Being IR35 compliant is a priority for many contractors and clients. To be found operating ‘inside’ IR35 can result in many financial implications that could affect the running of a business. In order to be fully IR35 compliant, contractors must understand the differences between IR35 compliance in the private sector and in the public sector.
First of all, if you’re wondering what IR35 is, it’s the UK’s anti-avoidance tax legislation. It was designed to prevent ‘disguised employees’ from paying less tax by claiming that they are a freelancer or contractor. Your IR35 status is often determined by the IR35 rules and an IR35 test, you may find yourself subject to an IR35 investigation if you do not meet HMRC standards in those areas.
What is the public sector?
Let’s begin by deciphering what exactly the public sector is. Unlike the private sector, the public sector is part of the UK economy that is made up of public services and enterprises. These companies are owned and operated by the government and provide a service for the people of the UK. Often public and private companies work together to achieve a mutual goal, but you will most likely be aware of which sector you’re working for.
The April 2017 IR35 reform
Although many people are discussing the April 2020 reform, this may be of less interest to you as a public sector contractor.
The April 2020 IR35 reform is the proposed change in the regulation of the IR35 tax avoidance legislation. It is following in the steps of the public sector IR35 reform which occurred on April 2017. As part of this change, the tax liability was moved from the contractor to the client. But what exactly does this mean? Before 2017, contractors were able to make their own declaration when it came to their IR35 and tax status. HMRC wasn’t satisfied with this system as many contractors were claiming that they were outside of the legislation when they were ‘disguised employees’ who were trying to pay less tax.
Following the change, it was down to clients or third-party intermediaries to determine the status of the contractor. This new responsibility for clients also meant that they would face any penalties for the wrong declaration of tax status. Unfortunately for contractors, this led to clients making blanket ‘inside’ IR35 decisions and painting all freelancers with the same brush. As you may be aware, having an ‘inside’ IR35 status means that more tax and National Insurance contributions must be paid and therefor many contractors were penalized for the blanket approach. HMRC appear to have addressed this with the 2020 private sector reform as now contractors can appeal their IR35 decision.
How to pass the IR35 test
As with many contractors, it’s likely that you want to avoid paying extra tax and National Insurance contributions by operating inside IR35. Instead, you want to be outside of the legislation and ensure that your contract passes the IR35 test. But, how can this be done?
Carrying out a contract review
Once you’ve educated yourself on IR35 and the ins and outs of the legislation, it’s important that you review your past, present and future contracts to ensure that they’re IR35 compliant. You may think that your past contracts are not important but you should bear in mind that HMRC can carry out IR35 investigations into contracts made over the past six years and demand any payments to be made if they believe the tax is owed – you can use our IR35 calculator to find out how much you might owe.
If you do not think that you are informed enough you review your own contracts, you can request that an expert does this for you. This could be a legal advisor for example who will take a look at any contracts and compare them to IR35 and ensure you are compliant. For example, it could be a good idea to do this before you sign any future contracts in order to ensure that you will not be caught out in the event of an investigation. HMRC do have their own department of advisors who can review a contract but bear in mind that if they discover you are non-compliant, they may subject you to further investigation.
Briefly, here are some of the things you should look out for in your contract that could suggest you are operating ‘inside IR35’:
- Set working patterns
- The implication of a rolling contract rather than a project that has a start and end date
- Specification that only you can complete the job, without the option of a substitute
- High-level of input from the client as to how the job should be completed
- Usage of the client’s equipment and not your own
- Specification that you cannot work for anyone else whilst you’re completing the job
- No indication of your own business property, such as insurance or an office
The points above can suggest to HMRC that you are working within an ‘employment relationship’. This implies that you are ‘inside’ IR35 and should be paying deemed payments from your payroll which consist of tax payments and National Insurance contributions. If you discover that your contract does include any of the points above, you should think twice on signing with this client. Alternatively, have a discussion with your client and determine if any of the above can be altered so that you remain compliant with IR35.
Educating your clients
As mentioned above, it’s a good idea for you to be fully clued up on IR35 and for you to have the confidence to communicate this with your end client. Following the April 2017 public sector reform, the tax liability was passed on to the end-client. This means that from that point, it was down to clients in the public sector to determine the IR35 status of a contractor. By openly talking about IR35, you can ensure that you’re both compliant with the legislation and you will not receive a nasty surprise if they declare you as ‘inside’ IR35.
Operating through an intermediary
Some contractors do not want to deal with the paperwork or administration that comes with complying with IR35. Instead, many contractors and freelancers choose to go through an intermediary. For many, this is an umbrella company who acts as an employer to them. These types of companies deal with the administration of payroll and therefore ensure that you are always compliant and not at risk of an investigation. This removes a lot of worry and stress for these types of workers.
How to prepare for an IR35 investigation
All contractors are at risk of an IR35 investigation as HMRC can launch an enquiry at any time. But how should you prepare for an IR35 investigation?
Evaluating your finances
If you are found to be non-compliant to IR35 in the public sector, it’s likely that HMRC will not only demand owed tax payments and National Insurance contributions, but you will also be asked to pay interest on the fees owed and penalties for breaking the rules. In some cases, this has amounted to tens of thousands of pounds which can be detrimental to your company. It’s a good idea to fully understand the financial implications for you in particular if you’re found to be operating within IR35. Not only can this prepare you for any unwanted investigations, but it will likely encourage you to be more compliant in the future. You can make these calculations with our IR35 calculator.
Taking out insurance
Another way to prepare yourself for an IR35 investigation is to take out IR35 insurance. There are many different types of cover when it comes to this type of insurance and we recommend a comprehensive policy. With this type of policy, you will be provided with an expert advisor who can assist you from beginning to end when it comes to your investigation. They could even shut down the investigation at the first stage if they send a satisfactory letter to HMRC. If your case does end up at a tribunal, you will be given a legal advisor who will be fully equipped and educated to take on your case with the best possible result. In the unfortunate case that you are found to be non-compliant, your insurance will cover any incurred costs and fees which could save your business from collapse.
As we can see, if you’re operating in the public sector, you have already experienced some changes back in April 2017. It is now down to your end client to determine your IR35 status and it’s important that you stay educated on the matter to ensure that your tax status is being declared correctly. There are certain rules that you should follow to remain compliant and other protective measures that you can take in order to prepare for an investigation.
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