IR35: Where are we now and what does the future hold?
This is one of a series of articles from our Commercial partners. The views expressed are those of the author and not necessarily those of ICAS.
After the government’s postponement of the IR35 changes, the off payroll in the private sector reforms are almost upon us
From April 6th, the focus of IR35 decision-making and tax liability moves almost universally away from the limited company contractor (often referred to as a personal service company or PSC) to end clients and recruitment agencies. But time is now running out for the parties to prepare for the off payroll working changes.
HMRC’s objectives and their potential effect on the labour supply market
Allegedly a level playing field, where you won’t have two individuals working side-by-side doing the same job with one being taxed as an employee and one being treated as an independent contractor.
HMRC had estimated that only 10% of the PSC population was treating engagements as “inside IR35” and if not addressed, the Treasury would lose up to £1.3bn per year by 2023-24. HMRC’s target: to increase the 10% to a third of all engagements being deemed inside IR35.
HMRC believe the off payroll working changes will affect approximately 60,000 medium and large-sized engagers and potentially 20,000 recruitment agencies. Contractors were being sold the changes as 170,000 contractors having less of an admin burden – presumably because a lot of them would be closing down their PSCs…
Why? Because it makes no financial sense for contractors to continue trading on ‘inside’ engagements though their PSCs: they lose the notional 5% allowance, leaving them unable to set off the expenses of running their company.
It seems highly likely that as a result of some of the kneejerk reactions of end clients last year to effectively bar the use of PSCs and the general antipathy of many others to address the legislation, HMRC is well on its way to achieving its target, but probably not in the way that it intended.
End clients: choices to be made
Many end clients (and fee payer agencies) were unprepared for the original April 2020 introduction and were saved when the Government announced the deferral of the legislation.
Yet where end clients did take action, they fell into two camps: those prepared to embrace the changes because they recognised the need to retain the best resources; and those – particularly in the banking sector – which sought to side-step the issue and only offer “employed solutions”:
- Take contractors on as staff
- Offer fixed-term contracts
- Engage as agency employees
- Engage via umbrella companies
Many organisations which made their decisions prior to the deferral, have continued down that path regardless. The consequence for contractors, who generally have not been able to negotiate increased rates to compensate, has been a significant loss of take-home income. The question is whether by limiting the options to employed outcomes, these end clients will lose out on the best freelancer talent?
Even businesses addressing IR35 status are taking a conservative approach, with ‘inside IR35’ decisions favoured. Where we have seen Status Determination Statements (SDS) issued, these haven’t always met reasonable care requirements. In short, there is much still to be done!
Defining the end client
When considering the practicalities of the legislation, one needs to determine who the end client is. This determines where the responsibility for making the status determination lies, and may affect where the tax liability exists. But the waters can be muddied because of issues around outsourcing.
Where end clients genuinely outsource a project or complete service – e.g. IT, HR, facilities management, security, catering etc – to a 3rd party, then that 3rd party becomes the end client for the purposes of IR35, and if engaging PSCs, has the end client decision-making responsibilities.
However, if the end client uses the consultancy to fill “vacancies”; i.e. to find a project manager, business analyst, tester, etc; the consultancy would NOT be the end client for the purposes of the legislation; it would assume the role of fee payer because it will be paying the freelancer’s company. In this scenario of filling roles, the original end client would be the decision-maker and if it hasn’t fulfilled its decision-making obligations, then it will assume the fee payer liability.
HMRC has been keen to point out that 1.5 million small companies are exempt from the legislation. Small companies, defined by s382(2) of CA2006 must meet two of the three following criteria:
- Turnover of no more than £10.2 million
- Balance sheet total of no more than £5.1 million
- No more than 50 employees
NB: Where a small company is part of a group, the group position must be considered.
Already contractors have come together to create small consultancies to undertake project work. A by-product of a small company consultancy being inserted in the contractual chain is that the original end client loses its IR35 decision-making responsibility, as well as any potential liability. If the small company is exempt, it means that decision-making and liability fall to the individual PSC contractor.
We wouldn’t be surprised if HMRC focus compliance effort on contractual chains containing small company consultancies to ensure that their existence is not to avoid the end client’s obligations. Having robust contracts throughout the supply chain and ensuring that the working practices match them will be key.
Recruitment agencies: an opportunity beckons
This legislation presents proactive agencies with a fantastic opportunity to approach end clients with a solution where the due diligence on contracts and working practices has been undertaken; i.e. the end client has all the information needed to create a valid SDS. Moreover, this can be insurance-backed, offering protection to the fee payer agency and removing end client concerns about the transfer of debt.
The future of contracting
Many contractors have seen a worsening of their tax position and feel aggrieved by the approach of some end clients, with many forced to take employed roles. However, the UK economy depends upon thriving small businesses and a flexible labour force. Contractors and freelancers will remain a cornerstone of that labour force, albeit not in the same numbers.
Some have questioned whether a reduction in PSC engagements could result in the off payroll legislation being self-defeating? More contractors engaged as employees means lower CT receipts and less VAT collected by HMRC. One assumes that HMRC expects increased PAYE to counteract this?
In summary, the legislation represents a massive and unquestionably difficult change which will bring unwanted cost and administration to end clients and agencies, as well as a greater tax burden for many contractors. Furthermore, as HMRC’s Resources and support for off-payroll working makes clear, they will not be deterred from implementation in April.
However, there is also help, guidance and protection available for all parties in the contractual chain. Markel Tax can ensure that your business can have robust compliance processes and insure its position to be protected and to move forward to take advantage of these changes.
Webinar: The questions you need to ask yourself about IR35
If you want to hear more on this topic, Paul Mason, Head of Tax Partnerships, has recorded an informative webinar on the questions you should ask about IR35 and what you can do to get ready for these changes.
If you would like to discuss our services or insurance product in more detail, please get in touch or call us on 0333 920 5708.