Everything every small business owner needs to know about IR35
Update - January 8, 2021
Changes to the IR35 tax rules are set to come into effect in a few weeks' time.
The proposed changes were delayed because of the coronavirus pandemic, and the decision to defer was announced as part of the £330bn financial package to support the UK economy.
But that year long deferral is almost up, so here's everything you need to know about the changes to IR35.
What is IR35?
IR35 is a set of tax laws used to work out whether a contractor works independently or is an employee of a client they work for.
But before we get into the details, let’s answer the all-important question…
Will IR35 affect my small business?
IR35 doesn’t apply to small businesses, which means you don’t need to do anything differently and needn’t worry about the changes that are coming in April.
If your small business employs freelancers or contractors - say, you’re a salon that hires out a chair to a barber that’s not on your books - it’s probably worth letting them know about the changes, but we’ll come on to that a little later.
Before that though, how do you know if you’re running a small business?
But how do I know if I’m a small business?
A small business is basically one that employs 50 people or less, and there are 2.7 million of them currently operating in the UK, according to figures from the Office for National Statistics (ONS) - that’s more than half of all UK SMEs.
Here’s how many of the UK’s top small business types fall into the ‘small business’ category:
- 87,600 - Restaurants and mobile food service activities (< 50 employees)
- 45,780 - Maintenance and repair of motor vehicles
- 43,425 - Hairdressing and other beauty treatment (< 50 employees)
- 30,605 - Retail sale in non-specialised stores with food; beverages or tobacco predominating
- 19,865 - Other retail sale of new goods in specialised stores
To complicate matters a little, HMRC has its own definition of what a small business is, and it’s this definition that is used to work out IR35. The good news is that the HMRC definition still works on the 50 employees principle, it just adds a couple more caveats.
So, if you employ fewer than 50 members of staff and have annual sales of £10.2 million or less and/or a balance sheet that shows £5.1 million or less, then you are definitely a small business and have no need to worry about IR35 now or after April 6.
Does IR35 apply to sole traders?
IR35 doesn’t apply to sole traders as they run their business as an individual and not through a company - this means they’re personally responsible for the finances of their business, including any losses it makes.
A sole trader is anyone who makes more than £1,000 from any self-employment in a single tax year, and it’s unlikely that any will be able to pull in figures like a turnover of more than £10.2 million or more than £5.1 million or on its balance sheet. This means they fall into the small company category and aren’t affected by IR35.
How might IR35 affect my contractors?
While small business owners don’t have to do anything differently, if you employ any contractors then they might need to know about the incoming changes.
If, for instance, you’re a salon owner that provides a work area and maybe even specialist equipment to a self-employed hairdresser or beauty therapist, this will be part of a Chair Rental Agreement that will see them pay a standard rental fee plus a share of their earnings to the salon owner.
Such contract workers aren’t an employee of your salon and their clients are their own, not yours, but it’s important that this distinction is clear for tax and IR35 reasons.
Independence is the key factor when it comes to IR35, which means they must be in complete control of their work and can, in theory at least, work when and where they choose and be able to send someone to work in their place, if necessary.
If this isn’t the case, they’ll be classed as employees and will have to be on your payroll.
There’s also the potential for problems with ‘gig economy’ workers, who are generally low-paid, but work on an almost freelance basis with big-money digital platforms like Uber and Deliveroo.
But there could be a work-around for these companies (there usually is) based on a few distinct differences between ‘gig economy’ workers and ‘contractors’.
One such difference is project length - while an Uber driver might agree to take on several short but frequent jobs, an IT contractor will usually work with the same client over a long period of time. The difference here is that while Uber is the umbrella company for drivers, they’re essentially self-employed and each customer is their own personal client, not Uber’s.
IR35 can get confusing, so just be glad that, as a small business owner, you don’t need to worry about it.
So, what is IR35?
Introduced in 1999, IR35 is a complicated set of laws used to work out whether a contractor is a genuine contractor or a ‘disguised’ employee who can take advantage of a tax loophole.
Although contractors may work in similar ways to employees, working through a private company - sometimes known as a personal service company (PSC) - usually means they can pay less in income tax and don’t have to pay national insurance at all.
The reason some contractors and freelancers set themselves up as a PSC is because some clients prefer to work with limited companies rather than unincorporated sole traders, particularly larger organisations and those in the financial sector.
IR35 was brought in to tackle the issue of contractors and freelancers getting tax breaks by operating through a PSC, and the rules are now being tightened to try and close this loophole completely.
In the past it was up to the individual contractor/freelancer/employee to work out whether they fall under the IR35 rules. But from April 2020, it will be the responsibility of medium and large businesses to decide whether their contractors fall under IR35.
The rule changes will only affect private sector companies, as those in the public sector have had to decide the status of their contractors since April 2017.
And, as we outlined above, if you run a small business that has a turnover of £10.2 million or less, has £5.1 million or less on its balance sheet and has no more than 50 employees (two out of the three will do), then you’ll not be affected by IR35.
What’s the problem?
HMRC wants to crack down on freelance contractors who essentially abuse the system by taking full-time positions in businesses while still working under the guise of a contractor. The trouble is, the majority of businesses don’t seem to know the first thing about the impending changes to IR35.
According to a report from business management consultants Sullivan & Stanley, almost three quarters (71%) of businesses aren’t aware of the IR35 changes that come into effect on April 6 2020.
Neil Tonks, a legislation expert at HR and payroll software provider MHR, said: “IR35 represents a significant change in the way organisations in the private sector employ and pay their contractors. Preparing for the change is no easy task with the process estimated to take three to four weeks to complete, so it is critical that companies don’t pay lip service to the new rules and treat IR35 assessments as an urgent priority to ensure they fully comply.”
Any business that doesn’t put systems in place to correctly assess freelance contractors could be hit with one or all of the following:
- Backdated demands for PAYE, tax and national insurance contributions
- Fines for delays and late submissions
- Reputational damage damaging an employer’s ability to attract freelancers
- IR35 can get pretty complicated and making sure you’re compliant can be complex
The main thing to remember is that you don’t need to worry about IR35 if your business fits the description of a small company. But, if you’re in any doubt, it’s probably worth getting some advice from a suitably-qualified professional, such as an accountant.
For more information on IR35, go to GOV.UK