IR35 (otherwise known as the Intermediaries Legislation) came into effect as part of the Finance Act in April 2000.
Deriving its name from the press release used to announce its creation, the government introduced the law to combat tax avoidance by the so-called ‘disguised employees’ offering their services to clients via an intermediary company. The idea behind the law is (according to HMRC)“to make sure that people who effectively work as employees pay the right amount of tax”.
Under IR35, if disguised employees are caught out, they have to pay National Insurance and income tax contributions as if they were employed by the company they have been contracted to work for. It’s a move that has been lambasted by many as a “short-sighted tax grab”, which could cause a significant amount of economic damage.
With IR35 regulations set to be extended to the private sector, businesses and employees need to be prepared. In order to be properly prepared, however, it’s always important to know your enemy.
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With any new tax regulation, it’s easy to get bogged down in the details and miss the wood for the trees. So, here are the 10 key points that both employers and workers in the private sector really need to know in order to adequately prepare themselves.
1. It won’t come into effect until April 2020
There was a tangible and widespread sigh of relief echoing across the business world in October 2018 when Philip Hammond announced the government’s decision to delay IR35’s introduction into the private sector to April 2020. It’s a delay that is entirely necessary in order for businesses to fully prepare themselves, not only for the law’s eventual introduction but for the industry changes set to be brought on by Brexit in March 2019.
2. The public sector roll-out has not gone well
Experts agree that the implementation of IR35 in the public sector has not been without its challenges, particularly following the updates to the legislation in April 2017. In fact, that’s a bold understatement. With the rules in place, many public sector contractors now either have to accept lower rates or increase their rates to cover the extra tax expenses; neither of which are good for contractor or client.
This has led to many hiring managers in the public sector losing out on skilled contractors. Indeed, the CIPD found that 51% of public sector hiring managers had lost skilled contractors as a direct result of the changes and 52% saw cost rises, delays and project cancellations. Several firms have highlighted the fact that the government should make it a priority to prove the legitimacy of the law in the public sector first, before rolling it out to the private sector.
“It’s clear more work needs to be done to truly define those taxed as employees.”
Nigel Morris, employment tax director at MHA MacIntyre Hudson, said: “The government needs to be open minded in how it delivers continued IR35 reform; the public sector rollout has not gone smoothly, and it is important these lessons are taken on board”. AAT’s tax policy expert, Brian Palmeragrees, adds: “With there being no evidence to date that ‘off-payroll’ rules have worked in the public sector last year, it’s clear more work needs to be done to truly define those taxed as employees from those taxed on a self-employed basis, and to allow private sector businesses adequate time to prepare”.
3. It’ll apply only to large and medium-sized businesses
IR35 has come under heavy criticism from the business community and tax experts alike. Particular criticism comes from those who feel it causes unnecessary costs and hardships for the legitimate small businesses that are following the rules, but are still being put through the wringer.
However, the budget states that IR35 will only apply to medium to large-sized businesses, which is certain to come as a welcome relief to small business owners who might rely on contracting self-employed workers. What is unclear, however, is what criteria will be used to differentiate a small firm from a medium firm. It has been said that the “smallest 1.5 million” business will be exempt, but it’s still not 100% clear which businesses fall into this bracket.
It’s also been suggested by Victoria Roythorne, head of compliance and contractor care at recruitment firm Outsource UK, that singling out larger firms could be seen as unfair. She explains: “Whilst it’s good that the government has listened to the consultation responses and has given businesses time to prepare for this change, the fact the law will only be applicable to large and medium firms makes little sense. Surely applying complicated legislation to only medium and large sized businesses doesn’t create a level playing field?”
4. It’s the employer (not the employee) who is responsible
Whereas it initially worked the other way around, the onus is now completely on the employers to make sure that National Insurance contributions and income tax apply to their off-payroll workers. This means businesses that don’t pay close attention to every single contractor on their books could be faced with non-compliance penalties. This is going to prove exceptionally costly for many businesses, particularly those with contractor numbers in their hundreds.
Of course, another drawback of increased client responsibility is that, whether they get it right or wrong, their decision still impacts the contractor. With this agency taken away from the employee, they could end up being chastised for mistakes made by their client that they had no part in.
