IR35 Changes 2021 – April 2021 private sector IR35 update

April 2021 saw some sweeping changes to IR35 for the private sector.

The underlying principles of IR35 didn’t really change – what changed is who is responsible for the decision as to whether or not an engagement is inside or outside of IR35.

Please note – in this article when we refer to ‘you’ we are referring to the contractor / freelancer working through their own personal service company.

Before April 2021, if you were working in the private sector, it was down to you to make the decision as to whether or not your engagement was inside of IR35 or outside of IR35.

However from April 2021 it is down to the end client to make the decision in most cases. They will need to tell you upfront if the engagement being offered is inside or outside of IR35.

If you accept a role that is inside of IR35 you will be paid after deductions for income tax and national insurance have been made, a bit like how an employee is taxed.

If, however, you accept a role that is outside of IR35 and you work through your own limited company, the client will pay your personal service company in full.

Before we get into further detail on the changes lets rewind a bit and go through some of the basics of IR35.

 

 

What is IR35?

HMRC introduced IR35 many years ago as a measure to tackle the situation where an individual would be treated as an employee were it not for the fact they were providing their services through a limited company, known as a ‘Personal Service Company’.

IR35 is also known as the ‘intermediaries legislation’.

This is an area that particularly affects contractors and freelancers providing their services through a limited company, although all limited companies need to be aware of this.

Trading through a limited company can lead to significant tax and national insurance savings but if HMRC investigate an outside IR35 contract and deem that it is actually inside IR35, they will seek the lost tax and national insurance and can potentially go back several years.

This is because if you are inside IR35 you aren’t allowed to pay dividends – essentially everything has to be treated as taxable salary and if you have paid dividends when you shouldn’t have then an adjustment will need to be made.

The optimum way to save tax for freelancers and contractors, is usually by taking a low level of salary with the rest of your income being taken as dividends.

This avoids unnecessary national insurance payments (there is an optimum level of salary which protects your national insurance position).

Under the old IR35 rules it was down to the freelancer / contractor to make the decision as to whether a role was inside or outside of IR35 and the responsibility for the decision was theirs.

New rules came in during 2017 which meant that if you worked for a client in the public sector the IR35 decision and responsibility flipped to being that of the end client.

The IR35 changes in April 2021 align the private sector with the 2017 public sector changes (unless your client is classed as a small business or is based wholly overseas, see later in article) and mean from April 2021 it is down to the end client to make the IR35 decision.

As a contractor / freelancer you will be told upfront if the engagement is inside or outside of IR35 and you can choose whether or not you want to consider an inside of IR35 role.

One positive result of these changes is that in most circumstances the responsibility will no longer be with the contractor / freelancer – as long as you are told an engagement is outside of IR35 you don’t need to worry about potential IR35 issues from HMRC.

 

Exception to IR35 2021 changes – small business clients

One of the key exceptions to the IR35 changes in April 2021 is if your client is in the private sector and is classed as a ‘small business’.

In these circumstances the IR35 changes will not apply and you will need to continue assessing your own IR35 position.

For a client to qualify as a small business it must meet at least two of the below three conditions:
• turnover of £10.2m or less;
• £5.1m or less on its balance sheet;
• 50 employees or less.

 

Exception to IR35 2021 changes – wholly overseas engagers

HMRC have confirmed another key exception to the IR35 changes – if your client is a wholly overseas organisation with no UK presence then the old IR35 rules will continue to apply and you will need to continue assessing your own IR35 position.

 

IR35 decision tree

From April 2021 the decision tree will be as follows:

 

Is your client either a ‘small business’ or based ‘wholly overseas’ ?

 

• YES – this means you have to decide whether a role is inside or outside of IR35:
  • Outside IR35 – you can choose to follow the typical tax efficient structure of low salary and dividends, normal business expenses can be claimed
  • Inside IR35 – you have to calculate the deemed salary payment and process through your own payroll. No dividends can be paid and no travel, subsistence or accommodation costs can be claimed

 

• NO – this means that the end client has to make the IR35 decision and must tell you up front about this
  • Outside IR35 – if the client tells you that a role is outside IR35 then you can choose to work through your own limited company and follow the typical tax efficient structure of low salary and dividends, normal business expenses can be claimed
  • Inside IR35  – if the client tells you that a role in inside IR35 then they will deduct tax and national insurance on your behalf before paying you – they will usually do this through an Umbrella company although occasionally they will still let you work through your own company

 

 

What are the key factors which affect whether an engagement is inside or outside of IR35?

