Could a new freelance company model spell the end for IR35?

The problem of having to prove self-employed status

The current tax system, whilst effective in collecting tax, was designed with a more rigid and predictable workforce in mind. Shifting working patterns and the move away from ‘traditional’ self-employed roles to more dynamic and specialised roles have undoubtedly blurred the once clear boundaries between employee and self-employed.

There is also no statutory definition of either employment or self-employment in the UK, so the employment status of an engagement is determined by referring to case law; which is often incredibly complex and yet vague in its conclusions.

Determining employment status is then further complicated by the fact that whilst there are two statuses for tax purposes – employed and self-employed – in employment law there are three statuses – employed, self-employed and worker.

We believe that the introduction of a new tax categorisation of companies in the form of the FLC could make it easier to identify characteristics that demonstrate genuine self-employment.

Could this remove the need for IR35?

HMRC has always maintained that the IR35 legislation and subsequent reforms have been to ‘clamp down on disguised employment.’ This is where, in the eyes of HMRC, a contractor is fulfilling the same role as a permanent employee but engaged as a contractor and paid through a limited company to avoid tax on employment income.

So, what if we clearly demonstrate that a freelancer is not a disguised employee?

We believe that the clearly defined characteristics of the FLC model could remove any possibility of a freelancer operating as a disguised employee and as such, remove the need for IR35 legislation to be applied.

How would the FLC work in practice?

The appeal of a dedicated company structure for single-person businesses is that it removes the need for employment status assessments to be made at the start of every engagement. The case for this has only strengthened since the introduction of the off-payroll working rules; but how can clients (and HMRC) be sure that an FLC owner is truly ‘in business’?

Entry Criteria

Self-employment is an active and informed choice by the individual – that’s why an FLC must be set up by you alone. Like a limited company, it would be registered with Companies House, but limited to a single shareholder – this wouldn’t prevent you from engaging other freelancers, or even from employing people.

A minimum capital requirement would be in place to demonstrate that there’s money ‘in’ the business to be used for its furtherance. The exact amount would be up for debate, but it would be low enough not to deter a genuine freelancer from opting in whilst still deterring tax-motivated incorporation. For those lacking the start-up capital, capital could be ‘unpaid’ at the time of formation and paid up over time as the business generates income.

Operating Criteria

Once a freelance company is up and running, it will need to continue behaving like a freelance company to keep its status. This means having its accounts signed off each year and incurring appropriate costs – things like professional and director insurances, regulatory and marketing costs – in the pursuit of business.

We’ve also proposed that freelancers would draw a minimum salary from their company – whether that’s a fixed amount, or a percentage of profits – as well as a dividend frequency restriction. Dividends would therefore remain an important component of the freelancer’s annual income – but not necessarily their regular income.

Freelancers would demonstrate its company’s compliance with these requirements to a competent authority on an annual basis. Failure to do so would result in the company becoming ‘dormant’ after a grace period in which the owner could continue trading whilst making necessary adjustments, or simply closing the business.

Taking the proposals to policymakers

Since developing the FLC model in 2015 in partnership with Ernst & Young (EY), IPSE has presented these ideas to the Taylor Review of Modern Working Practices, the Future of Work review led by the current government, and in regular engagement with MPs, civil servants and others.

Whilst this is only one possible alternative to the ruinous IR35 legislation, we believe that the case for a dedicated legal status for incorporated freelancers has only strengthened over time. This discussion at least demonstrates that not all contractors are these so-called ‘disguised employees’ - so shouldn’t we stop treating them all as if they are?

Your feedback

We are currently in discussions with our Policy & Research Committee about employment status reform and what IPSE's campaigning should be focused on.

We also want to hear your views on the proposal for a new legal entity for freelancers - please write to [email protected] to share your feedback and ideas for consideration.