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IR35 Private Sector 2020 Roll Out – Key Factors to Determine Employment Status

By Xenios Thrasyvoulou, Founder and CEO of TalentDesk.io

With the confusion surrounding IR35, many banks like HSBC and Barclays have announced that they will no longer engage contractors who operate via limited companies. As with many sectors, IR35 seems to be shaking things up within the banking industry, with other large players, such as Lloyds, Morgan Stanley and RBS communicating similar messages.

Xenios Thrasyvoulou
Xenios Thrasyvoulou

IR35 isn’t something new though. Taking effect from April 2000, the off-payroll rules came into effect in the public sector in April 2017. Since then, it has been down to the client to govern whether their contract workers are operating within the rules. If so, the fee payer (e.g. the body, agency or third-party) has to deduct NIC and tax at source for HM Revenue and Customs (HMRC). However, from April 2020 the government wants to extend these rules to the private sector.

The rules are aimed at people working through an intermediary, such as a limited company, also known as a personal services company (PSC) or in some instances partnerships. The key consideration is: would that person have been employed directly if it wasn’t for the company structure?

The legislation targets medium and large sized companies, and small businesses are exempt. According to the Companies Act 2006, small businesses are defined as meeting two or more of the criteria below:

  • No more than 50 employees
  • Annual turnover of no more than £10.2 million
  • Balance sheet total of no more than £5.1 million

However, if you’re not exempt and your business works with freelancers and contractors, now is a good time to assess the risks. How would your business cope with a shortage of talent in the market? Would you be willing to pay a premium for your contractors, should they raise their rates? What fallback options would you have? Determining these points ahead of time will help you manage compliance and get ahead of IR35. This is also when you should expedite the process of reviewing your freelancers’ contracts. Here’s what to keep a close eye on.

Key Factors to Determine IR35 Employment Status

HMRC has provided some guidance on how it determines an individual’s employment status. While their direction is not exhaustive, here are some important factors to be aware of:

  1. Taxation – With an employee, you are responsible for paying NIC, pension contributions, tax and more. However, a freelancer is responsible for these factors in relation to their business. This also means paying for VAT when applicable.
  2. Integration – How much does your business rely on the freelancer? They should not have a defined role within the business or perform services that would only be expected of a payroll employee.
  3. Substitution – Avoid clauses in your freelancer contracts stating that it is solely the named freelancer who has to do the work — allow them to provide a suitable substitute. Stating that you have the right to reject the substitute may indicate to HMRC that you have some level of control.
  4. Engagement (nature and length) – State what exactly a freelancer or contractor is being hired for and how long the project will last. It is advised that there is a clear end date in the contract as well. This will help prevent HMRC considering a rolling contract equating to you having control over the freelancer.
  5. Mutual obligation – Stipulate clearly that you are under no obligation to provide continued work to the freelancer. Unlike an employee, this is the element of risk that a freelancer bears — and it is what sets the two apart. This works both ways — freelancers do not have to accept all projects that you offer them.
  6. Pay and benefits – Freelancers are usually paid either on a commission basis, at the end of a project or a daily/hourly rate. They are not entitled to overtime or benefits like sick pay, pension schemes and paid leave. Additionally, perks like access to the company gym should be restricted only to employees.
  7. Facilities and equipment – Thinking of providing your freelancer with equipment? This could lead to some confusion about their employment status. A contractor should provide all the materials and equipment needed to carry out the task or project that you have engaged with them for. For example, even if they’re in the middle of a project and their laptop breaks, it is their responsibility to get it fixed in order to finish the tasks set out in their contract.
  8. Exclusivity – You cannot demand that the freelancer works solely for you. You can include such exclusivity clauses into your employees’ contracts — but a freelancer retains the right to work for clients simultaneously.
  9. Financial risk – The nature of freelance work means that they bear a certain amount of financial risk. Freelancers risk their own capital or equipment. For instance, if a piece of work does not meet your specifications, they may have to redo that work at their own cost. They may also bear a loss if they have quoted a fixed price, but the work overruns the estimated time. Ensure that these factors are all clearly defined in freelancer contracts.
  10. Right of control – While in the case of an employee you can manage when, where and how they work, when it comes to a freelancer, there should be no direct supervision. Specifying exact working hours, for instance, is highly not recommended.

The 10 factors above are some of the distinguishing factors between freelancers and full-time employees. Some carry more weight than others. However, it’s not all black and white, so you’ll need to review the rules and risks carefully. One way to help ease this process is to ensure that the HR department and any employees who take on freelancers within the business are educated on IR35. Create a clear policy for hiring and onboarding contractors – and make sure everyone adheres to it. Having a set process and the relevant payroll and systems in place to manage your freelancers will be fundamental to ensuring compliance.

While the added time is indeed welcome, make sure you don’t underestimate how long it could take to wrap your head around the complexities of the rules!