In less than a month, new IR35 tax changes will come into force in the private sector, meaning some self-employed workers – and the businesses that hire them – will have to pay tax differently.
More than a third of self-employed workers are still unaware of the forthcoming changes; a further three in 10 said they were aware of the changes, but did not understand how they would be impacted, according to research from EY TaxChat.
The changes were introduced in the public sector in 2017. They were meant to come into force in the private sector in April 2020, but were pushed back a year due to the financial impact of the coronavirus pandemic.
The government says genuine freelancers and self-employed workers won’t be affected.
Here, we explain what the IR35 rules are, and who may be affected by the changes starting from April 2021.
What is IR35?
IR35 refers to the off-payroll working rules that aim to ensure that contractors doing work for companies, and the companies themselves, are paying the correct level of tax.
HMRC believes that thousands of people employed via a Personal Services Company (PSC) or another intermediary have been paying incorrect taxes; they should actually be paying the same amount of tax as fully employed workers, rather than self-employed workers.
You’re deemed to fall within IR35 rules if you would be considered an employee of a company if the PSC wasn’t in place.
If you’re not sure whether you, or someone you employ, would fall inside IR35, there are three ‘tests’ you can use to check:
- Who has control over how the work is completed? If the company dictates your working hours and/or the location of where the work has to take place, you may be inside IR35.
- Is there a mutuality of obligations? If the company is obliged to give the worker more work once they’ve finished a task, they may be inside IR35.
- Do you personally have to complete the work you do? To be outside of IR35 there should be a substitute clause in your contract, and you should be in charge of that substitute.
It is down to the company hiring the individual to assess whether they fall inside or outside of the IR35 rules, and could face ramifications if it gets it wrong.
The measures have proved to be controversial. A consultation that ran between 5 March and 29 May 2019 found that affected contractors could stand to lose up to 20% of their income as a result of the changes.
Why are IR35 changes being introduced?
The effect of people ‘synthetically’ working as though they were self-employed means the Treasury misses out on income tax and National Insurance contributions from both them and the company employing them.
Basic-rate employed taxpayers have to pay 20% tax on income above the personal allowance up to £50,000 (rising to £50,270 in 2021-22), and 12% in National Insurance on earnings between £9,500 and £50,000 in 2020-21 (£9,568-£50,270 in 2021-22), and 2% on any earnings over and above. Employers also contribute 13.8% in NI payments above the £9,500 threshold for each employee on their payroll.
But if a self-employed worker operates under their own limited company, they effectively employ themselves and can therefore reduce their earnings so that they can completely avoid or significantly reduce the amount of income tax and NI they pay. They can instead top up their salary with dividends which are taxed at a lower rate. This is perfectly legal, as long as the worker does not fall inside of IR35 rules.
By doing this, instead of paying income tax rates of 20%, 40% and/or 45% on their salary (depending what income tax band they fall into), they might pay just 7.5%, 32.5% or 38.1% on dividend income.
The Treasury has previously estimated that non-compliance would cost more than £1.3bn a year by 2023-24 if the issue isn’t addressed.
- Find out more: self-employed National Insurance
What will change from April 2021?
From 6 April, all public sector authorities and medium and large-sized businesses in the private sector will be responsible for deciding whether IR35 rules apply.
If a contractor provides services to a small private sector client, the worker’s intermediary will be responsible for deciding if the rules apply.
The Treasury conducted a review into the IR35 rules in March 2020, announcing several changes that it hoped would help individuals and businesses prepare.
- Having a ‘light touch’ approach to enforcement: during the first year of the rollout, HMRC has been told not to place penalties on anyone with inaccuracies relating to the IR35 rules, but anyone who deliberately fails to comply can be charged.
- Not using information for new investigations: HMRC won’t use any information submitted as a result of the changes to launch new investigations into PSCs for the tax years before 6 April 2021, unless there’s a reason to suspect fraud or criminal behaviour.
- Making clients legally obligated to supply information: The government will place a legal obligation on clients that means they must respond to requests for information about their size from agencies or workers, so they can gauge whether they’re dealing with a medium or large-sized organisation.
- Rules only apply to services from 6 April 2021: The IR35 changes will only apply to work carried out on or after 6 April 2021.
Who could be affected by the off-payroll working rules?
Many contractors offer work to clients by setting up a PSC. The client hires the PSC, which in turn pays the contractor.
In many cases, this is a perfectly legitimate way of working, but HMRC has identified thousands of workers and companies who it thinks should be paying the same rate of tax as employees.
There are three main groups that are likely to be affected by the IR35 rollout in the private sector:
- Up to 170,000 individuals who are supplying services through an intermediary, such as a PSC, without which they would be fully employed
- Up to 60,000 medium and large private-sector organisations (with 50 or more employees), which hire workers via PSCs
- Around 20,000 recruitment agencies and other intermediaries which supply staff through PSCs.
You can find a range of resources on gov.uk with more details on how the IR35 rollout will work.
This story was updated on 18 March 2021 to remove the example of a sole trader and include information about how those with limited companies can pay lower income tax by making more of their salary through dividends.