In today’s enterprise environment, it’s common for businesses to outsource some of their responsibilities to third-party contractors. This is particularly true for IT departments who require a wide range of requirements, such as search engine optimisation, website design and customer resource management.
In the olden days, it was easy; if you wanted to hire a contractor you just hired one. Now, thanks to the introduction of IR35, things are a little more complicated.
What is IR35?
IR35 is tax legislation that is designed to combat tax avoidance. It came into effect in 2000. Before then, the most common way to operate as a contractor was to be self-employed, this meant workers could own their own limited companies and were allowed to receive payments from clients directly to the company and to use the company revenue.
National Insurance payments could be avoided too, as contractors could distribute profits as dividends.
According to Susan Ball, Head of Employers Advisory Services at Crowe UK, IR35 is designed to combat perceived tax avoidance by workers supplying their services to clients via an intermediary, such as a personal services company (PSC); but who would be an employee if the intermediary was not used. Under the rules, there is a requirement that employment taxes – income tax and national insurance contributions (NIC) – be paid by the PSC.
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What is significant about the forthcoming changes to IR35?
In the 2018 Budget, it was confirmed that IR35 regulation will be reformed to help people comply with the existing rules and extend the scope of the current rules to certain parts of the private sector by April 2020.
The rules will not apply to small businesses or self-employed workers. According to the UK’s Companies Act 2006, a company is ‘small’ if two or more of the following conditions are met:
- the company does not have a turnover of more than £10.2 million;
- the company does not have a balance sheet total of more than £5.1 million;
- the company does not have more than 50 employees.
However, the regulation aims to shift responsibility from employed individuals to the organisations engaging with them, who will need to make the appropriate deductions before the money is paid to the individuals.
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Susan Ball added: “The changes will have a significant impact on businesses engaging large numbers of contractors through intermediaries using PSCs or Limited Liability Partnerships (LLPs). Many engagers and contractors will not see this as a positive move. For engagers, managing the increased risks and costs of engaging with such intermediaries will be a major compliance exercise. For contractors, they may end up on the engager’s payroll and, therefore, suffer deductions which they might not agree are due, or where they are due; so it results in added complication to the running of the business they have.”
Although, according to Ball, this might create a more level playing field: when similar reforms were introduced to the public sector in April 2017 forcing responsibility on public sector authorities to determine the employment status of the people they engaged through intermediaries, deducting any income tax and paying employers’ NICs.
Ball said: “HMRC has confirmed that it is continuing to work with stakeholders to improve the Check Employment Status for Tax (CEST) service to help organisations determine whether the off-payroll working rules apply.
“Additionally, they will provide extensive support and guidance to help organisations implement the off-payroll working rules to ensure they apply them correctly.
The Treasury announcement on this can be seen on the GOV.UK website.
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According to Karen Holden, Founder of A City Law Firm, in light of the recent BBC case involving presenter Christa Ackroyd, who has been held liable for tax in excess of £400,000 because the Courts considered her to be an employee of the BBC even though her services were being paid through a separate limited company, we are left to question whether self-employed members of staff should be in fact be employed.
Holden argued: “If a worker is found to be a ‘disguised employee’, the financial impact of IR35 can be significant. The employer will have to pay income tax and National Insurance Contributions (NICs) as if they were employed and this can reduce net income by up to 25%. There can also be additional fines if the former employee pays late.”
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What steps should employers and contractors be taking to ensure they are IR35 complaint?
Although the changes are not immediate, ‘medium’ and ‘large’ businesses will need to consider whether this will impact them and, if so, what the financial and other implications will be.
They will also need to put in place appropriate actions to ensure that the new rules can be applied in 2020. Employers are liable for any under deductions of PAYE/NIC, plus interest and penalties if they get it wrong. Taking an immediate look at their processes will be beneficial both now and in the long run.
Ahead of the finalisation of the new rules, Susan Ball of Crowe UK has listed what engagers can do:
- identify the intermediaries such as PSCs that they currently engage via a review of accounts payable data and other sources;
- identify agencies that supply labour and obtain details of those not under the agency PAYE system;
- consider how they might deal with any requests from agencies for a decision (under the public sector rules these must be responded to within 31 days or the liability for PAYE/NIC is transferred);
- review contracts with agencies and other intermediaries to start to identify those caught by the new legislation, considering whether they provide a service or labour as well as potentially using the public sector rules as a starting point;
- review current systems and how to determine employment status to identify gaps;
- review systems, including checklists, process maps, internal guidance, contracts and policies to work out what will need to be changed when the final rules are known;
- consider the additional cost of employer’s NIC and the Apprenticeship levy;
- consider if they want to change their model of off-payroll worker usage;
- seek specialist advice and monitor further information when it becomes available.
For contractors, they should:
- prepare for the change by using the HMRC CEST tool and undertake a review of their contractual arrangements to find out if they are ‘inside’ or ‘outside’ IR35;
- review their current working practices, thinking about how IR35 changes could affect how they do business;
- consider the cost implication on their business if tax and NIC is deducted;
- consider how they might make an appeal if they disagree with any decision;
- monitor for further information as it becomes available.
Ball concluded: “Although there are few concrete details to show how IR35 reform will impact the private sector in 2020, it would no doubt help employers and employees to familiarise themselves on how the changes have already affected the public sector. Learning the lessons from public sector IR35 reform it could help enable businesses and their employees to stay one step ahead.”
Employers are also advised to take the HMRC IR35 Test available on HMRC website; for an initial indication, they should consult their accountant and take out a legal expenses insurance policy.