HMRC is currently undertaking a consultation about expanding the IR35 rules into the private sector. The consultation paper is available on GOV.UK and the process is due to run until 10 August.
The IR35 rules came into effect on 6 April 2000. They were designed to tackle what HMRC saw as tax avoidance, where some freelancers were paying less tax by operating through a limited company rather than being employed directly by the end user client.
The central IR35 test is whether “the circumstances are such that, if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client”. To put it simply, HMRC is asking “If there was no limited company then would the freelancer have been treated as the end user’s employee?”
Before the current IR35 rules became law, the original proposal was to make the ‘end user’ responsible for deciding if the assignment fell inside or outside the IR35 rules. However, following representations from the big users of freelancers (particularly banks and other financial institutions), the rules were changed to make it the limited company’s responsibility for determining whether IR35 applied or not.
IR35 changes in the public sector
From 6 April 2017, HMRC reverted to the original IR35 proposals. These mean that if a freelancer is working on a contract for a public sector body (e.g. the NHS) then it is up to that public sector body to decide if IR35 applies or not.
If public sector bodies think that IR35 does apply then they will deduct all the relevant tax and National Insurance. Typically, these bodies use HMRC’s online tool (Check Employment Status for Tax or “CEST” for short).
This has now led to a situation where, for example, one freelancer could be doing work on a particular project in the public sector and be taxed under IR35, whilst another freelancer could be working on an identical project in the private sector and not be taxed under IR35 because they are allowed to effectively self-assess their IR35 status.
The IR35 tests
The three key IR35 tests have not changed. They are:
- Control and direction, which typically means are you under the direct control of your client, i.e. do they have the right to decide how you perform your services?
- Personal service, i.e. do you have to perform all the work yourself or could your company bring in a substitute with equal or better skills?
- Mutuality of obligations, which typically exists when the end user expects the worker to undertake any work when requested and the worker expects to be given work on a regular basis
Although in recent cases HMRC seems to be particularly keen on control as being more indicative of an assignment being within the IR35 rules, nevertheless they still have to score three out of three.
HMRC believes that by allowing limited company freelancers in the private sector to self-assess their IR35 status, it is not receiving the correct amount of tax and National Insurance. This is the problem that it wants to address.
Although HMRC has always been able to carry out investigations into individual limited companies’ affairs, it doesn’t have the personnel or financial resources to do this effectively. As a result, HMRC wants to change the rules in the private sector so that they will probably look similar to those in the public sector, i.e. the end user or the agency will decide whether or not to apply the IR35 rules.
Although we have no way of knowing what changes will be brought in or from what date, it is clear that HMRC is keen to resolve what it still considers to be a problem. Unfortunately, neither tax law nor employment law has really kept up with changes in working practices over recent years.
It is possible that HMRC will simply revert to its original thinking from the late 1990s and make it the responsibility of the agency or the end user client to determine the freelancer’s IR35 status, possibly using the online CEST tool. If you’re a freelancer, it doesn’t of course automatically mean that you will find yourself caught by the IR35 rules.
Our specialists will be monitoring the outcome of the consultation process. If you’re already a BKL client, you are of course free to make direct representations to HMRC if you want to.
For more information, please get in touch with your usual BKL contact or use our enquiry form.