Upcoming changes to IR35 in the private sector
Following the 2019 General Election, HM Treasury confirmed that reforms to the way IR35 works in the private sector would go ahead. Due to the COVID-19 pandemic and subsequent lockdown, its implementation has been delayed.
From April 2021, status will be determined by the client not the contractor. If the client decides that the engagement falls in the scope of IR35, payment to the contractor's company will be taxed at source - as if they were an employee.
IPSE is strongly opposed to this proposal. We believe it will force thousands of compliant contractors out of business, reduce labour market flexibility and ultimately damage the UK economy. We have put these arguments directly to the Chancellor, the Financial Secretary and senior officials, and have submitted comprehensive responses to the various consultations. We have held and attended numerous roundtables and events, and commissioned surveys and independent research.
We remain committed to our lobbying efforts and will continue to make the case for this ill-thought through policy to be reconsidered. However, we must also advise our members on what to expect if the reforms come in to force, as the government intends.Become an IPSE member to support our campaign work
What is IR35?
- Also known as the “intermediaries legislation”, IR35 is intended to stop “disguised employment”. This is where employers engage their employees through limited companies, thus avoiding the need to pay Employer’s National Insurance Contributions, Sick Pay, and Holiday Pay, with the disguised employee also potentially able to benefit from a reduced tax bill. It has been in place since 2000.
- IR35 taxes the fees paid to limited companies in a manner similar to a salary where HMRC believes an engagement falls 'inside IR35'.
What does it mean to be 'inside IR35'?
- Being ‘inside IR35’ means that the freelancer is seen as an employee by HMRC.
- For IR35 to apply, HMRC has to determine whether the relationship between a freelancer and their client is in fact an employer-employee relationship, by referring to a number of complex and subjective tests established in case law. More information on these tests can be found on here.
- These tests are unclear, making it impossible for freelancers to determine with any certainty whether they fall inside IR35.
- Freelancers working through limited companies are often engaged by businesses because of the flexibility and skills they provide. The legislation creates risk and uncertainty for such individuals and it ignores the fact they are genuine businesses, not disguised employees.
How is IR35 changing?
The underlying IR35 rules are not changing, but the responsibility for determining whether they apply will shift from the contractor to the end client. The changes are due to come into force in April 2021.
The hiring organisation will determine the IR35 status of an engagement and will be required to provide the contractor with a Status Determination Statement (SDS). The IR35 SDS will inform the contractor of the status decision and the reasons behind it. The SDS will also be passed down the supply chain i.e. to the agency (if there is one).
If the client decides IR35 does apply, the contractor business will be taxed at source, through the Real Time Information (RTI) system, exactly like an employee. The tax will be deducted by the ‘fee payer’ – which is whoever it is that pays the contractor’s company. If you contract directly with the client, the client is the fee-payer. If your contract is with an agency, it’s the agency. It is also likely a payroll, or umbrella, company will enter the supply chain as the fee-payer, if the engagement has been deemed ‘inside IR35’.
The fee-payer will be liable for tax on any payments made after April. This is important. It is not about when the work is done, it is about when the payment is made. If you are paid in mid-April, for work you did in March, and the client decides IR35 applies, tax will be deducted from that payment.
Although contractors caught by this measure will have to pay tax like an employee, their employment status will not automatically change, so they will not necessarily receive the rights and benefits that go with employment such as pension contributions, holiday pay and unfair dismissal rights.These changes bring IR35 in the private sector into line with how it works in the public sector (where the rules changed in 2017). There are some new tweaks, notably the small company exemption.
What is the IR35 small company exemption?
The changes to IR35 will not apply where the end-client is ‘small’. To qualify as small company, the client must meet at least two of the following three criteria:
- No more than 50 employees
- No more than £10.2m turnover
- No more than £5.1m on the balance sheet
If the end-client is small, the contractor retains the responsibility to make the IR35 assessment, and the tax liability if they get it wrong – just as they have for the last twenty years.
The IR35 small company exemption only applies in the private sector. It may be more accurate to call it the small client exemption as it only applies where the end-client is small. It does not apply if the agency or contractor’s limited company is small.
Will clients be able to make an accurate IR35 determination?
This is IPSE’s primary concern. We fear that because the IR35 rules are so complex, clients will not be able to tell for certain whether an engagement is caught inside IR35. Clients will become liable if they make the wrong determination, so they are more likely to take a risk averse approach and decide to apply IR35 if there is any doubt whatsoever (and there is usually an element of doubt when it comes to IR35).
We have already seen some clients – most of the major banks and a few other large companies too – publicly announce they will no longer hire limited company contractors at all. They fear getting determinations wrong, so they have decided not to hire anyone that would require them to provide an SDS.
This is a highly worrying trend and it makes a mockery of the government’s claim the legislation won’t impact the genuinely self-employed. Very clearly, genuinely self-employed people are being impacted now. Their clients refuse to do business with them because of the compliance risk created by this legislation – we have made this point to the government.
Some clients may consider issuing ‘inside IR35’ determinations on all their engagements, regardless of the actual IR35 status. This is sometimes referred to as a ‘blanket determination’ or ‘blanket assessment’. Clients must not do this. The legislation requires them to take ‘reasonable care’ when determining status – blanket assessments fail the ‘reasonable care’ provision.
