IR35 UK: Legislations Explained
Erez Greenberg| Apr 06, 2023
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.
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.
There’s another way to ensure compliance that’s trusted by millions
Though the IR35 legislation is only a part of the constant changes and decisions regarding off-payroll working rules can seem confusing. And because IR35 could effect your business, it’s crucial you understand the legalities and responsibilities to stay compliant.
This is why thousands of organizations around the world trust Papaya Global to help manage their contractors. While you focus on your company’s goals, our local experts will walk you through all the applicable legislation to remain compliant in the UK. Schedule a demo and make sure you’re keeping your company safe from fees, liabilities, and penalties.
Who is affected by IR35?
All workers providing services to a client through their own intermediary are affected by IR35. In addition, all public sector clients and medium and large-sized private and voluntary sector clients are affected, as they need to review each contract they have with workers and determine the individual’s correct status.
What are the penalties for non-compliance with IR35?
Penalties for non-compliance include fees, interests on large tax bills, potential lawsuits, and other potential damages. Depending on your business and whether you took reasonable care in determining a worker’s status, you may have to pay a certain percentage of unpaid taxes.
How can a contractor determine their IR35k status?
First, it’s up to the business to determine the contractor’s status. If a contractor would also like to check their status, HMRC created an online employment status tool (CEST) to ensure accuracy.
Can businesses still hire contractors after IR35?
For businesses to continue working with contractors, they need to make sure the worker is either inside or outside IR35 before they continue the working relationship. Once your business determines the correct status, you’ll need to create a Status Determination Statement and communicate the status and the reasoning behind it to the contractor and/or agency.
What are the implications of IR35 on contractors?
For contractors, IR35 means they cannot classify themselves. The business will determine their status and depending on whether they are inside or outside IR35, contractors may need to pay income tax and National Insurance Contributions just like regular employees.
Does IR35 apply to foreign contractors?
If the contractor is classed as being overseas, (they aren’t a UK resident or don’t have a permanent establishment in the UK), the off-payroll working rules do not apply. If the contractor performs their services in the UK for a short period, they may be subject to the IR35 regulations. To avoid fines, it’s important to consult with an expert on the matter.