It’s more than a year since new private sector off-payroll (IR35) reforms came into force, and uncertainty still reigns among businesses and contractors alike.
The reforms, implemented across the private sector in April 2021, have seen many businesses and individuals rethink their contracting policies and strategies and policies.
The real impact of IR35 on the contracting industry is becoming more apparent, with contractors changing the way they work and, for some, ongoing confusion about what the rules mean for them.
Here, we take a closer look at why working with an independent ICT consultant can be considered as Outside IR35, and the benefits this can bring.
What is IR35, and why is it a concern?
IR35 is a piece of tax legislation introduced by HMRC to tackle tax avoidance by taxing off-payroll – or ‘disguised’ – employment at the same rate as regular employment.
It was designed to ensure that self-employed individuals, contractors or freelancers are taxed and treated the same as employees, regardless of whether they work through their own limited company or as employees of the end customer.
Off-payroll workers are those who carry out work for a business, with all the same responsibilities as a full-time employee, but don’t pay the same tax and National Insurance, and don’t receive the same benefits.
The new rules affect all public sector bodies, along with medium to large private sector companies that meet at least two of the following criteria:
- Annual turnover of at least £10.2m
- Balance sheet total of at least £5.1m
- 50 employees or more
Any businesses falling within the above criteria are now responsible for establishing the IR35 status of their contractors and deducting tax and National Insurance contributions for anyone falling Inside IR35. This can be done through internal accounting and payroll, or via an ‘umbrella company’. This is particularly relevant for recruitment agencies that provide workers but don’t have the internal capability to deal with tax or payroll.
What are the rules for small companies?
The rules differ slightly for small private sector companies, especially where small businesses are engaging contract workers through an intermediary such as a partnership, LLP or single-person limited company. In such instances, the responsibility for applying IR35 rules remains with the intermediary. The Companies Act 2006 defines what a small business is, as follows:
- Annual turnover not exceeding £10.2m
- Balance sheet total of no more than £5.1m
- Fewer than 50 employees for the company’s financial year
Where two or more of the above criteria are met in two consecutive financial years, the small business exemption applies and responsibility for applying IR35 rules remains with the intermediary.
Prior to the new rules being introduced, the contractor was responsible for determining whether the worker was an employee of the end customer or their own limited company.
The rule change has created a significant headache for hiring organisations and businesses – and for small business contractors too.
If the hiring organisation or intermediary wrongly assesses the contractor as working Outside IR35, they could be liable for the tax. So, there is an incentive from a risk perspective to deem all contractors inside IR35.
This, in turn, prevents micro-businesses from operating as businesses, as their staff on new work are taxed as employees of the client.
It causes problems for the contractor because although IR35 status is supposed to be determined on a case-by-case basis based on the appointed contractor, many jobs are now advertised stating up-front whether they are Inside IR35 or Outside IR35. This prevents contractors from applying for certain roles.
This may make sense in some instances. For example, if you appoint a temporary manager for a project who will be responsible for some of your staff, then this, by definition, is Inside IR35.
However, many roles where this is not the case are now being advertised as Inside IR35, denying the opportunity to apply for contractors who work Outside IR35.
How can you benefit from working with an ‘Outside IR35’ contractor?
Several measures define whether a contractor/employee of their own limited company should be deemed Inside IR35 or not, and while it may be appropriate in certain cases, working with an ‘Outside IR35’ contractor offers many benefits, including:
✔Control & direction
A key determinant of IR35 status revolves around the extent to which the end customer client controls or manages the contractor.
An independent ICT consultancy, will inevitably have to work with their clients to understand the requirement and make sure what they deliver matches the client’s needs. However, they would not work under the management of their customers. Instead, they prefer to work with their customers to write and agree a scoping or requirements document that defines what they will deliver and when. They then work on a ‘outcomes’ basis, where each outcome or deliverable is associated with a price.
For each project, they anticipate a range of tasks to be delivered, and these will be individually or collectively related to a payment milestone. Some of the other benefits of this way of working include:
- The consultancy staff work as a part of the customer’s team, but not under the supervision of customer staff members
- The consultancy staff work the hours required by the consultancy, not by the customer
- Since the consultancy is paid based on outcomes, the customer does not paid for time off, training or sickness
✔Personal service & substitution
Another critical element of IR35 status relates to whether the contractor has provided a service or their personal presence. Service provision is deemed Outside IR35, but the provision of a specific person would be deemed Inside IR35.
For a micro-business providing consultancy services based on the experience and skills of its staff, this is quite challenging – after all, typically such a business only has a very small team.
Any small business thrives on the knowledge and expertise of it’s staff. The only difference between a micro business and a larger ICT consultancy is the number of consultants. However, this means a micro consultancy can offer consultants with a set of skills and experience that can provide a service based on what they know and what skills they have, rather than a personal service based on who the person is.
Ensure that contracts include substitution clauses, and that the consultancy has provided more than one resource in previous contracts to ensure it’s the skills, expertise and service they deliver, not the person. Build the concept of substitution into your relationship with a micro consultancy and encourage them to make use of it to provide specialist skills that their primary staff do not have.
✔Mutuality of obligation
Mutuality of obligation exists where the contractor can expect more work to be provided to them, and the client can expect any work they provide to be delivered. In situations like this, the contractor is working Inside IR35.
When you look to extend a contract with a micro consultancy do not just ask for more time from their staff – instead ask for more deliverables / outcomes.
Ensure that contracts identify explicitly that the client is not obliged to offer additional work and that the micro consultancy is not obliged to accept offers of extra work. Make a point to record opportunities that were declined where the micro consultancy didn’t believe it was within their capabilities at the time.
✔Provision of equipment
Under IR35, HMRC can argue that if a contractor uses equipment provided by the client, they’re acting as an employee and would, therefore, fall Inside IR35.
Ensure that staff of the micro consultancy have their own devices even if you require them to use your devices due to security requirements.
✔Financial risk
Where the risk sits for non-completion of the work can be an indicator of IR35 status.
Ask the micro consultancy to create proposals for the work they will complete that identify assumptions, issues, dependencies and risks. These help both sides understand the likely challenges with the work and what’s expected of each party. Risk should be balanced fairly between the micro consultancy and the customer so that both sides are responsible for the problems they may cause.
Make sure that its clear contractually that on the very rare occasions when the consultancy completes work that isn’t to the client’s satisfaction, the consultancy are responsible for redoing that work to meet the defined requirement from the customer.
✔Payment
The method and manner of payment both affect IR35 status. Being paid a monthly salary or an hourly rate can be an indicator of being Inside IR35.
Consultancy tends to be paid per day or based on achieving desired outcomes. Ideally payment should be outcome-based, as it shifts away from the status as an employee. This also works better for the customer, as you don’t want to pay the consultancy for doing nothing for a day while waiting for you to take some action.
Why it pays to work with a micro consultancy
Many businesses are afraid of IR35 because they’re worried that if they determine a contractor’s status as Outside IR35 and get it wrong, they may find themselves facing a hefty fine.
Look for a consultancy that can tick all the below boxes:
- They are a business in their own right
- They have an office that they pay for monthly
- They are VAT registered
- They have a website that is updated regularly
- They have more than a single customer
- They have employed more than one staff member
- They have used sub-contractors
- They are members of a professional body like a chamber of commerce
- They are partners of a industry bodies or vendors
- They have professional indemnity insurance, public liability insurance and employee insurance
- They spend money on marketing and sales – both on social media and through various direct marketing channels
- They tender for work through various frameworks
This post was re-written to remove the references to AMDH Services Limited and make it more generic. The author does not profess to be an expert in IR35 so nothing in this post should be relied upon.
