If you’re a business with over 50 employees or a turnover of more than £10.2m, then how you work with freelancers is about to change. This, as a result of the IR35 rule, also known as the off payroll working rules. On the 6th April 2020, new IR35 regulations mean that medium and large private employers will be responsible for ensuring that any freelancers and contractors they work with are genuinely self-employed, to crack down on what’s known as ‘disguised employment’. And with significant penalties for noncompliance, it’s important to ensure you’re ready.
Here we look at how these changes will affect businesses employing freelancers and what you should do to prepare.
What is IR35?
Introduced back in 2000, the IR35 regulations are designed to assess whether freelancers and contractors are genuinely self-employed, or whether they are working that way to save both themselves and their employer from paying certain taxes. Freelancers working through limited companies enjoy certain tax benefits, while for employers it means they don’t have to pay National Insurance, holiday and sick pay, and other employee benefits. Under the original rules, the onus is on freelancers to assess whether they themselves are genuinely self-employed, and any liability for disguised employment therefore falls to the individual. However, this aspect of the rules is now changing.
What changes will be introduced in April 2020?
Next April, all medium and large private sector businesses will follow in the footsteps of the public sector, which saw the new rules introduced in 2017. The changes mean that it is now up to the employer to decide whether a freelancer or contractor is genuine, or whether they should in fact be an employee, paying National Insurance and Income Tax. Liability for tax payments therefore now falls on the employer, presenting a significant potential risk for businesses.
Why are the changes being brought in?
Self-employment has increased significantly in the last few years and the government is on a mission to claw back some of the employment taxes it is losing as a result. While most freelancers and contractors are genuine, some choose to work ‘off-payroll’ purely to reduce their tax liabilities, while also saving employers National Insurance and employee benefits costs. The original IR35 rules were designed to prevent this, however widespread noncompliance amongst individuals has led HMRC to shift the responsibility to organisations themselves. The Treasury expects this new measure to net £1.3bn per year by 2023.
How do you know whether a contractor or freelancer should be an employee?
The Government has set out a number of criteria to test whether an individual is a genuine freelancer – known as ‘outside IR35’ – or whether they are in fact in disguised employment and should therefore be moved on-payroll – known as ‘inside IR35’. The most important of these are:
- Supervision, direction and control: How much input do you as the client have over how the freelancer carries out their work? For example, if you require the individual to work at certain times or follow detailed instructions on how to complete a project, this indicates that they should be an employee. To be outside IR35, there needs to be a high degree of autonomy over when and how work is carried out.
- Substitution: Another important point is that a genuine freelancer or contractor should be able to send a substitute to carry out their work for them – as would be the case with a client-consultancy relationship. When carrying out checks, HMRC could ask for proof that this is possible and even details of who the substitute would be.
- Mutuality of obligation: If the client has an obligation to offer work to the freelancer, and/or the freelancer has an obligation to accept, then HMRC is likely to rule that they should be an employee. In contrast, a genuine freelance contract is more likely to involve working on a distinct project, or alternatively via a six or 12 month retainer contract where they manage their own time, output, have their own office space, and choose their own hours.
Other tests include whether the client provides the freelancer with equipment, whether the relationship is exclusive, and whether the employer is taking on all the financial risk in the relationship. If the answer to any of those is yes, it indicates that the freelancer should be an employee and the employer must start deducting NIC and Income tax from their pay.
HMRC has created an online tool to help both employers and individuals test where they stand in relation to the law.
What are the penalties for getting it wrong?
HMRC carries out spot-checks on freelancers and contractors to test whether they and their client are operating in the right way. If a contractor is wrongly working outside IR35, then the client will be required to pay any outstanding taxes from that period of employment, and ensure the individual is on-payroll going forward. HMRC may also charge interest on any tax and NICs owed, and additional penalties can be imposed if it can be proved that the IR35 rules were deliberately ignored or flouted.
How can you prepare?
April 2020 might seem like a long time away, but organisations affected by the new rules would be wise to start preparing now, to ensure they’re ready. Here are the key steps you should take:
- Do you need legal or HR expertise? First of all, review whether you have the right expertise to assess compliance. If not, consider hiring legal or HR support to help you.
- Review your freelance workforce: Review and assess how many freelancers and contractors your organization currently employs through personal service companies (PSCs) to see who could potentially be affected. Also bear in mind that even if you employ a freelancer through an intermediary, HMRC still has the power to work their way up the food chain, so your organisation could still be found liable.
- Timings: Check how many of these contracts extend past the 6th April 2020.
- Communication: Start to discuss with those affected whether the rules apply to them, assessing how their working arrangements stack up against the criteria set out by HMRC.
- Make changes: If you identify freelancers that could be caught by IR35, then you have two choices: Either bring them on to the payroll (if this is what they want) or change how you work with them to ensure they fall firmly outside the rules.
- Future process: Finally, ensure you revise your process for working with freelancers in future, to ensure that they aren’t accidentally caught on the wrong side of IR35. This could mean reviewing your contracts, training hiring managers and reevaluating your recruitment plans.
HMRC has faced a fair bit of criticism for IR35, with many commentators arguing that it could be cheating self-employed professionals out of their full earnings, while giving businesses additional bureaucracy to deal with. Furthermore, one of the big issues raised in the public sector is that employers have taken a blanket approach to putting freelancers on the payroll, rather than assessing fully whether that is the right approach for each individual. It is therefore vital that private sector employers take the time to understand the legislation and assess each freelancer individually based on how they work with the company.
And if you’re concerned about the impact it will have on your ability to use freelancers, there are lots of steps you can take to ensure you can continue to do so. For example, by ensuring they manage their own time and deliverables based on an agreed statement of work, and asking them to work remotely with regular meetings in the office. You could also consider breaking the work down and outsourcing to a team of freelancers, so that one person isn’t doing everything. Plus working through The Work Crowd ensures that if a freelancer is unwell or unable to work, you can easily substitute for an alternative.
Rethinking and restructuring how you work with freelancers will not only ensure you remain outside IR35, it should also benefit the individuals themselves, who thrive on that independence and flexibility, rather than simply being a substitute employee.