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Employment – What You Should Know About IR35 Regulation

Posted by: Marcin Durlak
Posted in: Employment
Date published: 02/04/2020

‘Employment in disguise’  –  what you should know about IR35 regulation.

The ironic thing about IR35 legislation is that when you type this phrase into Google, the first result that shows up is ‘IR35 changes’ and ‘IR35 how to avoid’. We know it also from our business clients that they are concerned and not sure how to manage their relations with contractors and employees in light of the regulation.

We know therefore that the IR35 regulation is important to you and you want to know more. Have you ever heard about it? If you have not, we invite you to spend few minutes with us on familiarizing yourself with legislation that may affect your business relations and models of cooperation you adopted in your practice.

As long as we do not recommend to avoid or ignore what the law says, we encourage you to make sure you comply with it in order to minimalize the risk of future issues that may have detrimental effect on your business in the turbulent times.

What is IR35 regulation?

The IR35 regulation was introduced to subdue the tax avoidance in the context of employment law. Some individuals may undertake to avoid paying employee income tax and national insurance contributions by providing their services through an intermediary company, usually individual’s own personal service company, and paying dividends, national insurance contributions and corporate tax that is significantly lower. This is so called ‘deemed employment’ or ‘disguised employment’.

In simple words, the legislation aims to distinguish whether the contractor working for a client is really an independent service provider or maybe an employee if the circumstances of the cooperation indicate that it is closer to employer-employee relation than business-to-business one.

The regulation apply if:

• An individual personally performs services for a client (or is obliged to do so),
• Those services are provided under arrangements involving an intermediary (defined as a person from which worker or associate receives a payment or some kind of benefits and whose relationship with the worker satisfies certain conditions depending on the type of the legal person the intermediary is).
• The circumstances are such that if the arrangements had been made directly between the individual and the client, the individual would have been considered as an employee by the client for national insurance contributions purposes.

If HM Revenue & Customs decided that someone is employed rather than just provide services, the worker and the intermediary will be treated as employee and employer for national insurance purposes. That basically means that they will have to pay income tax and national insurance contributions as if the person was employed.

Similar but slightly different solution has been adopted in order to determine whether the income tax will be payable.

The Income Tax (Earnings and Pensions) Act 2003 will be applicable if:

• An individual personally performs services for the client (or is obliged to do so).
• Those services are provided under the agreements involving an intermediary.
• The circumstances are such that if the arrangements had been directly between the individual and the client, the individual would have been regarded as “employed” by the client for income tax purposes.

Here, unlike the regulation for national insurance contributions purpose, all the third parties will be considered ‘intermediaries’ if there is only a relevant engagement between them.

We can say about the relevant engagement if the Chapter 8 of The Income Tax (Earnings and Pensions) Act 2003 applies in principle, the individual (or an ‘associate’) received or is entitled to receive a payment or benefit with is not employment income and also if certain conditions in relation to the intermediary are satisfied. The regulation differs depending on the type of the intermediary: it can be either company, partnership or individual.

If the intermediary is a company both the client and the intermediary are under the control of the worker and also the worker has a material interest, interpreted as for example the ownership or right to control more than 5% of the ordinary share of the company, in the company or the payment or benefit the worker received from the intermediary company can reasonably be taken to represent payment for the services provided by the worker to the client.

The partnership may be also an intermediary. If the worker receives payments and benefits as a member of it and is entitled to at least 60% of the profits of the partnership, or most of the profits relate to a single client, or the income of any of the partners is determined by reference to income earned by that partner when providing services under the relevant agreements, the partnership will fall under the definition.

The definition is even broader and even if worker receives payments or benefits other than he would as a member of the partnership, it still can be treated as an intermediary if the worker is paid directly by the intermediary and the payment can reasonably be taken to represent payment for the services provided by worker to the end client.

The individual can also be intermediary if the worker is paid directly by intermediary and the payment can reasonably be taken to represent payment for the services provided by worker to the end client.

Whenever the worker is considered to undertake the relevant engagement, he will be treated as employed by the intermediary, therefore again, the worker will be treated as an employee and intermediary as an employer for the purposes of income tax. 

Employment status

As you may see one of the conditions sine qua non in order to be caught under the IR35 rules is being considered as an employee of the client if the contract would be directly between the client and the worker.

Regardless of what the contract (either verbal or written) between the parties (client and contractor or employee and employer) says, there are some factors that indicate that the individual may be regard as an employee rather than contractor.

