IR35 – Change in Tax Implications for Employing Contractors through Personal Service Companies
In April 2020 the Government is changing the IR35 regulations, which will mirror the changes to Public Sector rules in 2017. In essence, the change will provide new rules surrounding ‘off payroll’ workers. This change relates to contractors who contract through an intermediary – this can be an umbrella company (who are the ‘de facto’ employer of the contractor who invoice the end user), or a Personal Services Company, which is typically a limited company which the contractors owns who is generally the only employee and who bills the end user. The current regime in the private sector essentially affords a much more beneficial tax arrangement for the contractor than if they were employed directly; with careful tax planning, the tax ‘take’ can be reduced significantly. The contractor can claim tax relief on a range of legitimate expenses – mileage to travel to work, day and night rate subsistence, use of home offices as a workplace. An entire industry exists today to facilitate these relatively convoluted arrangements, where either the umbrella or PSC collects invoices on the contractors behalf, and pays a dividend in lieu of a PAYE salary. Patently, where a contractor ‘looks’ like an employee, then logically their tax treatment should mirror those arrangements.
As a quid pro quo, there are benefits to the employers; firstly contractors have limited employment rights, contractors can afford significant flexibility to switch resource off and on, and many organisations will adopt a ‘temp to perm’ route to have a look at potential employees in a relatively risk free period to take a decision on their long term viability. Depending on the relationship, employers can also save on employer deductions for NI which is of course substantial. In the last 20 years, these ‘arms length’ contractor relationship have proliferated. Previously the territory of professional and executives to manage projects or provide temporary support, their use has extended to wider roles, including blue collar workers. The consequence of this – and therefore the motivation for the Government to act – is a potential reduction in tax revenues. Left unchecked, HMRC believes that this situation will result in losses of around £1.3bn annually. This also further underlines the governmental ‘Good Work Plan’. These changes affect (in HMRC speak) ‘medium to large companies’; that is determined on any two of:
- A turnover of over £10.2m per annum;
- A Balance Sheet showing equity of more than £5.1m or more;
- 50 employees or more
The key change is a pretty fundamental one – the onus on determining the tax status of a contractor will change from the contractor to the end user or client. Currently the contractors tax status is strictly a personal matter, and if its wrong in any way, the responsibility lies with the contractor.
In day to day terms, it will mean that (for qualifying companies) the company will need to determine at the outset whether the role is inside IR35 (meaning that the role is essentially ‘like an employee’) or not. That test sadly does not mirror exactly what we have become used to determining in the ‘worker/employee’ quandary. The test is covered at https://www.gov.uk/guidance/check-employment-status-for-tax. The test essentially determines if the appointment looks like the role could also be conducted by a direct employee or not; for example does the arrangement rely on personal service, or could the contractor send someone in their place; how or if their work is directed, the level of supervision direction and control, and a mutuality of obligation – are you obliged to offer, and are they obliged to accept an offer of work. Its worth noting that this tool is a guide only – HRMC determine it to provide correct answers in around 85% of cases, and the onus remains on you to get it correct…
In essence therefore we could presume that the vast majority of those currently working on contracts in our members companies are likely to fall inside of IR35, have that status confirmed and be subject to a similar tax and deduction regime as an employee. Even more esoteric tests – can they use the staff canteen, are they on organisation charts, do they unfettered access to your site can be indicators to HRMC that it is ‘like employment’. It restricts the more favourable tax treatment to genuine consultants or genuine sole trader contractors – with a wide remit, with responsibilities but basically acting on their own initiative etc.
On the practical level, this could mean that if you currently employ contractors who are ‘like employees’, then the likelihood is that any increase in their tax burden may be a factor in their quoted day rate. More worryingly, there is of course a risk that contractors work to create a relationship in writing which takes them outside of IR35, but which in reality is an administrative exercise and does not reflect reality.
At this point employers should focus on a couple of issues;
Do you currently employ contracts whose contract is extending beyond 1 April 2020? If that is the case, then you will face a challenge of the change in status at that time;
How likely is it that you do or will engage contractors who are genuinely outside of IR 35?
This is a complex area, and one which is favourable to none of the parties involved, and it is fair to say that there is significant opposition to the plans. We will issue any further guidance where we can.
