IR35 Refresh

Off-Payroll (IR35) legislation comes into play in the UK in April 2021, resulting in a sizeable impact on UK businesses that engage limited company contractors.

Contractors in the UK have historically been able to determine their tax status, based on whether they consider the conditions under which they deliver their services to a business to constitute employment or not. In the eyes of HMRC, are they operating as a genuine contractor or working as a disguised employee masquerading as a contractor for tax advantage purposes?

If the engagement is deemed as ‘employed’ for tax purposes, the contractor is subject to the same taxes that an employee pays.  Unsurprisingly, the majority of contractors currently deem their engagement services based, referred to as ‘outside IR35’ or soon to be called an ‘off-payroll’ engagement, meaning that they are paid for their services gross of tax, as per standard practice for any business to business engagement.

The tax reforms in April 2021 will shift the engagement status determination from limited company contractors to the business that engages them.  This means that limited company contractors (a.k.a. PSC contractors) working in the UK will be required to have each engagement and working practices assessed so that the business themselves can determine their employment status for taxation purposes.

Businesses need to start preparing now for April ’21

Should a contractor be deemed ‘inside IR35’ (i.e. the working practices of the contractor are broadly the same as an employee), the contractor will be subject to the same taxes as an employee and paid net of employment taxes.  This is without any of the benefits afforded to those who are permanently employed, but with the added risk that is associated when operating as a contractor, such as the lack of job security.

If HMRC investigates and determines that an incorrect status determination has been made by the business, namely, if they conclude that the contractor was assessed and declared ‘outside IR35’, but should have been declared as inside IR35 for tax purposes, and reasonable care was not taken in assessing the engagement or doesn’t reflect the actual ongoing working practices for the contractor, the end client becomes responsible for picking up the bill for backdated employment tax. Therefore payment for the contractor is for all intents and purposes considered a net payment, and the company is responsible for the ‘grossing up’ and paying the outstanding funds to HMRC. This has been estimated to be potentially as much as 55% on top of what the company originally paid for the services.  Ouch.

And to top it off, assessing the engagement is far from black and white for businesses, it is complex, grey and therefore fraught with risk. HMRCs own assessment tool, ‘CEST’, has been proven to be flawed, does not give accurate determinations and is heavily weighted in favour of inside IR35 results (who’d have guessed?).  A determination provided by CEST does not provide businesses with impenetrable protection from HMRC and can subject contractors to unfair tax deductions, making the engagement a much less attractive proposition.

The Impact

The flexible workforce in the UK contributes an estimated £140-£145 billion to the UK economy each year (CRSE, June 2019) and it’s estimated that HMRC expect to collect £1.6bn in additional tax revenue per year after the reforms pass.

Despite campaigning, a damning House of Lords report and a last minute push to delay the reforms in the house of commons, the reforms passed through in the Finance Bill in parliament on 1st July and royal assent on July 22nd . It has been reported that direct intervention from Rishi Sinak and Boris Johnson personally 24 hours prior to the parliamentary vote helped to influence ministers into voting to push the bill through without any delay or amendments. A clear indicator these reforms are being taken very seriously.

So you have a conundrum – genuine contractors do not wish to enter into contracts where the business will deem them ‘inside IR35’ due to the significant impact on earnings.  However, businesses in some cases have already taken a risk averse approach by introducing blanket bans on PSC contractors so as not to take on the tax risk engaging contractors will present.  But this is short sighted and is not deemed as taking reasonable care,  which businesses are required to demonstrate when assessing the contract engagement.  It will inevitably lead to further litigation and will have drawn attention from the HMRC.

Whilst the implications of the reforms are significant, there are particular industry sectors that will be feeling the burden more than others.  

The Opportunity in a Post COVID-19 World

New HMRC rules can drive positive change if embraced properly by businesses

Having an agile workforce is fundamental for businesses to retain a competitive edge, and highly skilled contractors, whether developing technical code, supporting a security implementation or strategically leading a marketing project, offers companies the opportunity to access skills without the commitment of permanent headcount, whilst supporting with the up-skilling of their permanent staff and accelerating delivery.  

As we emerge from COVID-19, it’s inevitable that businesses will not want to stand still and will look to engage highly skilled contractors rather than have the fixed cost of permanent staff. With April 2021 fast approaching businesses will need to be thinking differently about how they engage contractors now to prevent any complex upheaval next year.

With IR35 and remote working being part of the new normal, businesses that adopt a measured approach to IR35 assessments and take the time to embrace what will be for some new supplier models such as outcome-based services rather than T&M, will be able to manage performance and output more efficiently and have a distinct advantage over those businesses that have taken their eye off the ball and not prepared for next April.

To speak to IR35 determination specialists about managing contractors in your business, please call CoComply on +44 (0) 203 051 9792, email [email protected] or fill out the form below.