What is IR35?
How will you be affected now that off-payroll working rules have been extended to the private sector?
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HMRC first rolled out IR35 legislation in April 2000 to deal with the longstanding issue of contractors establishing limited companies to avoid making the same income tax and national insurance contributions that employed workers are compelled.
Limited companies are embedded with loopholes, such as allowing directors or "employees" to be paid dividends that have lower tax rates compared to income tax. More and more IT contractors were, therefore, setting up their own companies to take advantage of these benefits and minimise costs.
IR35, however, meant that contractors who worked for an organisation regularly enough that they would be near-indistinguishable from a hired worker would be liable to pay tax and national insurance as if they were processed through the payroll. The rules first applied to contractors working in the public sector, with self-employed staff needing to declare whether or not they’d fall under the IR35 rules.
Reforms in recent years shifted that burden from contractors to employers and also paved the way for the off-payroll working rules to be extended to private sector organisations. Following several consultations, and a few delays, the rules were finally extended to apply to all private sector organisations and contractors from 6 April 2021.
What are the origins of IR35?
With the introduction of IR35 rules, HMRC hoped to recoup the same levels of income tax and national insurance from contractors as they did from employees. Rather than demanding that contractors pay more tax directly, however, IR35 manages the relationship between the employer and the employee and requires employers to establish whether somebody working on a contractual basis should instead be deemed as being employed by that organisation.
The main argument against this equivalency is that contractors don’t benefit from the same perks as hired employees do, such as paid holiday, maternity or paternity pay, private health insurance or a pension with employer contributions. Contractors also claim that their situation is much more volatile and that their work can be terminated without notice.
When ex-chancellor Gordon Brown introduced IR35, he set out to collect an extra £200 million in National Insurance contributions per year, but only £1.5 million was recouped per year between 2002/2003 and 2007/2008, according to a Professional Contractors Group Freedom of Information (FOI) request.
More recently, the former chancellor Philip Hammond used the November 2016 Autumn Statement to announce reforms to the off-payroll working rules, also known as IR35. The organisations employing contractors, instead of the contractors themselves, would have to determine their employment status from April 2017.
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"The government believes public sector bodies have a duty to ensure that those who work for them pay the right amount of tax," Hammond's statement read. "This reform will help to tackle the high levels of non-compliance with the current rules and means that those working in a similar way to employees in the public sector will pay the same taxes as employees."
Then, the government announced it would extend these reforms to the private sector, subject to a lengthy consultation period. These changes were due to take effect from April 2020 but were delayed due to the COVID-19 pandemic. They finally came into force in April 2021.
How does IR35 affect me?
According to ContractorCalculator, workers should expect to pay approximately 25% more in tax every year if their work falls under the IR35 reforms. However, roughly half of all contractors will never go full-time with a company, despite the changes, according to research conducted by tax advisor Qdos Contractor. While 95% of those surveyed believed IR35 will make being self-employed less advantageous, just 4% said they plan to switch to working directly for a company.
Whether a contractor is subject to IR35 is determined by the organisations hiring the contractor, rather than the contractor themselves. They should both, however, separately assess whether IR35 applies to the particular job or work they have been brought in to complete.
What makes things more complicated though, is that there isn't a set of formal guidelines either the organisation or the contractor can refer to in order to decide whether they should be considered an employee or a contractor. It's all down to discretions. However, if the contractor:
- Works onsite in the organisation every day
- Uses equipment provided by the organisation rather than their own
- Manages people within the organisation
- Uses employees from the organisation to work on the project
It's pretty likely they would come under the scope of IR35 and their position should be carefully examined.
HMRC does have a tool that can be used to determine the tax status of a contractor and whether they are subject to the same tax as an employee, but another report suggested it isn't that reliable, with a third of cases inputted being flagged as not a case for IR35, despite being proven otherwise in court.
"The tool states that 'HMRC will stand by the result given unless a compliance check finds the information provided isn't accurate, which is no guarantee at all, because they just have to say 'you are wrong' and it doesn't count for anything," said ContractorCalculator LooCEO Dave Chaplin at the time.
What happened to the public sector?
Perhaps more so than the private sector, government and public bodies rely heavily on IT contractors. The introduction of IR35 was predicted to lead to an exodus of contractors, with the changes met with fury when first proposed.
Public sector 'walkouts'
Expectations, when IR35 changes were being rolled out to the public sector, were that project delivery would suffer after an 'exodus' of contractors from organisations. Research suggested that in the first few months, IR35 reforms had caused a fleet of contractors to quit the public sector. Indeed, results showed that 83% considered private sector jobs to be more attractive. Moreover, nearly half of contractors said the public sector lacked the digital skills needed to complete future projects, with 62% saying organisations will suffer from the departure of self-employed workers.
"The IR35 has clearly had a huge impact and it is really worrying to see IT contractors leave the public sector in their droves," said Dominic Harvey, director of CW Jobs, at the time.