5. IR35 enforcement is incredibly vague
The rule will be enforced by HMRC inspectors, who will disregard any existing written contracts between contractor and client. They will instead create their own contract based on how they perceive the working relationship. A tribunal judge will then take this ‘notional contract’ and use it to determine if, under the IR35 rules, it stands as an employment or B2B contract. If it’s the latter, it falls under the IR35 law; if it’s the former, it doesn’t.
The criteria used to determine whether or not a contractor is working as an employee ask what degree of control the client has over the contractor, whether a substitute could be sent in their place and whether or not there is a “mutuality of obligation” between contractor and client.
As a direct result of the vague nature of these tests, not to mention the in-depth knowledge of employment law required to fully understand them, IR35 has already been applied in thousands of cases where it simply doesn’t belong.
6. HMRC has a tool to help determine IR35 status, but it may not work
Ahead of the public sector IR35 reforms, a Check for Employment Status for Tax (CEST) tool was launched to allow businesses to assess whether or not they were IR35 compliant. However, not only did many organisations claim that this tool was inaccurate, but HMRC essentially agreed with them.
The consultation document launched by HMRC claimed that a “considerable proportion of public authorities did experience early difficulties in complying with the reform”, and that a major reason for this is because of their lack of “familiarisation with the CEST service”.
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Freelance advisory service Contractor Calculator published a white paper, co-authored by former HMRC inspector Philip Manley, branding CEST “not fit for purpose” due to 10 key failings. Chief amongst these failings is the fact that the check only asks 16 questions, when most inspectors would typically ask at least 50. Contractor Calculator even put the tool through its paces and found that 42% of the time, the results were flawed.
Of course, the service has reportedly improved in the months since, but it doesn’t bode well for private sector firms who will want to make 100% sure they are compliant before April 2020.
7. The extension of IR35 is just one of many options HMRC considered
Whilst it goes without saying that disguised employees needed to be curtailed, there were always other options on the table. Other options that will not be implemented included the possibility of setting up a Freelancer Limited Company structure that would provide certainty about businesses’ tax and employment status, whilst also protecting revenue for the exchequer.
Minimum contract lengths and the possibility of clients paying their employer’s NICs were also options that could have replaced IR35. It has also been chosen ahead of increasing NICs for the self-employed.
8. IR35 could cost private sector employees
The non-compliance cost to the private sector under IR35 is projected to increase from £700 million in 2018 to £1.2 billion in 2023. To make matters worse, it’s estimated that only 10% of contractors are currently compliant with IR35 rules, which means businesses are going to have to make some major changes in the next 18 months, or they could be in for a rather rude awakening. For contractors, meanwhile, it’s estimated that they could lose up to 25% of their income under IR35.
9. Contractors have threatened to avoid work that would place them under IR35
Research conducted by consultancy Contractor Calculator found that, of the 2,000 contractors surveyed, a staggering 98% would turn down work that would place them within IR35 rules. The same research also found that 89% would actually consider seeking legal action under such a regime.
“Simply put, there is no benefit to being a contractor if IR35 applies.”
Chris Brazier, senior associate at BP Collins, isn’t surprised at all. He said: “The majority of contractors I have acted for have indicated that they would step away from contracts where IR35 applied and this does not seem to be an empty threat. Simply put, there is no benefit to being a contractor if IR35 applies, as they are treated like an employee without any of the protection that goes with it”.
10. IR35 can backdate up to 6 years!
Perhaps the most frightening aspect of the law is that HMRC will be able to examine contracts dating back up to 6 years to check if the legislation applies. This could result in some serious backdated tax bills and there’s very little that can be done about it other than to go through your old contracts with a fine toothed comb and financially prepare for the worst.
Conclusions
There are already major uncertainties circling the private sector in the UK, with businesses unsure of how Brexit will affect their trade. IR35 is another fly in the ointment. Indeed, many concerns related to Brexit might actually be exacerbated by IR35, particularly when it comes to overseas talent.
We can be thankful, however, that we will have a full year after Brexit to get our affairs in order before IR35 further complicates matters. Above all else, the UK private sector has survived and flourished amidst waves of crisis and turmoil countless times before. This time should be no different. Just make sure you take the time to understand how IR35 legislation works and apply best practice to ensure it doesn’t apply to you when HMRC comes knocking in 18 months’ time.
