Change to the IR35 tax rules - some questions and answers
Recently a change to the IR35 tax rules has been rushed through for organisations and contractors in the Public Sector. Some common questions and answers below.
Firstly, some context. If you contract in the public sector via your own limited company you are currently responsible for deciding whether the IR35 rules apply to you and your company. If you decide they don't, you pay less tax due to the risk you take being in business on your own account. You are arguably in the best place to decide, after all, it's your limited company and you know who you do business with and how your business operates! From April the responsibility will fall to the client and agency (the buck stops with the agency). Because the client/agency do not know your affairs (rightly so) they will naturally be more risk adverse meaning you are likely to be designated as 'in', resulting in higher tax comparative to being outside the IR35 rules. The change essentially removes one of the main benefits of operating a limited company as a vehicle to contract in the public sector.
The mechanics that HMRC are enforcing state that should the individual be ‘in’ IR35 and continue to operate after April the agency will be responsible for deducting tax. i.e., payments to the contractor's limited company will be made net of tax and NI. Essentially paying tax on behalf of another company! Mad.
The rules only apply in the public sector (clearly, the government can push contractual changes here much more easily than the private sector) and you will only be affected if you operate your own limited company. Umbrella company / PAYE temp etc will see no change.
We see this partly as a test, prior to it being rolled out across the private sector if HMRC can 'prove' it works. It is a rather neat way of HMRC getting the business world to collect tax without expending too much effort.
Can't the agency just state its contractors are 'out' of the IR35 rules?
Not if they are running a legitimate long-term business. We will be looking at each case individually and if we genuinely believe the contractor is out (and we are supported by the client) we will state that and be prepared to fight it in court. The information and ‘digital tool’ given by HMRC are not clear. This isn’t surprising given IR35 has never been clear, therefore inevitably the courts will ultimately decide. Until there is some clear case law it could be a little messy.
An agency with any number of contractors working would quickly run up huge liabilities if they operated in this way (we estimate circa 3 to 4 times the margin at risk per contractor).
Why are the IR35 rules being changed?
Simply put, employment is at a historically low level and tax receipts have not gone up accordingly. HMRC believe this is due to incorporation (individuals gaining 'employment' through their own limited company and paying less tax). The way people work is changing, with growing numbers of people choosing to freelance/contract for a variety of reasons (favourable tax being way down the list in our opinion, the vast majority of contractors I've worked with are in it for the flexibility and variety). HMRC tax rules need to capture the new world of work and these changes are part of that.
What can I do?
Write to your MP and join one the freelance/contractor associations (IPSE for instance). Personally, I think there should be tax benefit if you contract, the risks are generally much higher when compared to permanent employment.
We expect most limited company contractors to engage with the public sector via an umbrella in the short to medium term. Negotiations will then start on rates, to bring take home pay back to previous levels (if outside of IR35). Some will move to the private sector or seek permanent employment.
Bizarrely there is potential for the additional revenue gathered in tax to be used to cover the increased costs as a result of this change!!?
What will clients do?
We believe most clients in the public sector will put out blanket rules stating they will only engage contractors via umbrella companies. Transport for London (2300 'off-payroll' workers apparently) has already confirmed they will not engage individuals via limited companies beyond April. The disruption this will create could be huge - think of the number of professional contractors in central government alone and the contribution they make!
There has been some massive push back by large public sector organisations so far with little effect. This could change however as momentum builds and the disruption created by the change takes hold.
Is contracting in the Public Sector going to be worth it past April 2017?
Clearly, it depends on your situation - but generally - yes. All organisations, public and private need expert flexible labour, it's a key strength of our economy.
Your skills will have some bearing, ask yourself the following questions:
- Is my skill-set predominantly used by the public sector?
- How critical is my limited company to my personal affairs (e.g., pension plans)
- How buoyant is the contractor market for my skills in the private sector?
We do not believe these changes are going to dramatically affect the market, however, it's likely there will be some disruption in the short to medium term.
Glass half full
Disruption often creates opportunity, therefore, you could find conditions in your area of expertise improve. An example, 40% Java Developers in the public sector operating through their own limited companies leave for the private sector in the coming 6 months (not that unrealistic given the demand for good Java skills). Demand for Java Developers in the public sector goes up accordingly. Rates go up. The remaining 60% now pay more tax but have higher rates and more opportunity. Net pay is about the same. More money goes through the system but ultimately nobody is better off - kind of like quantitative easing for the contractor market!