Introduction
IR35, a tax legislation introduced in the UK, aims to combat tax avoidance by workers supplying their services to clients via an intermediary, such as a personal service company (PSC), but who would be an employee if the intermediary was not used. Understanding IR35 is crucial for contractors, businesses, and public sector organizations. This article outlines what constitutes an exempt organisation, the criteria for determining IR35 status, and the consequences of falling inside or outside of off-payroll rules.
What is an Exempt Organisation?
Certain organisations are exempt from the IR35 off-payroll working rules. As of April 2021, these rules apply to medium and large-sized private sector clients and all public sector clients. An organisation is considered small and thus exempt if it meets two of the following criteria:
If a company meets the criteria for being small, it is the responsibility of the PSC to determine the IR35 status of the contract, rather than the client.
Determination for Falling Inside or Outside IR35
Determining whether a contract falls inside or outside of IR35 depends on the nature of the working relationship. Key factors include:
a. Control: The level of control the client has over what, how, when, and where the contractor completes the work. High control indicates employment, thus falling inside IR35.
b. Substitution: Whether the contractor can provide a substitute to do the work instead of them. The genuine right to substitute suggests the contractor is in business on their own account, indicating outside IR35.
c. Mutuality of Obligation: The client’s obligation to provide work and the contractor's obligation to accept it. A lack of mutuality points towards outside IR35.
d. Financial Risk: Whether the contractor bears financial risk, such as having to correct defective work at their own expense. Higher financial risk leans towards outside IR35.
e. Provision of Equipment: If the contractor uses their own equipment, it suggests they are running their own business, which indicates outside IR35.
f. Integration: The extent to which the contractor is integrated into the client's business. Less integration suggests outside IR35.
If a contract is determined to be inside IR35, it means:
- Tax and National Insurance: The contractor's income is subject to PAYE (Pay As You Earn) and National Insurance Contributions (NICs), just like an employee.
- Financial Impact: The contractor may face reduced take-home pay due to higher tax and NICs.
- Administrative Burden: The client (if not small) has to deduct tax and NICs, increasing their administrative workload.
Conclusion
IR35 legislation is complex and can significantly impact both contractors and businesses. Understanding whether an organization is exempt and how to determine the IR35 status of a contract is crucial for compliance and financial planning. Falling inside IR35 can lead to higher taxes and more administrative work, while falling outside can offer greater financial benefits and autonomy. Both contractors and clients should seek expert advice to navigate IR35 effectively, ensuring they remain compliant while optimizing their financial outcomes.
