined projects (as opposed to ongoing contracts), market their services, and work for more than one client.

If you work with a professional outside of IR35, your contract must outline their working practices with your business and include details of their services.

If your contractor is outside IR35, you may want to understand their rights and what they’re liable for. This will help you protect your business from fines, lawsuits, and other potential damages.

The Impacts of IR35k on Independent contractors

For tax purposes, it’s important to note that IR35 contractors are not considered employees. Independent contractors in the UK need to register for Self Assessment to pay tax as well as pay into the National Insurance.

As a business though, your prime responsibility is to correctly determine the worker’s employment status. And unlike with employees, your company is not required to pay contractor’s insurance or tax.

With that said, there are ways to correctly classify the individual.

What does IR35 form mean in Practice?

To get an idea of what it means to correctly determine a worker’s status, let’s review the differences between inside IR35 and outside IR35:

Inside IR35 – your business needs to match the income tax and national insurance paid by the worker. If payments aren’t correct, your business is liable and could face penalties and fees.

Outside IR35 – HMRC classifies the worker as a contractor and they’re responsible for ensuring that you (the business) pays the right amount of national insurance and tax on their earnings. As a business, you do not need to enact PAYE.

Still unsure of whether the worker is inside or outside IR35? HMRC created an online employment status tool (CEST) for businesses wanting to understand their liability under IR35. If the worker receives the same rights as a permanent employee (such as holidays, sick pay, or certain benefits), it’s likely they’re considered inside IR35.

Though the HMRC created a helpful tool for determining IR35 statuses, it’s often helpful to read about a practical example of what this can and can’t look like.

Here’s what it can look like if an employer successfully implemented IR35:

Tonya runs payroll at a large multinational company in England. After receiving training in employment status and off-payroll working rules, Tonya reviewed every contract with workers who provide services through personal service companies. She went through each one and determined who would be affected by the new rules.

While assessing contracts, Tonya realized that Harvey’s contract is impacted by off-payroll working rules. She then set a meeting with him and explained the changes and how they will affect him. She gave Harvey a Status Determination Statement (SDS) that states he’s an employee for tax purposes, providing the reasoning behind the status.

Tonya handed the Status Determination Statement to the agency that supplies Harvey’s services. The agency puts Harvey on PAYE and deducts income tax and NICs before paying him for his services. Everyone in this situation is IR35 compliant.

Now let’s take the same situation, only this time, Tonya, her business, and Harvey aren’t compliant:
Tonya is in charge of payroll, but instead of going through formal training, she decided to save time and make blanket assessments of the workers who provide services through agencies.

When it came to Harvey’s contract, she incorrectly identified him as an employee. Tonya did not provide a SDS for Harvey or communicate her decision to Harvey or his agency.

Because Tonya made a blanket assessment in Harvey’s case, she missed a few crucial principles that would impact his status. In fact, according to HMRC guidance, Harvey is a contractor. This opens up Tonya and the company to penalties and interests on large tax bills due to non-compliance.

In the first scenario, we learned Tonya provided Harvey and his agency with a SDS.

What is a SDS (Status Determination Statement) for IR35?

The SDS is a statement your business that declares a worker’s employment status after completing an IR35 assessment. The SDS must provide the reasoning behind the status. The Check Employment Status for Tax tool can help you correctly identify whether a worker is an employee or contractor according to the off-payroll working rules.

This tool can help businesses across the UK stay compliant and demonstrate that they’ve taken reasonable care in assessing the status of their workers. It’s also worth noting that it’s your company’s responsibility to deduct income tax and national insurance contributions until you notify the worker your status decision and the reasoning behind it.

Ensure compliance in the UK – and across the globe

Every country has its own complex regulations regarding contractors. It’s crucial you understand these legalities and responsibilities to stay compliant.

With Papaya Global, you get the expertise and the technology you need to not only follow these requirements but automate the processes, maintaining absolute compliance throughout.

Book a demo to learn more.