The general election fast approaching. Self-employment has been high on the agenda, with several key political figures suggesting a review of off-payroll rules may well be on the horizon.
IR35: What the 2018 Budget means for the self-employed
This year's budget covered some key changes that will impact our clients. Most importantly, the extension to IR35 rules.
The Budget in Summary
This year, Chancellor Philip Hammond dubbed his Budget announcements as “for the strivers, the grafters and the carers”, in light of his claim that “austerity is coming to an end”. But what does that mean for Britain’s flexible workforce?
One of the most significant announcements this year is an extension of the new IR35 rules, currently in force in the public sector, into the private sector from April 2020. It is an initiative that could impact thousands of private-sector contractors and bring uncertainty to their clients.
The clampdown is seen by many as the Budget’s biggest revenue-raiser.
Other important news:
VAT threshold frozen for further two years;
VAT domestic reverse charge to prevent VAT losses through ‘Missing Trader’ fraud, which occurs when traders collect VAT on sales but go missing before passing VAT to HMRC;
Responsibility for VAT will shift along supply chain, effective from 1st October 2019. - The contribution of small companies to apprenticeship levy to be reduced from 10% to 5%
The growth of Personal Service Companies (PSCs)
For many contractors, operating as a Limited Company can be a safe, convenient and tax-efficient way for contractors to work. A personal service company (PSC) has a sole director who owns most or all of the shares and may provide the bulk of the company’s trade themselves.
A personal service company will supply their services on a professional basis to the client either directly or through an agency. They will often provide specialist services to multiple clients and projects, rather than taking up PAYE employment with one business. In light of this, the client will pay the service company gross for work completed, without the need to make any income tax or National Insurance deductions under PAYE.
This has proven so successful because:
- Expenses are deductible against taxable profits
- Reduced tax deductions at source are beneficial from a cash-flow perspective
- Option to be paid in dividends is more tax efficient
What is IR35?
The Intermediaries Legislation or IR35 was introduced as part of the Finance Act in April 2000 to target ‘disguised employment’.
The tax legislation is aimed at contractors who supply services to their clients through a PSC but would have otherwise been an employee if this intermediary didn’t exist.
The new IR35 rules put the PSC’s client in charge of deciding whether IR35 applies. They were launched in the Public Sector in April 2017 and Chancellor Philip Hammond’s announcement on Monday extended this to the Private Sector from April 2020.
As a consequence of these changes, the responsibility for determining the right employment status and tax treatment in most cases will now sit with the Client.
How does IR35 work?
Previously, if a contractor is deemed by IR35 to be a disguised employee then PAYE must be operated on any payments. This process is underpinned by employment legislation and a series of IR35 case law.
There have been several notable cases, with Ready Mixed Concrete (South East) Ltd v Minister of Pensions (1968) being one of the landmark cases. You can find a list of key IR35 cases and their outcomes here.
Establishing whether a contractor should be classed as employed or self-employed for tax purposes can be difficult. We recommend always consulting with an expert in employment status. There are three key questions to consider when considering employment status:
Control: If a contractor is instructed on how the work should be carried out, rather deciding the approach themselves, it’s likely they would be classed as an employee for tax purposes, and ‘inside’ IR35.
Mutuality of Obligation: If there is an obligation for both the Client to provide work and the Contractor to carry out the work, then the contractor would be classed as an employee under IR35. This may be something as simple as required working hours or a retainer relationship.
Substitution: If the contractor is under an obligation provide their services personally, rather than deciding the required resource for a project, then a tribunal may view the contract as one of service and ‘inside’ IR35.
The Government released a tool which allows the Client to ‘check employment status for tax’. It is known by its acronym, CEST; you can find it here.
CEST allows Clients to get the HMRC view as to whether IR35 applies to an engagement or not.
What does IR35 mean for contractors?
Under the Government tax crackdown, IR35 could potentially cost some contractors between 13 and 25 per cent of their take-home pay. There could also be an increase in operating costs for their businesses.
Since the decision regarding employment status now sits squarely with the Client rather than the Contractor, an element of control will be removed for them. Contractors may need to re-think their approach to working and will have the choice of opting for either opting to become PAYE employed, or self-employed as a sole trader.
If a contractor is caught under IR35, they will be required to calculate what is known as ‘deemed payment’ on limited company income. This involves deducting Pay As You Earn (PAYE) salary, a 5% expenses allowance and any pension contributions.
Although it is highly unlikely, HMRC could potentially go back as far as six years and evaluate past contracts to see if IR35 applies.
What does IR35 mean for Clients?
In order to comply with new HMRC rules in time for April 2020, it is important to understand the risks of incorrect employment status classification. This will require a strong knowledge of tax and employment law – Always seek advice where possible.
It is likely that there will be a movement of contractors back into self-employment as sole traders, which would mean that clients will need to consider supervision, direction and control (SDC), which is what HMRC uses to determine wider employment status.
Be prepared for contractors’ expectations to change, along with their practices, contractual requirements and processes. If you have any concerns regarding IR35 and would like some advice and guidance on the steps you will need to take in order to remain compliant, please get in touch.
We’d love to talk.