As a contractor or subcontractor in the construction industry, you’ve probably heard of CIS and IR35. Perhaps you’re already enrolled in CIS and want to understand how - if at all - IR35 will impact you. Or perhaps you’re just looking for clarification on how IR35 works.
In this article, we’ll explore CIS, IR35, and the interaction between the two.
After reading, you should have a better idea of what changes you need to make - if any - to ensure you’re not falling afoul of any rules.
What Is CIS?
CIS stands for Construction Industry Scheme. It's an HMRC-operated scheme that lays out the rules for payments in the construction industry, along with the criteria that define contractors and subcontractors, and the obligations that fall on each side.
The CIS is a tax deduction scheme, which means that if you're enrolled as a subcontractor, tax is deducted at-source from paychecks arising from construction work.
As a contractor or subcontractor, you'll have certain income tax and national insurance obligations. CIS is designed to streamline this process and remove some of your obligations in the management of your tax affairs.
The definition between contractor and subcontractor includes several criteria, detailed elsewhere on our blog.
What Is IR35?
IR35 refers to the Intermediaries Legislation introduced by Gordon Brown when he was Chancellor of the Exchequer. The legislation pertains to intermediaries like partnerships and personal service companies, and it looks to prevent one route of tax avoidance whereby individuals can operate as directors while servicing their clients very similarly to how they would if they were an employee.
IR35 applies freelancers and contractors in the UK. It sets out the differences in tax obligations between full-time employees and limited company directors.
The IR35 is broadly designed to ensure that people can't switch and change their employment status to make their situation more tax favourable.
Its ultimate goal is to ensure the right amount of tax is paid to HMRC for an individual's status, and that a potential channel of tax avoidance is closed.
IR35: What You Need To Know
The first thing to say is that IR35 isn't as complicated or intimidating as it's often made out to be. So if you're worried about IR35 compliance, you can breathe a sigh of relief.
Secondly, there's a lot of jargon. So if you're reading this and feeling a bit overwhelmed by the concepts and terminology, don't worry.
IR35 sets out key differences between tax obligations for full-time employees and limited company directors.
As a full-time employee, your tax will be -
- Out of your hands: Your employer takes care of it.
- Fairly rigid: Certain exemptions are taken into account, then deductions are made based on your tax code.
As the director of a limited company, your tax will be a bit more flexible: You have more wriggle room in deciding how to take money from your business
IR35 makes sure that you can't be working as a full-time employee while registered as a director of a limited company, or vice versa. This is achieved by determining whether you are in legitimate self-employment as a contractor, or whether you're essentially an employee working under the director banner. The latter is known as being a 'disguised employee,' and is severely frowned upon.
If you're found to be a disguised employee - that is, working in a way that IR35 defines as full-time employment while being registered as the director of a limited company - you're considered to be "Inside IR35."
Conversely, if your registration aligns with the terms of the work you're doing, you're considered to be "Outside IR35."
Being Inside IR35 opens up the possibility of an HMRC investigation into your business affairs. Such investigations can be long and costly, and they can result in you having to pay back all of the tax you would have paid had you been registered as an employee under PAYE. Because of the different tax obligations for employees and directors, this amount can grow quite large.
HMRC uses "hypothetical contracts" to evaluate the relationship between a worker, a limited company, and a client. Depending on working practices and contractual terms, the contract will either be deemed to be between a limited company and their client (Outside IR35) or an employee and their client (thus Inside IR35 if the person deemed to be an employee is operating as a director).
How to be compliant with IR35
IR35 compliance is assessed for each assignment you work on, meaning that your IR35 status can vary between projects.
The best vehicle for compliance is understanding the rules and striving to work within them.
Here are the three main criteria used by HMRC to evaluate IR35 status -
- Who has control over the work? As a contractor, are you free to decide when, where, and how you complete the work, or is this determined by the client?
- Are you required to carry out the work yourself, or do you have the option to send someone else instead who operates under the umbrella of your company?
- Are you obliged to accept further work if the client offers it, or is it your prerogative to decide
If you have no control over when, where, and how to complete the work, and are also obliged to carry out the work yourself and accept all further work requests, this sits closer to employment than provision of a service through a company.
However if you have full flexibility on when, where, and how the work is completed, and by whom, with the option to exit the client / service provider relationship whenever you like, this reads more like service provision.
You can use an IR35 contractor tool to give an indication of whether you are compliant, however this cannot be accurately determined in all cases.
Your best bet is to work with a payroll services company who can advise on ensuring your business practices are IR35 compliant.
IR35 isn’t as intimidating as it’s made out to be, but the penalties for violating the rules - whether intentionally or otherwise - can be severe. As a subcontractor or contractor, it’s important to understand whether the way you operate brings you under the remit of IR35.
The way IR35 interacts with the Construction Industry Scheme (CIS) is changing, with new legislation set to come into effect in October 2020. As a contractor or subcontractor, it’s your responsibility to keep abreast of these changes and ensure compliance where applicable.
Working with a CIS payroll service provider is one surefire way to make sure that you’re not inadvertently falling afoul of any rules.