When HMRC perform an IR35 investigation they will look at both the actual contract in place between the contractor and engager as well as what the real day to day working practices are.

HMRC will speak to the engager and the contractor during their investigation.

Ensuring you have an ‘outside IR35’ contract in place is an important step, but it’s just as important to make sure that the working arrangements actually do reflect the contractual terms.

There are a number of key areas to consider when determining IR35 status – they will all be looked at to form an overall assessment, we outline some of these below.

 

Personal service / substitution

It is important to understand that a self-employed contractor / freelancer should be providing a service rather than their own personal skills and if required they should be allowed to provide someone else to do their work.

This is known as ‘substitution’.

If you were an employee of a client then you would be providing your services personally with no ability for you to bring in someone else to do the work.

The tricky thing is that for many contractors and freelancers, in reality, they will never bring anyone else in to do their work, so substitution is often a theoretical situation, however as long as their contract with the client provides a right to substitute someone else to undertake the work (and this is genuine) then this is an important step towards not being caught by IR35.

It is often the case that the client / engager retains a right to say no to a substitution on reasonable grounds but this should be limited to factors such as the experience or qualifications of the potential substitute.

It is important that the client can only reject a substitution on reasonable grounds.

 

Mutuality of obligation

This means that there is no obligation on either the client or the contractor to offer or be offered continuing work.

A self-employed contractor will work on the specific project that they are being contracted to do and once finished there should be no expectation of any further work by either side.

An issue can arise in a situation where work is continued to be performed over a longer period of time – purely on the basis of this ‘habit’ HMRC could try and argue that the contractor has become an employee.

Your contract should let you leave a contract early if you wish, and equally the client should be able to terminate early.

It is also good habit for a notice period to not be longer than one month.

 

Control

The more direction and control that a contractor has over the services they are providing, the better.

A true subcontractor is being engaged to provide their expert services, not to come into a business and be told what to do.

The more specialist skills and expertise that a contractor has, the more control they are likely to have over their services.

For example, if a manager tells a contractor to move from one job to another, it tends to be an indicator of employment.

 

Other important IR35 factors

Although the above three areas are important, there are many other factors to consider, including:

Intention of the parties – the intention of both parties at the outset of the agreement is important, was there always a clear intention of self-employment.

Financial risk – if a contractor does something wrong they should have to correct the mistake at their own cost and should not be paid for the additional work.

Own equipment – the more of their own equipment that a contractor uses to perform their services, the better. Ideally they should provide their own computers and phones.

Other work – it is important that a contractor has the right to take on other work / work for other clients – if a contract states that they are not allowed to work for anyone else this is an indicator of employment rather than self-employment. They should also be in a position where they have sufficient spare time to be able to do other work should they wish.

Length of relationship – the longer a contractor is working with a client, the higher the risk of the role being inside of IR35.

Part and parcel – HMRC will look at whether a contractor is in effect ‘part and parcel’ of the organisation they are providing services to – examples of this would include having a client email address, being on internal employee contact lists, having reviews or receiving employment benefits, staff training, holiday and sick pay. A genuine self-employed contractor should not be treated like an employee in any way.

Being in business – general proof that a contractor is a real business is good, for example do they have a website, business insurances and other typical things that businesses would have but employees would not.

As you can see there are many factors to consider with IR35 and employment status – it is important to ensure that the contract covers these factors and also that the day to day working practices are in line with the contract.

 

Three key reasons why being inside of IR35 is not tax efficient

The are three key reasons why being inside of IR35 under these new rules could be costly for you:

• National insurance – you will pay national insurance which you would typically not be paying under the typical outside of IR35 tax planning strategy of low salary and dividends
• Income splitting with spouse – if you used to pay your spouse a salary and/or dividends you will no longer be able to do this if you are inside of IR35 as all the income will be taxed on just you – if you’re a higher rate tax payer this could be costly
• Expenses – you will no longer be able to claim key expenses such as travel & subsistence if you are inside of IR35

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