What is IR35?
Introduced in the budget of 1999, the changes were intended to combat tax avoidance through the use of ‘personal service companies’ (PSCs).
The new ‘off-payroll working rules’ were detailed in the Inland Revenue press release number 35 (hence ‘IR35’) which noted “there has for some time been general concern about the hiring of individuals through their own service companies so that they can exploit the fiscal advantages offered by a corporate structure”.
IR35 came into force in April 2000, and after a turbulent 20 years, a beefed up new and improved IR35 will be launched in April 2021.
Who does it affect?
IR35 applies to the self-employed who, if paid directly, would be classed as employees. Instead these workers provide their services to their employer, or ‘client’, through an intermediary such as their own limited company.
Before the introduction of IR35, workers who owned their own limited company could receive payments via this intermediary in the form of dividends, which are not subject to National Insurance contributions (NICs).
They could also reduce their tax liability by sharing ownership of their limited company with family members to distribute income more widely within lower tax-bands.
IR35 was simply intended to make sure that contractors and consultants pay broadly the same amount of tax and national insurance contributions as employees.
Since the construction industry runs on contractors and consultants, IR35 affects many people.
What is changing?
Since the introduction of IR35 over 20 years ago, the liability for tax and National Insurance contributions (NICs) has been with the individual’s intermediary, or PSC. The freelancer must therefore decide if the rules apply on a contract-by-contract basis.
After 6th April 2021 this changes for huge numbers of freelancers. Medium and large-sized clients will assume the legal responsibility for determining whether IR35 applies to their contractors and consultants. This is already the case for workers in the public sector and has been since April 2017.
HMRC defines a medium-large client as having two out of the three following features:
• turnover of more than £10.2m;
• a balance sheet of more than £5.1m;
• an average of more than 50 employees.
If the rules apply, the client must deduct tax and NICs from fees and pay these directly to HMRC. The taxman is expecting to raise an extra £1.2bn through the new scheme in the first year alone.
What is the industry response?
For many large companies it is difficult to know if IR35 is an issue for HR, legal, accounts, procurement & purchasing or site managers. This leads to confusion and poor decision-making.
As a consequence, many companies are making blanket determinations and dictating that suppliers such as small subcontractors cannot use self-employed people on projects. They are also asking for questionnaires to be completed and asking suppliers to enter into new contracts.
One positive outcome of the new IR35 rules could be the opportunity for companies to tie down highly-valued freelancers into employment contracts. However most are being dumped onto umbrella contracts which some would argue represents the worst of all worlds.
• “IR35 applies to all self-employed including CIS sole-traders”. It doesn’t, it applies to personal service companies (PSCs), tax saving partnership schemes, and individuals who act as middlemen.
• “IR35 means I take responsibility for the employment taxes of all my suppliers who provide labour as part of what they do”. Not true. If your suppliers provide you with a composite of services from labour, plant, materials and management, IR35 does not apply to your relationship with them. They may be end users in their own right but IR35 could not pass from them to you.
• “IR35 means all of my subcontractors must use a fully employed workforce on my sites”. No it doesn’t. You only need worry about PSC freelancers and agencies.
• “My agency says it is a commercial contractor providing construction services so IR35 doesn’t apply through the agency to my freelancers”. It does not matter what a business calls itself. If all it does is provide labour, IR35 would apply through that agency to any PSCs it supplies to you.
• “I must issue a ‘status determination statement’ (SDS) to every freelancer and supplier”. Wrong again. An SDS is only required for freelancers engaged directly or via an employment business, and even then they are of limited value unless you say IR35 applies.
Case study 1
Who is not genuinely self-employed?
Take ‘Simon J’, a managing quantity surveyor who works for Acme Construction, a fictional groundworks and civils contractor. He has been with the firm for five years and is in charge of the quantity surveying department.
Simon reports to the commercial director and provides monthly reports detailing the performance of sites and staff under his control. His daily responsibilities include assigning work to the four quantity surveyors who report to him and hiring, firing, appraising and arranging training for the team.
Simon can sign off large tenders, enter into high-value contracts with subcontractors and sign off final accounts with customers. He works for Acme through his own company, SJ Commercial Services Ltd, but does not have a contract in place and has not felt the need for one, given the longevity of the relationship. He is paid weekly but submits an invoice once a month so he can collect VAT due from Acme.
Simon is not genuinely self-employed. He has a managerial role and executive powers. He would be unable to substitute himself with others because they would lack his authority. He could not turn down work because his work is not defined project by project – his tasks are linked and overlapping. He would find it difficult to work for anyone else at the same time because of his position. Simon is integrated into the company, presents himself as a senior member of staff and acts and is treated like an employee.
Case study 2
Who is genuinely self-employed?
‘Andrew D’ is a senior quantity surveyor who does some work for the fictional Acme Construction. He has consulted for the firm for five years, helping deal with the commercial aspects of projects and tendering for new works. He works on a project-by-project basis.
Andrew reports to the commercial director and provides monthly reports detailing the commercial performance of sites he is asked to look at and provides feedback on staff working on those sites. He may provide suggestions on how best the company could deploy its in-house and freelance quantity surveyors and identify training needs.
Andrew might work on tenders, appraise them and make recommendations but he cannot sign them off. He can evaluate subcontract orders but cannot sign them off. He can work on final accounts but, again, he cannot sign them off.
Andrew works for Acme through his own company, AD Commercial Services Ltd, which uses a formal contract under which services are provided. The company submits invoices at the end of every month under terms that state payment must be follow within 14 days.
Andrew is genuinely self-employed. He does not hold a managerial role or have executive powers. It would be feasible to substitute himself with others, and his contract allows it, because what he does is purely technical and based on qualifications and experience held by many others similar to himself. He works project by project and sometimes turns down work to take time off or work for others.
The role of umbrella companies
Specialist subcontractors need to be careful when selecting their advisors. We have seen some bizarre solutions in the market. In one case, a large utility firm in England ordered all subcontractors working on their projects to use one specific umbrella agency to engage their labour. This was anti-competitive and probably illegal.
Despite the fact that it is unlawful to do so, some umbrella companies charge freelancers for all employment taxes usually picked up by the employer and the employee, and then add a margin or fee. Anyone who knows their value will simply refuse to enter into these arrangements and one would hope that firms pushing this as a solution will lose their best freelancers.
Should I be worried?
If you are a contractor, freelancer or consultant who is genuinely in business on your own account, you will not be caught by IR35 and have nothing to worry about.
But if you are a de facto employee operating under the guise of a freelancer, the effect of being caught by IR35 could be costly, reducing your net income by as much as 25%.
Medium-large client organisations that employ contractors through ‘disguised employment’ might also find themselves out of pocket. As well as employers’ National Insurance contributions they might find themselves liable to pay the Apprenticeship Levy, fines, penalties and legal fees.
Construction firms could lose access to some of the best freelancers in the industry if they act on poor advice or issue blanket determinations.
Subcontractors could be wrapped in red tape dealing with unnecessary demands that needlessly apply IR35 principles to them as suppliers of construction services, rather than just to the personal service companies and labour providers at whom the legislation is aimied. If the worst happens, the best of these could take their services elsewhere too.
About the Author
Ian Anfield is managing director of Hudson Contract, UK construction’s biggest payer of subcontractors. Before joining the company in 2007, he spent 17 years in the industry with firms such as Balfour Beatty, Mowlem and Alfred McAlpine, progressing from civil engineering trainee to project manager.