by Dawn Ford
What is IR35?
IR35 is tax legislation designed to combat tax avoidance by workers supplying their services to clients via an “intermediary” such as their own limited company (a “PSC”) or an umbrella company. In brief, the legislation seeks to draw a distinction between those who are in business on their own account who are termed “outside IR35” and those who are effectively treated as an employee either under the terms of the contract or more usually based upon how the client treats them, so-called “inside IR35”. Those inside IR35 experience a higher tax and social security burden overall than those outside IR35.
In the private sector currently, the worker determines their IR35 status (with assistance from their accountant if they wish). Placing that determination in the hands of people who are largely not tax experts, necessarily causes some inadvertent non-compliance. Additionally, the existing legislation has not been well policed over many years so there has been a significant quantity of purposeful non-compliance: that is to say, people who claim to be outside IR35, but whose circumstances determine they should, in fact, be inside IR35. HMRC calls these workers “disguised employees”.
In April 2017, the Government introduced a change to this legislation for contractors working in the public sector. The burden of determining IR35 status moved from the worker to the client and if the client determined a role to be inside IR35 then the company directly above the intermediary in the contractual chain (often an agency but sometimes an MSP or end client) would have to tax the intermediary at the source. That proved a not inconsiderable challenge because agencies, MSPs and end clients were suddenly faced with the challenge of applying employee taxation directly to a company (the intermediary).
Reform is coming
Almost immediately it was introduced, HMRC declared the roll out a success, despite the obvious feedback from agencies, MSPs and clients to the contrary. But whatever the business perspective, the political direction of travel was clear and it was only a matter of time before a comparable change was rolled out to public sector clients.
In the Autumn Budget 2018, the Government announced there would be a roll out of substantially the public sector model, to the private sector, in April 2020. There are two changes to the public sector model:
The private sector rollout will not be applicable to small companies (in broad terms companies with a turnover of less than or equal to £10.2m, a balance sheet of less than or equal to £5.1m and not more than 50 employees). For some clients and contractors, this might be a get out of jail free card, but for the vast majority of users of workers in the UK, this exception won’t be a help.
The second challenge is the issue of the CEST tool. The CEST tool was devised to help non-tax-specialist hiring managers within clients analyse whether a role was inside or outside of IR35. Despite widespread staffing industry feedback to HMRC that the tool did not match the existing law (and widespread rebuttal of the same by HMRC), the CEST tool went into use in 2017. In a case of brilliant or terrible timing, depending on which side of the fence you sit, 12 days before the Budget, a contractor by the name of Tony Elbourn challenged HMRC and won – the conclusion of the judge being that the CEST tool did not reflect existing law and Mr Elbourn had been misclassified under IR35 as a consequence.
So what we know now is that HMRC will be trying to correct the CEST tool, hopefully ahead of the summer consultation, through which we should learn the outcome of the final private sector legislation.
What does this mean for the private sector?
This legislation has been controversial amongst contractors from its inception. Contractors have been arguing for years with agencies about minor alterations to contracts, which the contractors, rightly or wrongly believed, would protect them from an IR35 investigation. But now that IR35 status determination will be taken from their hands altogether, that changes the nature of the conversation from tax risks straight to bottom-line take-home pay. And that will always be a more emotive subject.
In its earlier consultation papers, HMRC has indicated it believes about one-third of all contractors working through intermediaries are inside IR35 when in fact only about 10% declare inside. Volt’s view is that that is an over-estimation of how many are as a point of fact inside IR35, but it is nonetheless the case that a number of contractors will find themselves with a change of tax status from April 2020.
This change presents them with a number of options:
a. They could jump ship and move to “small” companies who fall outside of the legislation. On balance we consider this a very small risk because, for most contractors, their skills are such that likely only a medium or large company would need them.
b. They could accept the reduction in take-home pay. This might happen in a sector which currently has a surplus of available workers, but those are few and far between and becoming rarer as emigration increases with the Brexit deadline looming.
c. The most likely outcome is that a contractor whose tax status is changing in a way that is negative for them is going to look to the client to make up the difference. And then, of course, it is a question of commercial negotiation – how much does a client need that specific contractor versus how much do they need to not increase their budget.
And aside from the direct bottom line potential cost increase to the contractor, there is also the cost of training hiring managers (or HR as your business determines) to make the IR35 analysis, working out a means of documenting your analysis (the CEST tool has no audit function so you can’t store your outcome there), managing the risk of penalty payments if the assessment is incorrect and perhaps more importantly still, managing the potential reputational damage of incorrectly assessing someone – in a time when tax avoidance has become a dirty word in the media – caution is needed.
How can we help you?
Risk and budget management form the cornerstone of prudent business. If you want to be prepared and be comfortable that your budget reflects any potential cost increases, you need to start working on this now.
You need to begin with an audit of your contractors. Which of them will be affected by this reform, are they key workers and what likely cost uplift that would be needed for them to remain on the same net take home pay. This would also be a good time to audit your other processes – are you working within the Agency Worker Regulations, are your agencies or MSPs correctly reporting under the Intermediaries legislation, do your suppliers have adequate and appropriate insurance?
Having worked out your potential cost, you also need to think about your risk to business? If you lost any of your key workers, what would be the impact on your business – do you need to think about different ways of retaining them now?
How will your workforce look after the reform? Is that what your business needs? Do you have the right strategies in place to make sure you can attract the best talent in 3 years, 5 years, 10 years? Talk to us if you need more help.
And then training your staff? Do you have the skills in house to do this, or do you need help?
And what about statement of work? Does this change in the law present a catalyst for you to think about whether outsourcing part of your current “contracted” workforce might be a better model for you?
And just in case you thought at least there is only this to overcome – spoiler alert – the reforms in response to the Matthew Taylor consultations are hoving into view too. Busy year? You bet. We’re looking forward to continuing the conversation.