IR35 is a UK tax legislation, which aims to reduce the number of businesses and self-employed individuals trying to avoid tax by attempting to pass as non-employees.
The supposed allure of trying to diguise authentic employment status is because working as a contractor through your own business can be more tax-efficient than the latter.
However, the tax is now the sole responsibility of the end client – whoever is ultimately paying for the work – to determine whether a contract should be treated as employment (inside IR35) or not (outside IR35). Case-by-case decisions must be made for each engagement and should be based on the specific nature of the work to be undertaken, rather than the personal circumstances of individual freelancers.
In this article, we’ll explore the question ‘what is IR35 and how does it affect contractors and businesses?’
The key changes: Why IR35 Matters
Some questions still remain about the impact of the legislation on the freelance consulting world. What is clear is the need for companies, freelancers and agencies to engage practically with the new rules, recognise that compromises lie ahead and commit to working through any challenges in collaboration.
There are tremendous benefits to hiring freelancers. Although the overall self-employed population shrunk in 2020, business and research freelancing grew by 7% and has been key to many firms staying afloat through the pandemic and recovering post-pandemic. As people strategy continues to shift towards blended, distributed and agile models, firms that develop robust assessment processes for contract status determination will be best placed to continue to take advantage of the rich expertise of the UK’s freelance consulting workforce - especially if they are in need of senior expertise.
At Freshminds we’ve been working closely with our clients, freelance consultants and advisors to ensure a smooth transition over the last few years. Key advice and practical suggestions are summarised below and for further information, you can watch our latest webinar and read our follow-up fact sheet here.
How will IR35 affect me?
The rules of IR35 apply to all medium and large companies based in the UK / with a UK connection who wish to engage a UK-registered limited company, regardless of where the work is carried out. Small businesses* are currently exempt however if a firm is a subsidiary of a larger UK group, IR35 will still be in scope.
For overseas end clients or limited companies based outside of the UK IR35 may not apply but other legislation will apply. It is important for all parties to understand the specific situation of the entity with which they are dealing.
Inside IR35, freelancers are taxed in the same way as employees. Income tax and NI are deducted at source and freelancers are paid net by the fee-payer (either the end client or an intermediary agency). It is the fee-payers responsibility to ensure accurate calculations and deductions.
While freelancers and third parties cannot make the decision as to whether work is inside IR35, a freelancer can challenge a decision and it is important that all parties understand and document the process by which a decision has been reached.
*Small businesses have two of the following (<50 staff, <£10.2m turnover, <£5.1m on balance sheet )
There is no mandated process for IR35 status determination. Companies must form their own judgements on a case-by-case basis with particular reference to the four key criteria outlined by HMRC: mutuality of Obligation, Substitution, Direction, Supervision and Control, and Financial Risk.
Online tools are available to aid decision-making but it is generally agreed that these should not be relied on entirely. Businesses should work cross-functionally to agree on frameworks and consistent, documented processes for contract status determination and Freelancers should be engaged in a clear discussion and be able to understand how a decision has been reached. Processes should be continually reviewed in light of new case law and a mechanism for rapid review should be determined in case a freelancer wishes to challenge a decision.
As a client, if you have a preference as to how an engagement is treated, you may need to make changes to its scope and nature before hiring. Consider whether:
You are comfortable offering this work outside of IR35.
Are happy for a limited company to determine their own hours.
You have the right of substitution and the right to refuse to take on work outside of the scope of the brief.
You are happy to have minimal control beyond the agreement of the brief and receipt of output.
Audits and investigations will look into the reality of a freelancer’s working practices. While contract wording is very important, as is a freelancer’s marketing information (it should be clear, for example, that the limited company and the services it provides are separate from a freelancer as a named individual) it is also important to be able to demonstrate that practice matches up.
For those who are self-employed, you should bear in mind that some firms may be ultra-cautious, particularly in the short term while they adjust to the changes. Some contracts that you would expect to fall outside IR35 may be caught, equally some engagements may be re-structured in order to fall outside IR35.
"If a contract is advertised as ‘outside IR35’, don’t take this as read. Do your own due diligence. HMRC won’t give clearance on a contract that isn’t live." - Rob Woodward: Associate Director, Global Employer Services / Employment Tax at BDO.
Communicate, collaborate: Proactively engage with your clients to understand their processes of status determination.
Stay open: We suggest you identify separate day rates for work inside and outside of IR35 and remain open to both types of contract*. Having income tax and NI deducted at source can make life simpler and you may be able to mitigate impact on earnings by negotiating a higher fee / including holiday accrual etc. Also bear in mind that clients may shift their approach as time goes on and just because a working relationship that begins with an ‘inside IR35’ engagement, this doesn’t preclude working outside further down the line.
Ensure compliance from your end: Seek independent advice from qualified professionals if you are unsure of anything. Keep clear documentation your end of any status determination conversations and make sure that the wording of any contracts is both in line with its status determination and reflected by your working practice.
What should we be doing right now?
"Be patient. Communicate. Whether you’re an engager or a contractor, remember – you’re both trying to work out what the rules mean."- Bhavna Bhatt: Head of Resourcing, Contingent Workforce at the BBC.
As an end client: You can continue to enjoy all the benefits of hiring on-demand freelancers - you just need to establish a clear, consistent process for contract status determination and assessing cost. Blanket decisions are unlikely to be constructive for your business in the long run and firms who are open to offering work both inside and outside of IR35 are likely to have faster access to a wider choice of better talent.
Communicate, collaborate: Internally, pull together a cross-functional team – HR, Tax Finance etc – and begin by identifying your current freelance populations: what are different ways that your business engages freelancers? Do they fall into different categories? Who will be contracted on / beyond 6th April and will therefore need a statement of determination? Talk to your agencies and suppliers – work out a way forward together and make sure everyone knows what is being done when, how and by whom.
Design clear compliant assessment processes: Depending on how you currently engage with freelancers, you may need a number of assessment pathways. Make sure your pathways allow for consistent data gathering and documentation – this will allow hirers across your business to be confident that they are taking reasonable care and mean a straightforward process if you are audited / challenged by a freelancer. Once you have a process, tell everyone!
Stay engaged, keep reviewing:This is new legislation and at the moment there are still a lot of questions / grey areas. Work out a mechanism for quick review should new case law prompt changes to the processes you adopt early on or require you to review specific decisions.
"Sit down (sooner rather than later) and carry out a status analysis... Talk to your agencies and suppliers – you may have to change some things but it doesn’t have to be bad!"- Oliver Weiss: Partner, Employment & Immigration at Harrison Clark Rickerbys.
The long view
Although the short term will see more contracts falling inside IR35, this is likely to rebalance over time as companies clarify their processes for case-by-case assessment. While some freelancers may decide to seek permanent employment, many will continue to work flexibly, adjusting rates and negotiating terms according to contract status determination.
While there will necessarily be some compromise around fees and margins, close collaboration and clear communication between clients, freelancers and agencies/suppliers should allow all parties to reap the benefits of contract staffing without a significant impact on costs.
Flexible, contingent talent models are already core to workforce planning in many industries and will be fundamental to future business success. Freelance consultants deliver huge value in terms of growth and innovation capacity, access to niche expertise and the ability to respond rapidly to market needs. Irrespective of IR35 changes, the post-pandemic recovery world is set to be a golden age for flexible workforces.