What Is Off-payroll Working (IR35) And How Does It Affect You?

Posted on 24th July 2023

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If you are an employer or contractor, you will be aware of IR35. The name came from a press release from the Inland Revenue over two decades ago. Changes to tax laws are nothing new, but this one required employers to be transparent about their use of contractors.

Failure to do some will lead to heavy fines for contractors and their employers. Therefore, you must understand the technicalities of off-payroll working and IR35.

Fortunately, there is plenty of advice and solutions for off-payroll working and IR35 compliance. This brief guide aims to outline what IR35 is, and how it might affect you.

An overview of IR35 and off-payroll working

Businesses employ workers in a number of different ways. Temporary staff may be used when demand is high. Outsourcing is useful for utilising a wider talent pool. And contractors are used for specialist skills and flexibility.

Outsourcing and contracting may result in different tax regulations than regular employees. Suspicions of tax avoidance led to the Inland Revenue looking at off-payroll working more closely. This in turn led to IR35 being implemented.

What is off-payroll working?

A business’s payroll department deals with employees’ salaries. But, when a company makes an arrangement with an outside party they are paid off-payroll.

For example, a business employs individuals through a personal service company rather than employing them directly. It is common practice for office cleaners to be employed through a PSC.

The PSC will provide individuals to carry out the work requested by the employer. The PSC then invoices the employer for services rendered. From this payment, the individual workers will receive their salary.

As you can see, the workers from the PSC are not directly on the payroll of the employer. This is off-payroll working.

Why was IR35 implemented?

IR35 is the name that stuck to a particular tax regulation from 2000. It was implemented to stop tax avoidance through misusing personal service companies. The term ‘disguised employment’ is used a lot when IR35 is mentioned.

To gain tax advantages, many workers were using personal service companies to disguise their employment. Through the use of PSCs, many workers were able to pay less income tax and reduced NI contributions.

Instead of taking a salary from the PSC, the worker would instead receive a combination of dividends and salary. Dividends are subject to much less tax than salaries are.

The practice became so widespread that the government had to take notice. By hiding behind PSCs, some workers were paying far less tax than equivalent employees. This led to an imbalance between contractors and employees in comparable roles.

What implications are there with IR35 for contractors and employers?

One major change to IR35 compliance occurred in 2021. There have been a few updates to the regulations over the years. But, 2021 saw a shift in responsibility.

Instead of contractors being solely responsible for tax obligations, the end client became responsible. The onus is now on the employer or client to determine IR35 status and apply the rules. This switch has led to the closing of some loopholes and helped to increase compliance.

Outsourcing business procedures such as finance and HR is commonplace now. But, there are regulations in place to determine that tax avoidance doesn’t occur.

The implications for the end client and contractor are stiff financial penalties. The employer or client may be responsible for 100% of any unpaid tax along with NI contributions. On top of this, other penalties may be added.

Are there benefits to off-payroll working?

Using contractors brings many benefits to a business. Off-payroll workers allow more flexibility than full-time employees. Instead of recruiting and training, contractors may be brought in when necessary with no long-term commitment needed.

Outsourcing or contracting work brings a bigger pool of talent too. Access to specialised skills and expert knowledge will be highly beneficial to any business.

Using off-payroll workers is cost effective also. Using contractors means forgoing employment benefits, bonuses, and pensions. Any statutory obligations needed for permanent employees are unnecessary with contractors. There may be some tax benefits too.

However, fully understanding off-payroll working is needed for compliance. While there are benefits to off-payroll working, there are some difficulties attached.

What difficulties does IR35 cause?

IR35 requires serious attention. Businesses that are proven to be non-compliant face penalties as you have read. There are certain challenges to IR35, and here are three of them.

Determining IR35 status

Businesses that employ off-payroll workers are required to determine their employment status. The end client must determine whether the work needs to be classified as an employee or as a self-employed contractor.

Complexity of IR35

Making the above decision more difficult is the interpretation of IR35. The complexity of this legislation has created confusion for contractors and their clients. Accidental misclassification of a worker by a client can still lead to potential fines and penalties for both parties/

The burden on the client and contractor

Determining employment status and complying with legislation leads to administrative burden. Taxes need to be managed along with National Insurance contributions. And there are reporting requirements to follow also.

Legal considerations for IR35

There are tests to help determine the employment status of workers. These include control tests and substitution tests.

Employment status involves these three tests:

• Direction and control
• Right of substitution
• Mutuality of agreement

The tax office also has an online tool that will give the HRMCs verdict on a worker’s employment status. The Check Employment Status for Tax tool shows how the HRMC believes a worker’s status should be recorded.

Summary

Off-payroll working has benefits for the contractor and the client. However, close attention to employment status and IR35 regulations is essential.

Employment lawyers and tax advisors will help your firm stay compliant. And there are other solutions online that help to determine the employment status of your workers.

With the responsibility shifting toward the client, businesses must be fully aware of IR35 regulations and what they mean to them.