According to HMRC’s statistics, only around 10% of limited company contractors who should comply with the off-payroll tax rules – better known as IR35 - currently do so. The taxman also estimates it could lose out on £1.2 billion a year by 2022/23 as a direct result. While it’s unclear how HMRC arrived at those numbers (which seem remarkable), they appear to be ploughing ahead with the private sector IR35 reform regardless.
Understandably, these upcoming changes carry serious implications both for contractors and the businesses that engage them, but it doesn’t have to mean the end of mutually-beneficially flexible working. Here’s what you need to know.
What is IR35?
IR35 is the name for HMRC’s off-payroll working rules, which were first introduced in 2000. The intent behind these rules is to catch and make sure so-called ‘disguised employees’ pay broadly the same tax and National Insurance Contributions (NICs) as an employee would, rather than benefit from the tax cuts that allow genuine contractors to fund their own overheads for things like equipment, time off work, and pension savings. A contractor could be classed as a ‘disguised employee’ if they:
- provide services to clients through their own intermediary – most commonly a limited company that they control, but this could also be a partnership, a managed service company or an individual - and
- enjoy an employee-employer relationship, i.e. are guaranteed work, have set working hours, are supplied equipment, and receive the same benefits as employees.
What is a disguised employee?
Here is an example of what a ‘disguised employee’ looks like:
ShopCo, a large retail firm, needs someone to maintain and update its new website. They hire Lily, a self-employed web developer, to work for three days a week, eight hours a day. They provide her with a laptop and smartphone so she can work at their offices - or at home, provided she agrees the days beforehand - and ask her to adhere to a strict dress code while in the office.
Lily reports to the head of ShopCo’s IT department, who is responsible for providing and updating the software Lily needs to do her work. This Head of IT controls Lily’s hours and expects her to attend regular appraisals to keep her work on track. Lily can’t work with another company unless ShopCo gives her permission, and she must give at least 3 months’ notice is she wants to terminate her current contract.
How can you tell if a contractor is genuine?
A genuine contractor (regardless of if they provide their services through an intermediary) should be able to work when and where they like and should supply their own equipment. They should be free from certain employee policies like dress code (provided their attire is still appropriate to carry out their job) and they should be free to work with multiple clients at any given time.
IR35 is designed to ensure limited company contractors like Lily pay PAYE income tax and NICs like an employee, which is what their working practices and contract indicate their employment status should be. However, the government has decided its existing IR35 rules aren’t working as they should, which is where the reform comes in.
What the IR35 reform means for contractors from April 2020
Currently, contractors in the private sector are responsible for making their own employment status determination – i.e. whether you’re ‘inside’ or ‘outside’ IR35. If you’re inside the legislation, that means that you’re a ‘disguised employee’ and should be paying income tax and NICs accordingly. It’s also currently up to you as a contractor to deduct that tax from your own income.
The IR35 rule changes coming into effect on 6th April 2020 (as it currently stands) see the employment status determination responsibility taken from the contractor and given to the end client. This is only applicable if your client is a medium or large-sized organisation with a turnover of more than £10.2m, more than 50 employees, and/or a balance sheet total of £5.1m or more. If you’re found to be inside IR35, it’s your client that will be responsible for paying your tax and employee NICs too.
What impact will the IR35 reform have on contracting?
HMRC’s latest factsheet on the imminent reforms confirms the following:
‘From 6 April 2020, medium and large-sized organisations outside the public sector will be responsible for deciding the employment status of contractors for tax purposes. Currently, contractors themselves are responsible for making this decision in these sectors.’
HMRC rolled these reforms out in the public sector back in 2017, transferring the liability for employer NICs to the client or recruitment agency who is responsible for deducting the correct taxes to ensure that the worker and the client fulfil their tax obligations.
It’s been damaging, to say the least. The reforms have directly lead to blanket IR35 determinations, with contractors either being forced out of existing arrangements or having to join the payroll as employees - but without receiving any employee benefits or protections to go with the new tax code. Despite the reform still being 3 months away, trouble has already hit the private sector. Anticipating difficulties ahead, firms in the private sector, including HSBC, Barclays, Lloyds and GlaxoSmithKline – all who have previously engaged hundreds of contractors – have confirmed they will stop using a flexible workforce altogether unless they join the employee payroll.
Who will be affected?
So far, HMRC has said that the IR35 reform will only apply to contractors being engaged by medium or large-sized organisations. If you provide services to a smaller company (i.e. one with a turnover of less than 10.2 million, fewer than 50 employees, and/or a balance sheet of less than £5.1m), you’ll remain responsible for determining your own employment status. If your clients are larger, then you’re likely to be affected by the new rules – even if that just means having an annual status determination carried out by your client.
Depending on the situation you find yourself in, it’s possible that you will be liable for additional income tax and NICs if you had not previously been applying IR35 correctly. HMRC has said it won’t open a new enquiry into earlier years unless it suspects fraud or criminal behaviour, but it’d advisable to get a contract and working practices review done anyway to understand your position.
The bottom line is that while the legislation has caused a great deal of anxiety across the industry, genuine contractors shouldn’t be too concerned. With an increasing number of large companies investing in getting ready for IR35 the right way – i.e. avoiding blanket determinations at all costs – thanks to press exposure and pressure from the industry, UK contracting should continue to thrive.
How to prepare for IR35 with Larsen Howie
While HMRC has said that contractors don’t need to take any action before April, it’s worth getting prepared if you haven’t already. We recommend speaking with your clients to understand how they are going to determine your employment status and what that will mean for both of you. You may also choose to get advice from a tax expert to check through your contracts and determine your IR35 status.
At Larsen Howie, we offer a range of IR35 reviews. To find out more about which option suits you, check here. And should you find yourself under investigation from HMRC, we provide comprehensive IR35 investigation insurance too.
For any further information or advice, please call us on 0116 380 0400 or send us an email. You can also head to our Knowledge Hub for more IR35 advice and the latest industry insights.