Tax and Employment Status

The exact rules to determine the position are complex and you can read an overview of the main considerations online. Alternatively, you should seek professional advice. In exceptional circumstances, some musicians may qualify for what is termed ‘Reserved Trading Income Status’ (previously known as ‘Reserved Schedule D Status’). They will continue to be taxed on income from theatrical work as self-employed so long as tax liabilities are properly discharged and there is no break in their employment.

Employment Status Anti-Avoidance (“IR35”) 

Where an individual supplies personal services via a Limited Company (or more rarely a partnership), HMRC can invoke anti-avoidance legislation (known as “IR35”) which effectively treats income arising from the engagement as Employment Income. If successful HMRC will require the intermediary Company to account for Tax and National Insurance Contributions (including the Employers NIC). It can also mean that certain expenses incurred in fulfilling the engagement no longer qualify for a tax deduction. HMRC will be successful in pursuing these extra liabilities where, but for the interposition of the Company, the relationship between the Engager and the Worker is “master/servant” – i.e. an employment. Care is needed before any decision to supply services through a Company or Partnership is taken. Professional advice is recommended. 

On 6 April 2017, some changes were introduced to the IR35 rules which purport to affect individuals supplying their services through intermediary companies or partnerships to “public bodies” (as defined). These rules extend to all medium and large businesses in the private sector from 6 April 2020. 

The effect of this change is more wide reaching than originally envisaged. The main effect is that, in a situation where IR35 does apply to the services, it is now the responsibility of the public body to account for tax and national insurance in relation to the engagement. Understandably, the public bodies are reluctant to take any significant risk in relation to this matter and therefore in any situation where the employment status of the individual supplying the services is unclear, they frequently insist on deducting tax and national insurance at source from the relevant income. 

Although HMRC has produced an employment status test (called CEST) to assist in determining the employment status of a particular contributor, many commentators think that this is heavily skewed towards producing the “employed” or possibly “unable to determine” results. Where either of these results is obtained under the test, individuals will inevitably find that the public body has decided to deduct tax and national insurance contributions at source before making the contractual payment. HMRC has gone on record to say that the IR35 rules are merely “deeming for tax purposes” such that a test which produces the result “employed” would not necessarily be reliable for employment law purposes. So the determination does not necessarily bring legal rights. 

Perhaps a slightly less obvious consequence of this new legislation is that all larger businesses are now looking at all of their “off payroll” engagements (i.e. not just those involving companies or partnerships but those where the engagement is directly with an individual) and applying the CEST test to determine employment status for tax purposes. In turn, this means that many freelance individuals will also find that their income from contracts with public bodies is being subjected to tax and national insurance deductions. Although it is possible to challenge the outcome of a CEST determination, the public bodies are understandably reluctant to enter into detailed negotiations on these matters and will invariably direct the contributor to take the matter up with HMRC. 

IR35 exemptions

Small private sector companies are exempt from the IR35 regulations since they came into effect in April 2021. According to Section 382 of the Companies Act 2006, a company is defined as “small” if it satisfies at least two of the following:

• Annual turnover not more than £10.2 million
• Balance sheet total not more than £5.1 million
• Employees numbering not more than 50

In which case the personal service company (PSC) remains responsible for determining the IR35 status of their relationship, and the small company engaging them can continue to pay them gross of any deductions.

If a small company fails to satisfy at least two of the above criteria for two consecutive financial years, they will be subject to reclassification as a medium or large entity and will then be responsible for the IR35 determination. If the small company is part of a larger group of companies, the criteria (turnover, balance, employees) of the entire group will be considered in the judgement of whether the company is “small”.

Learn more about off-payroll working