If your client hasn’t yet spoken to you about IR35, you may want to consider approaching them. You should explain why the engagement doesn’t fall within IR35 and provide evidence to back that up. That could be a contract review or even a CEST result (see more on CEST below). You could set out in writing the true nature of the engagement, noting all the reasons why your engagement could not, and should not, be misconstrued as a disguised employment.
If you suspect your client is blissfully unaware of its soon-to-be imposed IR35 obligations, and is likely to remain so, it may be in your best interests to stay quiet. After all it will be your client, not you, who will be held liable for its lack of action. But sooner or later the client will wake up to IR35, and may well be tempted to take a very risk-averse approach. If you have a good relationship with your client, it is better to lead them (where possible) and try to help them come to the correct IR35 determination.
Can contractors appeal against the client’s decision if they don’t agree with it?
Yes, but don’t get excited. Contractors have the right to challenge the SDS, if they disagree with it. The client then has 45 days in which to respond. But there is nothing to compel the client to change its mind and the contractor has no access to the courts or other independent arbitration service. We believe clients are extremely unlikely to change their mind on a status decision, and so the dispute procedure, in the vast majority of cases, will not result in the SDS being corrected.
Nevertheless, if you feel your client has got the SDS wrong, it is worth a challenge. You should provide evidence which demonstrates the engagement sits outside IR35. This could be a contract review, or even your own CEST results, assuming they determined the engagement was ‘outside IR35’.
Will HMRC retrospectively investigate engagements that have now been determined to be inside IR35?
This question has come up a lot. Contractors are understandably worried that if their client decides in April that IR35 should apply, does that mean HMRC will be more likely to look at the months preceding April and ask "shouldn’t IR35 have been applied to income received before then too?"
The government has been somewhat helpful here and issued assurance that HMRC will not use the new SDS to open an investigation into previous years, unless it suspects fraud or criminal behaviour. That statement of assurance can be found in the penultimate paragraph of Section 2 of this guidance.
However, there is nothing in the legislation which prevents HMRC from breaking its promise. Contractors considering remaining in an engagement, even after the client has issued an ‘inside’ SDS, should therefore consider taking steps that might help to draw a clear line between the pre-April ‘outside IR35’ contract, and the post-April ‘inside’ one. At the very least you should get a new contract in place. You may also consider the more nuclear option of terminating your engagement with that client altogether and finding work elsewhere.
At the end-of-the-day HMRC retain the ability to launch an investigation into the last six years, when you – not your client – had the liability. IPSE membership will continue to provide IR35 investigation insurance, even after the change to the rules this April.Become a member
What about employment rights?
In January 2020 the government issued a fact sheet which sought to clarify the position on rights:
“Where the rules apply, it is important to note that, unless you have a direct employment contract, you will not be classed as a direct employee of the hiring organisation you provide your services to. This means that you will not be entitled to statutory payments or employment rights from them.”
IPSE is not convinced the legal position on employment rights is quite so straightforward. We also feel there is an ethical question about whether it is right for a client to decide a role is very close to an employment (for IR35 purposes) but then not be obliged to employ that person.
In 2018, IPSE supported one of its members, Susan Winchester, in her claim for holiday pay against her client, HMRC, after the public sector rules were introduced. The case was settled for the full amount just before a tribunal was due to take place. You can read more about this case here.
But this area of the law is far from clear. Every case has its own permutations and complex supply chains make matters even more difficult. The default position, therefore, is that employment rights do not automatically flow from an ‘inside IR35’ determination. But if you were minded to challenge that, it is possible a tribunal would be sympathetic, depending on the individual circumstances.
How much worse off are individuals likely to be?
This is very difficult to say. It depends on your circumstances and the structure of your company. If you are currently claiming tax relief on travel and subsistence expenses, then that will be stopped so depending on the value of that relief, the impact could be significant. In addition, the direct tax impact will be greater if you currently take the maximum in dividends, or if pay yourself a significant salary. You may have a spouse as a company director; you may leave money in your company to invest at a later date; you may get involved in tax planning.
If IR35 is deemed to apply to an engagement then all income from that engagement will be taxed as employment income. This will largely shut down the options listed above. It will probably make some engagements unviable, particularly those which involve high travel and subsistence expenses. A lot will also depend on who ultimately picks up the bill for the Employers’ National Insurance Contributions (see below).
'Outside IR35' tax calculation compared to an 'inside IR35' tax calculation
Even if you make use of none of the above options, the tax you pay will increase if IR35 is applied. Below is an example which compares a very straight forward ‘outside IR35’ tax calculation, to an ‘inside IR35’ calculation.*
Jill’s limited company charges £500 p/day and works for 42 weeks in the year. Her turnover is £105,000. IR35 does not apply to any of the income, so Jill’s company must account for the tax itself.
Jill pays herself a salary of £8,632 (the primary threshold for National Insurance). After corporation tax and dividend tax have been taken into account, Jill is left with £72,597.
