(Updated March 2025) On 29th October 2018, the Chancellor announced that all medium and large sized businesses in the private sector who employ Contractors will become responsible for assessing the Contractors ’employment status’ – where the individual works through their own Limited Company (or through other ‘intermediaries’) – from 6th April 2020.
You can see our new March 2025 post about IR35 ‘small’ company threshold changes here.
The background to this is (you can see our previous IR35 post about the Public Sector here):
Since April 6th 2017, the IR35 status for Public Sector Contractors with Limited Companies (or Contractors working through other ‘intermediaries’) has been determined by the client (the Employer), not the contractor. The client becomes liable if they make the wrong IR35 determination. This is because HMRC is convinced that a large proportion of contractors are “disguised employees”. This change means the responsibility for enforcing IR35 in the public sector shifts away from the HMRC and the Contractor and onto the end client i.e. the public sector body.
Therefore, the client (employer) therefore needs to assess the Contractors’ working practices and if they believe that the underlying relationship between the Client and the Contractor providing the services if one of ’employment’ then IR35 applies. This means that the contractors company will be taxed at source by the Client (through PAYE), exactly as if it were an employee (and employee and employer NIC’s need to be paid as well by the Client).
However, the contractors’ employment status does not change, so they will not receive the rights and benefits that go with full ’employee’ employment (e.g. holiday pay, SSP, unfair dismissal/redundancy rights etc). To complicate this, there has already been a successful claim from an affected Contractor in the public sector, for holiday pay, which you can read here.
The HRMC provide a ‘Check employment status for tax’ (CEST) tool which is designed to test whether an engagement is inside or outside IR35, which you can see here – https://www.gov.uk/guidance/check-employment-status-for-tax
In the Government’s Budget Guidance of October 2018, the Government said that “The reform will not apply to the smallest 1.5 million businesses”, which means that this will only apply to Contractors working with large or medium sized clients.
So, if you are the Client and your business is classed as ‘medium or large’ this change will affect you, and when you employ someone who has their own limited Company, you will be responsible for determining if the Contractor can legitimately work for you as a Limited Company or must be taxed as an employee (from 6th April 2020).
After the 2018 announcement there was a debate about what ‘small’, ‘medium and large’ business actually meant, and this was not confirmed until the draft Finance Bill legislation was published in July 2019, when it was confirmed that the definition of a ‘small’ company would be determined by the existing Companies Act statutory definition.
However, from 1st April 2025 the definition of a ‘small’ company for IR35 purposes will change and we detail these changes below.
So where the ‘client’ company satisfies 2 of more of the following requirements they will be deemed as ‘small’ and outside of this reform (i.e. not affected – so the Contractor will continue to make his/her ’employment status’ determination, and the Client will not have to):
- an annual turnover of not more than £10.2 million – this increases to £15 million from 1st April 2025;
- a balance sheet total of not more than £5.1 million – this increases to £7.5 million from 1st April 2025;
- and a number of employees of not more than 50 (averaged over the year; only PAYE employees are counted who have a Contract of Service with their Employer; using the definition that is set out in section 382 of the Companies Act) – this does not change in April 2025.
- All Businesses will be ‘small’ in their first year (and will remain ‘small’ until they meet two of the above criteria).
This could obviously cause a major headache for business that move in and out of being a ‘small’ business. Business that are not companies, such as partnerships and unincorporated bodies) will be ‘small’ for these purposes if their turnover does not exceed £10.2million. Business who are subsidiaries of a larger company will not qualify as a small company if they are part of a larger group (that is classed as a ‘medium’ or ‘large’ company).
What seems clear at the moment is:
- Contractors will, from April 2020, have to know how big their client is (number of employees or turnover/balance sheet) when deciding whether to accept a contract with them, as that may determine their tax status.
- However, July 2019’s draft legislation does not require Client Companies to declare if their size makes them exempt from the rules (i.e. Companies don’t have to say if they are ‘small’!). Which could make it difficult for Contractors to know if they should consider IR35 for the contract.