"We are now facing a perfect storm of a brain drain from the public sector, questions over future project delivery, and an increase in fees from those contractors choosing to stay put: all are a real cause for concern."
Since the reforms took shape in 2017, there has been no less derision among contractors and the wider tech sector.
Subsequent research commissioned by HMRC suggested there was some hardship felt across the public sector, with 32% of public sector bodies finding it more difficult to fill contract vacancies. Approximately a third of public sector bodies, meanwhile, said contractors were less willing to carry out work for them since the reforms were introduced. Alarmingly, 60% of central government bodies reported that their staff had spent more time on administration since the reforms.
Government 'doesn't understand' impact of IR35 enforcement
In March 2018, critics leapt on comments made by the Treasury's financial secretary regarding IR35, claiming they show that the government simply did not understand the true impact of IR35 on the UK's two million independent workers.
In response to a question directed at former chancellor Philip Hammond regarding the effect IR35 reform has had on UK small businesses, Mel Stride MP said: "The off-payroll working rules (sometimes known as IR35), do not affect small business owners who are genuinely self-employed."
Qdos Contactor's CEO, Maley, said that this was another example of the government's "total lack of understanding on the impact IR35 reform has had and continues to have, on genuinely self-employed contractors".
"In theory, IR35 shouldn't affect the genuinely self-employed, but in reality, it's a different story altogether," he claimed. Maley added that following public sector reform last year, a number of organisations, including the NHS, made blanket decisions placing their entire contractor workforce inside IR35 to protect their liability.
"This, along with many inaccurate IR35 decisions, placed many genuinely self-employed contractors inside IR35, resulting in the workers paying similar taxes to employees, but without any of the benefits," he said. "The Treasury's attitude towards IR35 is short-sighted - a real concern given private sector reform increasingly looks on the cards."
IR35 complexity has led HMRC to wrongfully tell self-employed contractors the rules did not apply to them, according to a trade body for umbrella companies.
PRISM said it has identified dozen-plus incidents in which HMRC made the wrong decision due to the alleged complexity of the tax rules, which public sector bodies must enforce on their contractor workforces.
"This is the most recent change to the tax legislation affecting contractors and the mistakes being made by HMRC are causing confusion and further tensions across the market," said Crawford Temple, CEO of PRISM.
"This is more evidence, if any were needed, that the whole system of tax and employment legislation is too complicated for people to understand."
Additionally, the Freelancer and Contractor Services Association (FCSA) said HMRC's software is proving an obstacle for contractors trying to submit online tax returns, as it cannot compute how the dividend tax allowance impacts other tax allowances.
Julia Kermode, FCSA's chief executive, said: "Once again the UK's smallest businesses are being hindered and it appears that HMRC has no intention of resolving the software issue."
Justifying the expansion of IR35
One reason why the government is so adamant in pushing through private sector reforms, extending the rule changes from applying to just the public sector, could lie in the immediate changes that occurred.
The public sector was generally a less attractive place for contractors to work, with many tech workers not enthused by the prospective loss of revenue that would occur from taking up public sector work. Of course, extending the rule change to both spheres would eliminate this as a factor entirely, and perhaps negate some of the effects on public sector recruitment.
The government ran two consultations in 2019 on the extent to which it will extend the reforms to the private sector, and earmarked April 2020 as the date by which contractors and employers must abide by the rule change. The results of the second consultation can be seen here.
The government said at the time that not extending the IR35 reforms to the private sector would cost the Treasury £1.3 billion in lost revenue, however, as the public sector reforms show, the figure recouped will likely be lower than this.
Concerns raised by the House of Lords
On 22 April 2020, the House of Lords wrote a letter to the Treasury with a list of concerns it has regarding the rollout of the IR35 tax legislation.
The letter was written by the chair of the Finance Bill Sub-Committee Lord Forsyth of Drumlean and addresses such issues as non-compliant umbrella companies, the reliability of the Check Employment Status for Tax (CEST) tool, and the success of the 2017 introduction of IR35 reforms to the public sector. The letter also touches upon the uncertain economic situation due to the coronavirus lockdown.
“Contractors have told us that the coronavirus pandemic means that they do not expect to win new business in the next few months. How will the government support these people? Will they be compensated for any business lost because companies terminated contracts in anticipation of the implementation of the new rules in April 2020?” wrote Lord Forsyth.
“What assessment has the government made of whether those engagers with contractors who are treated as employees for tax purposes but not for employment rights will cancel contracts rather than keep contractors on under the COVID-19 job retention scheme? If such contractors have been using PAYE, will they be able to benefit from any measures that the government puts in place to protect self-employed people during the coronavirus outbreak?”
The reforms, nevertheless, came into force from 6 April 2021, although businesses and contractors will benefit from a 12-month grace period, during which time HMRC will take a "light touch" approach to IR35 enforcement. They should expect tougher action against those who violate the IR35 rules from April 2022.
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