The factors that should be considered are as follows:

• In an employment relationship there is an obligation on the part of the worker to provide his work and the obligation from the employer to pay the worker for the service.
• Personal service. The individual is required to provide their services personally. He cannot appoint the substitute to provide the service instead of him if he is employed.
• Right of control. The engager has a right to control the employee, but the right does not need to be exercised by the employer. The control takes different forms, for instance imposing strict working time, providing obligation to comply with internal policies or give employee instructions on how he should provide his work. An individual who is providing services cannot be controlled in the same way as the employee could be.
• Exclusivity. The employee usually cannot provide services for other organisations that the employer’s. If he wishes to engage somewhere else, it will normally require obtaining express consent from his employer.  An individual who is not employed but is providing services can enter in so many contracts as he wants and cannot be deprived of this right to do so.
• Length of the engagement. The length of the engagement is usually not determined (with the exception of fixed-term contracts). It is more likely that an employee will have an open-ended contract than is engaged for a one project only.
• Integration. The employee will be usually treated as a part of the company. He will be expected to meet standard and quality requirements, he may be using uniform provided by the employer, his business cards and may be associated with some internal structures, like committees or teams.
• Facilities and equipment. The company provides the individual with the facilities and equipment required by them to carry out their job if he is employed. Service provider will be rather expected to have his own materials, tools and equipment.
• Salary and benefits. If an individual is entitled to benefits such as annual leave, maternity or paternity leave, pension scheme and is paid on weekly or monthly basis regardless of the workload and result of the work provided, it may indicate that he is employed.
• Financial risk. The individual who is employed will not risk his own money by engaging with the employer. The risk of making a loss is considered as a strong indicator of self-employment.
• Opportunity to profit. The employee usually does not participate in a profit of the company just on the same way he does not directly suffer from loss (financial risk). The individual is likely to be paid the same amount of money as per the agreement no matter what is the current financial situation of the employer.
• Taxation. The individual is not responsible for payment of income tax and national insurance contributions on their earnings. The indication who is paying taxes and what kind of taxes may give a hint on the status of the individual in question.
• Right to terminate contract. A right to terminate an engagement for a reason other than serious breach, by giving notice of a specified length, may be viewed as indicative of a contract of employment.

Since the above may be helpful in determining the status, please bear in mind that you should be looking at the overall picture of the relation as between the parties. The list of factors is non-exhaustive and should be treated as a guidance only.

In March 2017 HMRC has introduced a new tool, CEST – Check employment status for tax one can use to assess the status of the role. It may be very useful to make sure whether IR35 legislation applies or not to the certain situation. The result will base on answers user provide in an online questionnaire available on HMRC’s website.

New rules from April 2020

The rules that are currently in force will change from 6^th April 2020. From this day onwards client being a public authority (already applicable), medium or large-size (legal) person will have to determine employment status of each worker. Moreover, they will have to give the reason why they decided the way they did. Failure to do so or providing unreasonable basis may result in imposing the decision to pay the worker’s tax and national insurance contribution.

Please note that the worker or agency the client will have to notify may object the decision providing the reasons why what will mean that this will be client’s turn to respond and address the issues they raised.

If you are a company, limited liability partnership, unregistered company or overseas company with an annual turnover of more than £10.2 million, balance sheet total of more than £5.1 million or employee more than 50, you most likely will be affected by the changes.

How to protect your business?

First of all, have a look at the contracts as entered in to between the intermediary and the client and between the intermediary and the worker.

When conducting the investigation the HMRC is likely to examine the contracts and the realm of the cooperation as between the parties, therefore you need to make sure they include clauses that are unambiguous and reduce the likelihood for you to be caught under IR35 regulation.

If the individual is required to provide the work personally and the obligations are mutual, it is very likely that such relation will be considered as employment relation (just like in Synaptek Limited v Young (HM Inspector of Taxes) [2003] EWHC 645).

Whenever the individual or intermediary is required to comply with client’s internal policies, use its equipment or is enrolled to programmes and schemes dedicated to permanent workers there is a significant risk of considering the relation as employment one.

If you feel you may need a further advice or if you are not sure if the IR35 regulation may apply to you, please do not hesitate and contact our team of employment law specialists who will be more than happy to assist you with your enquiry.

If you require help or additional information, please contact one of the lawyers in our business team on 0330 107 0106 or email m.durlak@imd.co.uk.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.