If your business uses freelancers and contractors to deliver projects and campaigns, you might be used to paying them separately from your staff. But are those people actually working as employees in the eyes of tax law?

That’s a question medium and large sized businesses are required to address as of 6 April this year, as reforms to the legislation known as IR35 came into effect.

Under those rules, businesses are responsible for determining their workers’ employment status for tax purposes.

IR35 is intended to prevent tax avoidance through what’s known as ‘disguised employment’, but it’s been met with controversy over the years as contractor and business groups say the rules also affect genuinely self-employed people.

The creative industry, which tends to rely fairly heavily on freelance and contract work, could face some pressure as a result.

As John McVay, chief executive of the Producers Alliance for Cinema & Television (PACT), told the Finance Bill sub-committee last year there were worries across the industry that the change would “create confusion for the people we would like to hire and will be a burden on employers”, potentially causing contractor rates to rise.

Research by the Association of Independent Professionals and the Self-Employed also suggested 50% of freelancers are planning to stop contracting in the UK unless they can get contracts that are unaffected by IR35.

What is IR35?

IR35 is the term most commonly used to talk about a piece of anti-tax avoidance legislation that was first implemented back in April 2000. It aims to prevent businesses from engaging workers on a self-employed basis through an intermediary, so they could reduce the amount of tax and National Insurance contributions due.

It does this by setting out rules to determine whether someone is genuinely self-employed, or working in essentially the same way as an employee.

Previously, this was down to the worker’s intermediary to determine, but more recently it’s been adjusted so that responsibility lies with the client purchasing the services. In 2017, this reform was rolled out for public sector organisations, and from April 2021 it applies to the private sector.

Does IR35 affect you?

The first thing to note is that IR35 only applies where workers operate through an intermediary, such as their own limited company. So if you directly hire a freelance sole trader, you shouldn’t be affected by IR35.

Secondly, small businesses are exempt from the responsibility to determine employment status. Whether your business counts as ‘small’ is based on the definition given by the Companies Act 2006, which requires businesses to meet two or more of the following criteria:

  • An annual turnover of no more than £10.2 million
  • A balance sheet total of no more than £5.1 million
  • No more than 50 employees.

If your business comes under that definition, you shouldn’t need to do anything differently when paying for services from off-payroll workers, as the responsibility for determining employment status will remain with the intermediary.

When is a worker classed as employed?

This is one of the more complex areas of tax and employment law, partly because it’s not based on one straightforward list of rules set by HMRC – instead, it’s heavily influenced by ever-changing case law.

That said, experts tend to agree that the following three points are the most important indicators for deciding someone’s employment status.

  • Control and direction: Do they have full control over the work they do, when they do it and how they go about it? If you set start and end times for a contractor and assign them a line manager, for example, you might find they are considered an employee in the eyes of tax law.
  • Personal service: Are they required to carry out the work themselves, or could they choose to send in a substitute? If you wouldn’t allow a freelancer to choose someone equally skilled to carry out the work in their place, their contract might be considered similar to that of an employee.
  • Mutuality of obligation: Are you obliged to keep providing work, and is the worker obliged to accept it? In the case of genuine freelancers, this mutual obligation generally doesn’t exist, so you can engage their services as and when you need to – and they have the freedom to reject the work you offer.

Other factors could include whether or not they’re required to bring their own equipment, whether they take on financial risk, how they’re paid, and whether they’re considered to be trading ‘on their own account’.

All contracts should be considered on a case-by-case basis, and matching some of the indicators of self-employed status is no guarantee a worker will be outside of IR35 overall.

HMRC will also be on the lookout for signs of businesses bending the rules or contriving situations to prevent an ‘inside IR35’ determination, so make sure any arrangements you write into contracts are true to the way your contractors work in practice.

To check whether a particular engagement is classed as employment or self-employment, you can use HMRC’s check employment status for tax (CEST) tool.

HMRC has said it will stand by the result produced by CEST, provided it’s used correctly and all the information is accurate.

What happens if workers are inside IR35?

If a worker falls within these rules and is considered employed under IR35 rules, you’ll need to pass your determination of this on to the organisation they contract with. This might mean passing the decision directly to them if they’re working through their own company.

When you pay them, you’ll then need to deduct income tax and National Insurance and pay this to HMRC.

This will generally be more expensive than it would be to pay a freelancer in the normal way, but as long as you act in accordance with the off-payroll rules, you shouldn’t face any penalties for engaging workers who are inside IR35.

You can find out more on HMRC’s guidance pages, or talk to us for more information on the IR35 reforms.