EPW IR35 - Useful Guidance
Companies claiming R&D for Externally Provided Workers (‘EPWs’) may find it helpful to fully understand if those companies have correctly operated IR35. Here is a useful reminder of the tax implications.
IR35
The IR35 rules exist as a way for HMRC to challenge the employment status of individuals working via their own limited company – referred to as a personal service company or PSC.
If HMRC can demonstrate that the individual’s working arrangements look more like employment than a service provided by an independent business, the IR35 rules mean HMRC can tax that individual’s income as employment income. Having to treat income as employment income in this way is called being ‘caught by IR35’.
Historically, the PSC was responsible for deciding how to treat income for tax purposes and was liable for the tax and NIC if they got it wrong.
However, the IR35 rules changed in 2021. There are now different IR35 rules depending on whether a small business, or a medium or large business engages the PSC.
Where a small business engages PSCs, the PSC remains responsible for applying IR35.
Where a medium or large company engages PSCs, the company must take responsibility for the IR35 status of those workers, along with the associated tax liability.
1. CHECK WHETHER THE CLIENT IS A SMALL BUSINESS AS PER THE COMPANIES ACT 2006
Small Business
The definition of a ‘small business’ is taken from the Companies Act 2006. A business will be small if it satisfies two or more of the following requirements:
- It has an annual turnover not exceeding £10.2m;
- It has a balance sheet total of not more than £5.1m;
- It had an average of no more than 50 employees for the company’s financial year.
If the company is a small business, the IR35 rules from 2021 do not apply, and any PSCs engaged retain responsibility for the correct operation of IR35.
Keep an eye on these criteria for growing businesses, and take advice when there is a concern.
If the company is part of a group structure or joint venture, the small business test must be applied to the group. The aggregate turnover and balance sheet totals of all connected entities or persons must be considered.
Note that the tests for a small business in the Companies Act and for the purposes of IR35 are very different from those used for R&D purposes.
2. IF THE COMPANY IS NOT A SMALL COMPANY, CHECK WHETHER IT ENGAGES ANY PSCS EITHER DIRECTLY OR VIA AGENCIES
Medium or Large Businesses
If the company does not meet the small companies’ exemption, then ascertain whether any individuals engaged by the client are Personal Service Companies (‘PSCs’), commonly referred to as ‘one man band’ limited companies. This includes PSCs engaged via an agency.
If no PSCs are engaged, no further action is required. However, if the company engages any PSCs directly or via an agency, the company must correctly operate the IR35 rules.
Under IR35, a medium or large company must determine the IR35 status of every PSC’s engagement.
Determining whether an engagement is caught by IR35 is a complex decision. There are many factors to be considered and it’s prudent for a company to seek professional advice.
Whatever the company’s decision, this must be formally communicated to the PSC and worker, and the agency if there is one.
In addition, if the engagement is determined to be ‘caught by IR35’, payments made to the PSC must be subject to deduction of tax and NIC by the company that pays the PSC for the services.
R&D and IR35 Tax Liability
You may be thinking ‘what does this have to do with R&D?’.
A worker provided by a PSC can be categorised as an ‘Externally Provided Worker’ or ‘EPW’ for R&D purposes.
Importantly, EPW status requires the personal service of the worker, and that the worker provides services under the supervision of the company. These factors strongly suggest an ‘inside IR35’ engagement.
3. CHECK WHETHER A MEDIUM OR LARGE COMPANY HAS TREATED PSCS AS EPWS AS PART OF AN R&D CLAIM
As mentioned above, the conditions of an EPW for R&D purposes suggest that PSCs should not be deemed outside of IR35.
Therefore, the deduction of tax and NIC on payments to the PSC is advisable if a PSC is treated as an EPW. Note the company’s obligation to confirm this in writing to the worker before payments are made.
If a medium or large company has already made an R&D claim which includes work undertaken by PSCs, we recommend that advice is taken as soon as possible. This is to check whether the company has any retrospective IR35 issues or liability from incorrectly treating PSCs as outside of IR35, and to ensure IR35 is dealt with correctly going forward.
NOTE: Where a company claims for Subcontractors as part of its R&D claim, even though the definition of Subcontractors is favourable in terms of IR35, the company is still required to make a decision, keep adequate records, and issue documents confirming this, and HMRC could still challenge the decision under IR35.
Further, suppose a company directly engages individuals on a self-employed basis (i.e., not via an intermediary company, PSC, or otherwise). In that case, there are no statutory obligations for providing information; the company is still responsible for the subcontractors’ employment status and tax liability if this treatment is incorrect.
HQ35 are experts in all self-employment compliance matters including IR35, sole-trader and intermediary engagements. Email darren@hq35.co.uk to see how HQ35 Ltd can partner with your practice to help your clients in this very complex area.
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