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Recently, the UK introduced new legislation to change a tax loophole and redefine certain relationships between contractors and companies. If you employ workers or have contractors in the UK (or if your company is based in the UK), you should know how the new IR35 rules could affect your business.
The IR35 legislation affects both companies dealing with contractors and the contractors themselves.
Many contractors in the UK have historically set up a limited company structure to take payments from clients and pay less in taxes. The UK government believed some of these workers were exploiting the tax system by operating as contractors when they should have been classified as employees. Anyone who would meet the definition of “employee” without the existence of the limited company (also known as a personal service company or PSC) is now termed a “deemed employee” and therefore is subject to employment taxes.
Some small businesses are excepted from the new rules, which apply primarily to medium- and large-sized companies in the private sector and all sized companies in the public sector. To qualify for the exemption, a small business must meet two of the following criteria:
Annual turnover of less than £10.1 million
Gross assets of less than £5.1 million
Fewer than 50 employees
All businesses that do not meet the small business criteria are subject to IR35 legislation.
In the past, the duty of discovering contractors exploiting tax loopholes fell to HMRC, the UK’s tax authority. Under IR35 legislation, companies subject to the new rules are responsible for determining the IR35 status of their own contractors. Small businesses are excepted from the rule because of their limited resources, but larger companies working with contractors are now required to vet the IR35 status of their own contract workforces.
IR35 legislation separates workers into “outside IR35” and “inside IR35” groups:
Contractors considered to be “outside IR35” — that is, contractors who are correctly classified as contractors and are not avoiding paying all relevant taxes — are considered self-employed. They are free to pay themselves in whatever way they find to be most efficient for their tax liability. This may include working through a limited company, as long as the arrangement makes sense and is not misused to avoid paying taxes.
Contractors who could be deemed as “employees” by IR35 are considered “inside IR35” and are therefore required to pay tax at the same rate as an employee in the same tax bracket. Companies working with contractors who fall inside IR35 must pay taxes as if the contractor were one of their employees. As such, the company (the “fee payer” in this instance) must deduct National Insurance Contributions (NICs) and income taxes on behalf of the contractor, as well as pay employer National Insurance Contributions and an Apprenticeship Levy. For more information on UK taxes, including employer taxes, see Remote’s UK Country Explorer page.
No. While contractors found to be inside IR35 must pay taxes on their earnings as if they were employees, and their employing companies must do the same, this does not make them full employees automatically. Laws relating to classification and taxation remain separate at this time. Contractors who become “deemed employees” under IR35 are not automatically entitled to employment rights, such as benefits and paid time off.
When a contractor is termed a “deemed employee” under IR35, penalties occur if the contractor was previously classified outside IR35 and not paying the appropriate taxes. A contractor found to be in violation of IR35 (one being paid through a limited company who should be classified as an employee inside IR35) must pay back all missing back taxes, plus interest and any penalties. HMRC has the power to investigate as far back as six years, so penalties can be severe.
Businesses working with contractors (that is, end clients of contractor services) must also pay penalties and back taxes with interest if found in violation. The UK government announced it would not enforce penalties for accidental offenders taking “reasonable care” in 2021, but it may continue to punish companies deliberately breaking the rules. The government may also publicly criticize companies that fail to comply to encourage more widespread adherence to the new rules.
First, companies under IR35 must produce a Status Determination Statement (SDS) for each contractor. The SDS goes from the end user or end client (the company receiving the service) to the agency (if applicable), then through the PSC/limited company and finally to the individual contractor. The SDS must include information on the decision the company made regarding the contractor’s status as either inside or outside IR35, plus the reasoning for the decision and evidence of reasonable care in deciding.
If the contract changes, the company engaging the contractor’s services must create a new SDS to determine whether the relationship with the contractor changed under IR35.
Contractors may appeal SDS decisions verbally or in writing within 45 days of receiving the notification. Once the company receives the complaint, the company has an additional 45 days to respond.
Companies in this situation have two options:
Uphold the decision and respond to the contractor in writing citing the reasons why.
Change the SDS and issue a new one.
If the company fails to comply with the 45-day limit, the company becomes responsible for taxes and NICs incurred by the contractor for the changed status.
HMRC expects companies to collect relevant information via SDS to determine whether contractors lie inside or outside IR35. Due diligence can vary, but should include records like:
Does the contractor have other clients?
Does the contractor take financial risks, i.e. is the contractor legitimately represented through the PSC/limited company?
What actual work practices does the contractor perform? Are these practices different from those conducted by full employees at the company?
Answering questions like these demonstrates reasonable care that the company attempted to comply with IR35 rules. Companies must maintain these records and document their reasoning for determining contractor status. Under no circumstances should companies make a ‘blanket’ decision about all their contractors’ statuses.
The CEST is an online tool created by HMRC that presents a series of questions to help businesses determine the status of contractors and employees for tax purposes. This tool can be used as part of “reasonable care.”
Businesses can access the CEST on the UK government’s website.
With the wealth of talented workers in the UK, businesses should not let IR35 rules scare them away. Highly experienced contractors and employees in a variety of industries live and work in the UK, and these new regulations are intended to close a tax loophole, not make doing business in the country more difficult.
We've pulled together a collection of information about hiring and paying employees based in the United Kingdom. Use these guides to help your recruitment team understand the unique local requirements of hiring British workers.
Guide to hiring employees in the UK: Whatever your situation, this guide on hiring employees in the UK can help you get familiar with the basics of UK employment law, payroll practices, common benefits, and more.
How to pay remote workers in the UK: Paying international employees doesn't have to be complicated, costly, or time-consuming. This article guides you through the nuances of paying British workers. Remember, the IR35 rules are critical here. To pay employees in the UK, a company based outside the country must either set up a local legal entity or employ their foreign workers through an employer of record, like Remote. Companies can also pay their workers as contractors: however, this approach is only valid if the relationship is legitimately a contractor relationship. Otherwise, the company could be subject to penalties and fines.
What does Brexit mean for employers?: Learn more about the specific employment ramifications of Brexit, including visa requirements, work permits, transfer requirements, and taxation changes.
Overview of the most critical labor laws in the UK: IR35 is just one of a collection of unique employment considerations for teams hiring and managing remote workers in the United Kingdom. This article introduces the most important aspects of the UK's laws around contractor classification, work permits, union requirements, terminations, and severance pay.
Benefits to offer employees in the UK: Companies in the UK must offer a specific set of employee benefits to remain compliant with UK labor laws. This is especially important for foreign employers of remote UK workers who may not be familiar with common benefits in the UK (don't forget that Remote also makes it easy to manage a consistent and competitive benefits program from contractors as well as employees).
If you are interested in working with contractors or employees in the UK, contact Remote and let us know! Through our legal entity in the UK, Remote guarantees your business receives the best payroll, benefits, taxes, and compliance services. Contact us today to learn more about our cost-effective global employment solutions.
Always work with your legal team and tax accountants to ensure an accurate IR35 status is selected. Once you’ve established the contractor’s IR35 status, our team can help implement invoicing or any other changes necessary within the Remote platform.
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