Preparing for IR35 changes

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Preparing for IR35 changes

In last month’s Budget, chancellor Philip Hammond put an end to longstanding rumours and announced plans to radically change the way thousands of private sector businesses engage the estimated 900,000 limited company contractors in the UK.

From April 2020, every medium and large private sector business in the UK will become responsible for setting the tax status – or as it is more commonly known, IR35 – of any contract worker they use.

This controversial and unpopular move will also see these organisations – widely referred to as ‘engagers’ – carry the liability should HM Revenue & Customs decide it has made any incorrect assessments.

This is not an entirely new concept though – the same rules already apply to all public sector organisations following changes introduced in 2017.

The IR35 rule, also known as the off payroll working rules, are not as clear as they ought to be given the size and importance of the independent workforce.

They were introduced in 2000 by then chancellor, Gordon Brown, in an attempt to stop ‘disguised employment’ and prevent contractors working through their own limited company to avoid tax, when in reality, their working arrangement reflected employment.

From the very beginning, IR35 has been criticised for its complexity and for ignoring the difficulties when interpreting the boundaries between a genuinely self-employed contractor and an employee. 

When working outside the scope of IR35, a contractor is able to pay themselves through their limited company and, marginally, more tax-efficiently.

When sitting inside IR35, a contractor is deemed ‘employed for tax purposes’, which means they are required to pay income tax and national insurance contributions, just as an employee would.

The key tax differential, however, is the employer’s NICs, which would have been levied at the engager the contractor is working for. 

Key Points

  • From April 2020, every medium and large private sector business in the UK will become responsible for setting the IR35 status of any contract worker
  • Many contractors do not receive employment rights for the additional tax they are made to pay
  • Businesses need to prioritise accurate decisions and avoid panicked determinations

One of the problems lies in the fact that contractors, when working inside IR35, do not receive any employment rights in return for the additional tax they are made to pay. Contractors are understandably asking where the fairness is in this.

And ultimately, it is one of many factors that has led to huge discontent among independent workers, who feel targeted by HMRC and are perceived to be a soft target by the government. It is hard to ignore their case.

Justification for change

HMRC sees things differently though. By leaving contractors in charge of setting their own IR35 status, the government believes there is widespread tax avoidance. In fact, HM Treasury thinks there is £1.3bn missing each year as a direct result of individuals outwitting HMRC by operating outside IR35 when their contract amounts to employment.

The government has tried to justify IR35 reform by claiming that 90 per cent of the individuals working outside the rules are doing so non-compliantly.

But many specialists, including contractor services provider Qdos, beg to differ.

Qdos has supported contractors in more than 1,600 IR35 investigations, and ultimately only three of these were found to be inside IR35 by HMRC and/or tribunal judges. 

Under pressure to raise tax revenues, the chancellor introduced IR35 reform in the public sector last year, in what many considered the pilot project for the recently announced private sector changes.

Now, with all public sector engagers in charge of setting a contractor’s IR35 status and also liable for any mistakes should HMRC investigate, thousands of contractors have been placed inside IR35 without a fair review of their working arrangement. 

These organisations were not helped by the government’s haphazard implementation of reform and were perhaps motivated to protect their own liability – which can run to hundreds of thousands of pounds.

A number of public sector bodies made risk-averse IR35 decisions, which resulted in contractors being taxed like employees, yet without receiving any of the rights that come with employment - a lose-lose as far as a contractor is concerned. 

Are the reforms working?

Despite the unrest caused by these measures, the government truly believes public sector reform has worked. But their only measure of success seems to be the additional £550m raised through reform so far.

Questions still remain over whether it has been collected fairly or improved IR35 compliance at all. It is very possible that thousands of contractors have been wrongly placed inside IR35 and therefore have been overtaxed. 

As a result of chaotic public sector changes, disenchanted contractors left the sector, which led to skills gaps and caused project delays. As you can imagine, contractors would rather work outside IR35, or at the very least, have a fair shot at having their tax status properly assessed. 

With private sector reform on the horizon, it is vital there is not a repeat performance of public sector changes. It is also in the interests of private sector companies for projects that belong outside IR35, to sit outside the rules. After all, companies will be needlessly paying employers NICs if they wrongly place contractors inside the rules.

The focus is now on medium and large companies – those with a net turnover of more than £10.2m, a balance sheet total greater than £5.1m or more than 50 employees – to prepare well in advance of the 2020 rollout. 

Recruitment agencies also have a role to play in all of this. When handling payments on behalf of the end client, it is widely expected agencies will carry the IR35 liability, despite the fact the engager remains responsible for making the decision.

The specific details of changes are yet to be published, but there is no reason to believe agencies will avoid some sort of liability or obligation.

Lessons learned

So, can the private sector manage incoming reform and continue to engage contractors outside IR35 while, at the same time, protect their own liability? In short, yes.

Incoming changes are manageable, but these businesses need to prioritise accurate decisions and avoid panicked determinations. And the work should start now. 

Lessons from mistakes made in the public sector need to be learned and misjudgments avoided this time round. As convenient as they may be, ‘blanket’ determinations, which typically result in a whole contractor workforce being placed inside IR35, are short-sighted.

Not only will a one-size-fits-all approach to assessments dissuade contractors, but by the letter of the law, blanket determinations are non-compliant. Therefore, private sector organisations areadvised to assess contractors individually, on a case-by-case basis.

Use the right tools

This brings us to the methods of setting IR35 status. There has been ongoing criticism of HMRC’s IR35 testing tool – CEST. Simply, it fails to consider the specific details of a working arrangement that IR35 status can often hinge on.

And plenty of experts have advised against using the tool as the sole way of setting a contractor’s status. But it is not, as many companies presume, mandatory, and independent contract reviews are perfectly acceptable. 

Huge question marks remain over CEST’s reliability, which were highlighted yet again recently when a judge overturned an ‘inside IR35’ answer it provided. The government has promised to improve the tool, but given it was released back in April 2017 – with flaws upon its arrival – contractors are not holding out much hope. 

CEST only needs input from the end client to provide an answer, whereas in our experience, joined-up thinking is needed when setting IR35 status accurately. It is important that companies collaborate with contractors and when involved, agencies, to get the right result. 

While further IR35 reform was not the news the vast majority of UK business wanted to hear, it is, contrary to speculation, manageable. And the chancellor has at least seen sense to a certain extent, by delaying changes until 2020. 

It is now up to the private sector to use this time wisely.

Seb Maley is chief executive of Qdos