- Contractors will be concerned that medium/large sized organisations may be overcautious and avoid any risks and ‘blanket’ all Contractors as ’employees’ (as has happened widely in the public sector and is being discussed openly in the private sector). However, the legislation tries to prevent businesses making a ‘blanket determination’ of all its Contractors at the same time; the legislation says that a determination will be invalid if the organisation fails to take “reasonable care” in reaching its conclusions about each consultants’ status. (Organisations are called “clients”, as they are clients of the services provided by the Contractor).
- Medium and Large Companies should start planning and auditing their Contractors now (including those that come via employment agencies); and they will incur costs in the planning and work involved in identifying all their Contractors (and determining if the new rules will apply to them), potentially face a shrinking talent pool and reduced flexibility, and/or higher costs of hiring Contractors (Contractors raising rates and/or tax/NIC payments increasing) and possible later legal challenges from Contractors (if they do not agree with their ‘status’). Companies who are going to be covered by the new rules should also ensure their contracts are IR35 compliant now.
- From April 2020 Client Companies who need to make a determination on the employment status of each individual Contractor (because they are a ‘medium’ or ‘large’ Company), should make a status decision and communicate this in writing to the party who they contract with (the Limited Company) and the individual Contractor themselves – this will be called a ‘Status Determination Statement’. The Client Company must give a reason for their status determination. This must take place before the time of the first payment under the contract. In the event the Client does not communicate in time they would bear the tax liability.
- In a situation where the individual/Contractor disagrees with the client’s status determination it will be for the 2 parties to resolve this and the Client must provide a dispute resolution process to allow this status challenge – this will be a statutory requirement and will be called a ‘Status Disagreement process’. However there is no formal resolution process provided by the legislation/HMRC. Client Companies will have 45 days in which to respond to contractors who are concerned about their status determination.
- Where the Client Company determines that the IR35 rules apply (and they normally pay the consultancy fee directly to the personal service company) then the Client Company must deduct income tax and Employee NIC’s (13.8%) from the Consultancy fee and account to HMRC for them (through the PAYE system), and also pay Employers NIC’s on the Consultancy fees. If the fee is normally paid to the personal service company via an agency, then the agency must operate the PAYE/NIC deductions and account to HMRC for them. This is called a ‘deemed payment’. The legislation sets out how the deemed payment is calculated – it excludes amounts in respect of VAT and the direct cost of materials.
- Where a Personal Service Company is found to be inside IR35 they will lose the ability to claim 5% of their turnover as an allowable deduction to cover the cost of operating their PSC.
- Where Client Companies fail to comply with the new IR35 rules they are at risk of financial penalties and/or unpaid tax and NIC bills. There is also the possibility of a criminal conviction for failure to prevent tax evasion.
- Some commentators believe the ‘immunity’ for small businesses may only be temporary (so it will apply to all private businesses in the future).
How do you determine a Contractor’s employment status?
IR35 will apply if the contractor is under an obligation to provide services personally to the client company and they would be viewed as an employee of the clients business. There are several competing factors to be balanced, some of which come from case law and HMRC have a guide (its Employment Status Manual) summarising the factors it considers to be most relevant to determine whether an ’employment’ relationship exists. HMRC considers the key factor is ‘mutuality of obligation’; other factors are the genuine right to substitution; the extent to which the Contractor bears financial risks for their own business; and control. You can read more details about status here.
HMRC’s CEST tool can be used to check Contractors status now, although it has been heavily criticised, or some companies may prefer to take legal advice or contact IR35 Contract Review firms. The Government responded to their first Consultation by acknowleding that the HMRC needs to improve its CEST tool (see information here) so it is effective in the private sector. In July 2019 the Government acknowledged that status determinations can be difficult! And made promises of more detailed guidance from the HMRC and a new and improved CEST tool before April 2020. So using CEST now may not be a reliable indicator of the result if you will repeat the status check using CEST at a later date (assuming changes are actually made!!).
However, the CEST Tool is not mentioned in the draft IR35 legislation, which means that there will be no statutory obligation to use it.
We understand that the draft IR35 legislation should be finalised by November 2019, although many commentators hope it will never become law! – We’ll update this post and our affected Clients as more news comes in (last updated July 2019).