If Jill’s client had decided IR35 applies, the fees would have been taxed at source. After income tax (PAYE), employee’s NIC and personal allowances had been accounted for, Jill would have been left with £68,433. Jill’s client (assuming they are the fee payer) would also have to pay the Employers’ National Insurance Contributions which are £13,300.
So, Jill is worse off by £4,164 if IR35 is deemed to apply. Her client is worse off by £13,300.
The client may try to pass down the employers’ NI cost by cutting the fees paid to Jill by £11,686. This would neutralise the IR35 cost for the client – they are still paying £105,000 over the year for Jill’s services.
Because of the cut in her fees, Jill is now on a day rate of £444. Her annual take home pay is £57,579. She is £15,018 worse off because the client applied IR35, and adjusted her rate to cover their NI costs.
These calculations are illustrated in the tables in the appendix, along with other day rate examples
*All calculations are estimates and may vary depending on specific circumstances
Who pays the employer's National Insurance?
The fee payer must pay the Employers’ National Insurance (NI), but they may try to charge it back to the contractor through a cut in rates. The client or agency (whoever is the fee payer) will pay Employers’ NI, should it be determined that IR35 applies to the engagement. If your company is paid by the client, the client will pay it; if an agency pays your company, they will pay it.
What role do umbrella companies play in this?
It will often be the case that the fee-payers will not want the contractor on their own payroll, even though the client has determined IR35 applies. Instead they will turn to an umbrella company (or ask you to find one) which will make the tax deductions and give the net pay to you. Many umbrellas will ‘employ’ you directly, taking your limited company out of the picture. You will receive holiday pay, but it will be ‘rolled-up’ into your pay (in other words you will effectively pay for it yourself).
Umbrella companies are not well regulated in the UK at present. While some are entirely compliant, there are others who are not. You may find umbrella companies that offer elaborate schemes with very attractive take home rates. IPSE advises extreme caution when considering these companies. It is highly likely HMRC will take the view that they are using disguised renumeration schemes, which could leave you with a huge tax bill in years to come. Many of those who are suffering from the effects of the Loan Charge entered into schemes such as these through unscrupulous umbrella companies. If you find yourself having to work through an umbrella, go with one that has a good reputation. FCSA accreditation is a good place to start.
IPSE has told the government it should regulate umbrella companies before it introduces the IR35 changes. We continue to make this point.
IR35 has always been a huge burden on contractors. These changes will, for most, make it worse. Clients and agencies, which have never had to grapple with these arcane rules before, will now be thrust into the Kafkaesque world of determining status. They will frequently get it wrong, often to the detriment of the contractors they hire. Others will be so afraid of IR35, they will stop hiring contractors altogether; some clients are already turning their backs on the contractor model that has served them so well over many years.
For these reasons, and a few more besides, IPSE remains committed to fighting against these proposals and we are still pushing for the government to change the policy. But we must also advise our members on what the government intends to do and how they will be affected.
Although contractors will be largely powerless when it comes to determining the IR35 status of their engagements, and therefore the amount of tax they pay, there a few steps they can take which could help. They have been discussed throughout this document but the following checklist might be of use:
|If you intend to remain in your current engagement, get your contract and working practices independently reviewed now. IPSE has a review service. Members get a discount|
|Consider approaching your client on IR35 (if they haven’t spoken to you already). Explain why IR35 doesn’t apply. Show them the results of the contract and working practices reviews (if they determine IR35 doesn’t apply)|
|Complete the CEST tool. IPSE doesn’t like the tool, but it might determine IR35 doesn’t apply, in which case show the result to your client. (If CEST doesn’t put you outside IR35, don’t worry – its anonymous and you don’t have to share it with anyone)|
|If you disagree with your client’s determination you can dispute it. Again, show them any evidence you have that IR35 doesn’t apply. To be honest, it is likely they will stick to their determination, but it may be worth a shot – you have nothing to lose|
|An inside IR35 determination may provide an opportunity to negotiate an increase in your day rate. If your client wants to keep you on the project, they may be prepared to ease the tax burden by paying you more|
|For future engagements, think about how you present your business. The more you can demonstrate that you are in business-on-own-account, the more confident the client will feel about determining the engagement sits outside IR35|
|Remember the new rules do not apply where the client is ‘small’, so if you want to avoid these difficult discussions with your clients altogether, and if it’s feasible (which it isn’t for many contractors) find small clients to work with|
|Statement of Work contracts can be helpful but the engagement must be structured around the genuine delivery of a project. Being paid on the achievement of milestones is helpful, but not essential|
|Contracted-out services, possibly combined with Statement of Work contracts, might form part of a solution to this, but it’s really up to the client whether they accept these models|
|If you work via an umbrella company be very, very wary of eye-catching take home rates. It is probably a non-compliant umbrella and you could end up with a huge bill to pay at the end of it|
|Remember, although clients and agencies will have the IR35 liability from April 2020, you are still liable for the last six years. Your IPSE membership protects you from the risk of investigation over that period, provided you retain it.|
See how IR35 will affect you: 'Outside IR35' calculations compared to 'inside IR35' calculations
[All figures are estimates and may vary depending on specific circumstances]