Over the last decade, the freelance economy has grown to levels that make it a true force within the wider labour market. In conjunction with this growth, there is a real consistency in how national economies legislate for independent professionals.
Even with this growth, the UK government is broadening its IR35 legalisation to include private sector is the biggest shift in the freelancer/contractor industry for some time. It effects both sides of the coin - how organisations approach the hiring of contingent labour, and, at its simplest, how freelancers are paid.
But to truly understand the new normal, we need to start at the basics.
IR35 is tax legislation to make sure that the right amount of tax is paid for ‘disguised employees’.It’s been around since 2000. The problem the Government said it was originally designed to fix was described it in the Budget press release at the time:
"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. It is possible for someone to leave work as an employee on a Friday, only to return the following Monday to
do exactly the same job as an indirectly engaged ‘consultant’ paying substantially reduced tax and national insurance.
The aim of the proposed changes is to ensure that people working in what is, in effect, disguised employment will, in practice, pay the same tax and national insurance as someone employed directly."
The rules have been referred to as ‘IR35’ ever since, because that was the number of that original press release. The new rules which are coming into force in April 2021 are different to the original rules and technically called the ‘off payroll rules’. So you might hear that term around too. But whatever the label, you need to know about them now.
To understand what’s changing, you’ll need a little bit of history. IR35 was designed to stop an individual doing employee-like work but doing so as a service via their ‘intermediary’, as a way of reducing income tax and employer and employee National Insurance Contributions (NICs).
The rules say that individuals doing employee-like work via intermediaries are not genuinely self-employed and are ‘disguised employees’. HMRC see this as tax avoidance. This is because of how income tax and NICs are calculated and paid: an individual using an intermediary can pay less than if they were an employee. For example, a director of a limited company can pay themselves a low salary and take out the rest of the profits via dividends.
Intermediaries covered by IR35 include the classic ‘personal services company’, where services are provided by the individual via a limited company in which they have a material interest. That is by far the most common form of intermediary. But other intermediary structures may also be caught, including providing services via another individual, or providing via either a partnership or unincorporated association in which the individual is a member with certain rights. In HMRC-speak all of these are a ‘PSC’, so that’s the tag we’ll use too.
In a nutshell, someone’s a disguised employee if they provide their services to you via a PSC and both of these criteria are met:1. The individual personally performs, or is under an obligation personally to perform, services for you.
2. If there were a direct contract, the individual would be regarded for tax purposes as an employee (or you’ve made them an office holder).Whether or not someone is regarded as an employee for tax purposes is complicated and can be a bit of a headache to answer.
The original rules put an obligation on the PSC to mark their own homework on whether an individual had been a ‘disguised employee’. Effectively an obligation to look at each contract carried out by the individual, then report and pay additional income tax and NICs due for those contracts where the individual had been a ‘disguised employee’.
To try and make this easier for PSCs HMRC created an online tool called CEST which can help determine if the individual has been a ‘disguised employee’, but it’s not a perfect solution.
Right now, HMRC say the rules are not working. Quotes from the HMRC consultation document about the scale of underpaid tax they perceive in this area points to the motivation for changes; HMRC say the cost of non-compliance in the private sector is increasing and is projected to reach £1.3bn in 2023-24. So HMRC are shaking things up and that’s why you need to pay attention.
From April 2021 the legal responsibility for determining whether or not a contractor performing services is a ‘disguised employee’ (their ‘IR35 status’) will transfer from the PSC to the client engaging the contractor. These rules have been in operation in the public sector since 2017, and now they are being rolled out to the private sector. So, all clients who use contractors will have a primary legal obligation to assess the contract in advance and determine the IR35 status of the contract. With that comes significant tax compliance risk.
For every single engagement with a contractor you will need to assess the services the contractor is being asked to provide, the working practices in your business, the terms between you, and taking all that into account, determine if the contract is ‘Inside IR35’ or ‘Outside IR35’.
For every single engagement you have with a client your client will need to assess the services you are being asked to provide, the working practices in their business, the terms between you, and taking all that into account, determine if the contract is ‘Inside IR35’ or ‘Outside IR35’.
But don't fooled in thinking it's a one-and-done scenario. You can be inside IR35 and outside IR35 at different times
You may find, depending on the contracts that you accept, you end up working sometimes inside IR35 for certain contracts and sometimes outside for other contracts inside a single year. IR35 status is determined on a contract-by-contract basis, rather than being an assigned status for a particular tax year or discipline. All that matters is that you pay the right tax for the specific contract that you’re working on.
If you’re a small business you may be exempt from IR35. The definition of small business for IR35 exemptions is likely to be based on the definition in the Companies Act, which is met if a company meets any two of the three triggers below:
1. Annual turnover – Not more than £10.2 million
2. Balance sheet total – Not more than £5.1 million
3. Number of employees – Not more than 50
So as you can see, it's both quite the shake up as well as being rooted in things being made more consistent with public sector practise. But the quicker you adapt to the changes - either as a freelancer or business, the smoother this transition will be.
The freelance industry is stronger than ever and there are no signs of its growth and penetration in major sectors slowing - but there is definitely going to be a period of adjustment where industry finds a new normal.