On April 6, 2020, the United Kingdom’s anti-avoidance tax law called Inland Revenue 35 (IR35), or “off-payroll working,” changes significantly for independent contractors and employers. The tax law updates impact more than 170,000 independent contractors in the UK and their employers. While there are several updates to consider, the liability for defining employment status now falls to the employer instead of the employee.
Both workers and employers must familiarize themselves with IR35’s updates to ensure proper employment status, tax contributions, and other essential factors.
Classifying Independent Contractors from Full-time Employees
Independent contractors are common in the UK, but employers must hire with caution; misclassification risks lead to severe penalties. There are long-standing gray areas associated with the off-payroll working rules between independent contractors and full-time employees. The 2020 IR35 tax update creates clear distinctions between the two.
Classifying independent contractors in the UK is no easy task. However, there are specific indicators that an employee is operating as an independent contractor.
These factors include:
- Billing for services through a personal services company (PSC)
- Using their own limited business to pay themselves a small salary
- Receiving income classified as dividends, which are exempt from National Insurance Contributions (NICs)
- Paying less than 45% income tax on earnings
By contrast, full-time employees pay taxes and NICs up to 45% and 12%, respectively. In short, independent contractors, also referred to as “disguised employees,” with the same roles and responsibilities as full-time employees take home more income. The IR35 updates address this discrepancy and ensure each party pays the correct amount of taxes.
Under IR35’s 2017 updates, the government provides assessment criteria, which public sector employers must use to classify all workers under their purview. These primary criteria include:
- Control: An individual is an employee if they control how and when they execute their responsibilities, as well as which duties they perform.
- Substitution: An individual is an employee if their employer does not allow them to pass off or substitute responsibilities to another individual.
- Mutuality of Obligation: An individual is an employee if obliged to offer their services, and the employer is equally obliged to accept those services.
- Miscellaneous Factors: How the individual is paid, and if they supply the equipment necessary to complete their responsibilities
A 2015 IR35 review revealed that IR35 noncompliance cost the country over £400 million in unpaid taxes annually. Because of this noncompliance and lost tax revenue, status classification and reporting became public sector employers’ responsibility, rather than employees’ in the 2017 IR35 update.
2020 IR35 Tax Updates
The 2017 reporting reform resulted in an additional £550 million in income tax and NICs and deemed a success because of the worker/employee reclassifications and extra tax revenue generated from these updates. Because of these successful amendments, UK regulators extended public sector employers’ classification responsibilities to private sector employers. This 2020 update reduces noncompliance and generates additional income tax. The reform extends these 2017 provisions to the following private sector employers in the UK:
- Independent contractors
- Recruitment agencies
- Medium- to large-sized companies
However, the 2020 IR35 updates exempt 1.5 million private small businesses meeting the following criteria:
- 50 or fewer employees
- Annual turnover not exceeding £10.2 million
- Balance sheet totaling £5.1 million or less
No small business, public sector organization exemptions exist.
How to Ensure 2020 IR35 Compliance
To ensure compliance, the UK government made mandatory Status Determination Statements (SDSs). An SDS includes IR35 contract status confirmation that is provided to the contractor by the employer paying the personal services company. This SDS is an official form that determines the status of the worker. However, IR35 updates include a provision that allows contractors and PSCs to dispute the status. If PSCs challenge contractor status, employers must revisit the status decision and reply within 45 days. Any tax liabilities exposed by the SDS are the employer’s responsibility to pay.
How Your Businesses Prepares for IR35 Updates
Businesses need to plan for these changes, as they require significant oversight and preparation. Companies must prepare for IR35 changes by:
- Planning for any immediate costs
- Determining workers’ statuses employed via PSCs or other contracts
- Identifying any IR35 provisions impacting contracts with dates beyond 2020
- Speaking with all contractors about IR35 changes
- Establishing a protocol for any future IR35-relevant working relationships
Employees Benefit Businesses. Hire Compliantly with an Experienced Partner.
Independent contractors invite risks. With the IR35 updates, businesses expose any intentional or unintentional worker-employer relationships. Contractors converted to employee status need not worry about improper NICs. Similarly, with IR35, employers can navigate these challenges to compliantly hire legitimate employees—and build a robust and scalable team.
Want to learn more about how Velocity Global’s team of employment law experts can help your firm understand the IR35 changes, complexities, and other UK employment law considerations? Reach out to us today.