Changes to IR35, the tax legislation that looks over off-payroll working, are coming in April 2021 after being delayed by a year as a result of the pandemic.
Named after the press release that announced it back in 1999, IR35 was originally adopted to stem the growing number of “one-man” limited companies providing services to businesses as freelancers – thereby avoiding a considerable amount of tax – while still maintaining a traditional employee-employer relationship.
Being determined as outside IR35 legislation means freelancers can continue to pay themselves through their own limited companies. But being inside IR35 means the freelancer has essentially been deemed an employee, and should therefore be paid – and taxed – as such.
In 2018, it was announced that changes to the legislation would be rolled out to the private sector – having already been successfully introduced to the public sector in 2016. After being delayed by a year in the wake of the coronavirus pandemic, these changes will come into effect on 6 April.
What are the changes?
Before 6 April 2021, freelancers and contractors working in the private sector are able to decide their own workers’ status. Essentially, they’re able to identify as freelancers and contractors and sort their own tax out accordingly at the end of the financial year.
However, after this date, the onus shifts from the workers to the clients they are servicing. Clients are required to evaluate their relationships with contractors – if they find these workers fall inside IR35, then it is their responsibility to start paying them as a “deemed employee”, thus incurring all the associated tax and National Insurance expenses.
What’s wrong with that?
The changes present a problem, according to some employers, who say the introduction of a “deemed employee” status will make it more expensive to take on freelancers and that the additional tax costs may have to be skimmed off of freelancers’ fees if a consultancy feels unable to absorb it or pass it on to a project client.
“What we’re worried about is that freelancers might be less inclined to work for larger agencies because it’s going to cost both freelancers and agencies more money to do so,” says Design Business Association (DBA) head of services Adam Fennelow.
Fennelow makes the specific point about larger consultancies missing out because of certain rules and exceptions included in the new IR35 changes, (an idea which we will revisit later). However, he says smaller agencies could end up feeling the effect of this too.
“And from the smaller agency perspective, a lot of these studios will rely on freelancers but might find that there are fewer going around – we don’t know for sure yet, but can imagine that some freelancers aren’t going to want to be freelancers anymore. And that might reduce their talent pool too,” he says.
How can design businesses prepare?
The first port of call, for freelancers or businesses alike, should be the Check Employment Status for Tax (CEST) test on the HMRC website.
The test isn’t perfect though. Even the government’s own data, released in December 2020, showed that the tool was unable to make a determination in 20 per cent of cases. However, it is at present the Government recommended way for you to check.
The CEST test uses 16 questions to determine whether your role in a company truly is as a freelancer (outside IR35) or if you actually perform the role of an employee (inside IR35). It makes a decision based on some of the following considerations:
- Mutuality of obligation – is your client obliged to offer you work, and are you obliged to accept it? Do you need to work on certain days (for example, 9-5, Monday to Friday employment) in order to get paid?
- Personal service – are you required to carry out the work your limited company has been contracted for, or can you send someone in your place?
- Control – following on from personal service, how else are you in control of the job at hand? Does the client control your output, or can you conduct the work in the way you see fit (for example, working late nights, working from home, or not wearing a company uniform)?
- Financial risk – would you be at financial risk for sub-standard work? Would you get paid, even if you didn’t perform the job given to you?
- Day-to-day functioning – is your personal service company actually independent, or are you an integral art of the day-to-day operations and organisational structure of the business you work for?
Even if you’re not using the CEST test, you still need to have in place a framework to ensure you’re complying with the rules, according to media law firm Wiggin LLP partner Ceri Stoner.
The first thing she recommends for design businesses is working out which of your contingent workforce is going to be affected. This can be a big undertaking on its own, because the nature of a freelance workforce means “people can come and go”, she says.
The next step is conducting the assessment and letting your freelance workforce know about what you have decided, she says. You need to have a clear explanation as to why you’ve come to the decision you have and need to be prepared with a disagreement process if a contractor doesn’t agree with your assessment.
“This is a huge relationship management exercise – it’s in everyone’s best interest for freelancers and clients to both be happy,” says Stoner.
“It is important that people are aware it’s coming,” Stoner adds. “I think now is really the time to start messaging people about it – the first time they hear about this shouldn’t be when you’re delivering them the results.”
Finally, Stoner says it is important to apply the same process to the whole of the workforce. Your regular freelancers are likely to know each other.
“You need to be seen as treating everyone fairly and consistently,” she says.
Are there any exemptions?
The principle exemption from the updated IR35 legislation is small businesses, and this hasn’t changed in the year since its postponement.
Freelancers contracted by a small business will still be able to identify as freelancers, because the onus will fall on them rather than the company hiring them. HMRC defines a small company as meeting two or more of the following:
- Its annual turnover is not more than £10.2 million;
- Its annual balance sheet total doesn’t exceed £5.1 million;
- It doesn’t employ more than 50 people.
At the moment, many freelance designers’ contracts will likely fall into this category, and similarly most design businesses procuring freelance work will too as they are classed as small companies.
However one thing Fennelow points out as worth remembering is that in the eyes of the government, networked design businesses count as one large business, rather than a set of smaller ones. Networked design studios then could indeed be classed as medium or large enterprises without realising it.
“So if you are a design agency that is part of a networked group, it is the whole group,” he says. “I’m sure the likes of WPP businesses are well aware of this, but there are a lot of smaller networks that might only have three or four businesses, but will suddenly fall into this category.”
Should I be worried about all this?
We have an idea of the impact of IR35, given that the same rules were adopted by the public sector in 2016. That said, there are likely to still be some teething problems.
And herein lies the problem, according to Jack Tindale, outgoing design and innovation policy manager at thinktank Policy Connect, who says: “More than anything else, the lack of certainty for designers is what makes a lot of this difficult.”
It doesn’t help, he adds, that the changes to IR35 come after a turbulent year filled with worries about Brexit, No Deal and the pandemic.
There is no doubt the changes to IR35 will mean more paperwork, but Fennelow says it’s unlikely the government will crack down severely right away. Additionally, the fact most design businesses are classed as small enterprises is a bonus too.
“But the rules are there, and they have to be followed,” he says. “So we’re encouraging agencies to be aware of it all and to act accordingly.”