IR35 reform: What the future holds

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Seb Maley reveals what’s changing with IR35, what’s not and takes a look at HMRC’s new status tool.

The intermediaries legislation, commonly known as IR35, was introduced in April 2000 to combat tax avoidance through the use of personal service companies (PSCs).

For the last 16 years it has been a huge bone of contention for contractors and freelancers, with relentless calls for it to be changed or scrapped.

Well, it’s certainly not going to be scrapped, but it is about to change and in quite a major way.

There has been a lot of press interest into perceived tax avoidance in the public sector, which often involves the use of PSCs and what HMRC refers to as “off-payroll” engagements. It gained public attention in a big way when it was revealed Ed Lester, the head of the Student Loans Company, was working through his own PSC. More recently dozens of BBC news presenters have been investigated for operating in a similar manner.

At the same time, HMRC has struggled to adequately police the IR35 rules. A chronic lack of resources meant investigations dropped from well over 1,000 a year to just 12 in 2009/10. While they have steadily increased since then, they are still a long way off what they were in the early years. This has also caused the ‘deterrent’ effect of the legislation to diminish, with a marked increase in workers choosing to use the PSC route.

What’s changing?

Since the inception of IR35, the workers themselves have been responsible for determining whether they are inside or outside the legislation – i.e. a disguised employee or genuinely self-employed. From 6 April the responsibility of determining the status of an engagement in the public sector will shift from the worker to the end client.

While there are a number of complexities (and grey areas) in the draft legislation, the basic process will be as follows:

  1. The end client decides whether engagement is inside or outside IR35
  2. If there is another party in the chain who pays the PSC (i.e. an agency) the end client will advise them of their decision
  3. If the engagement is outside IR35 the worker can continue to operate as normal and decide how to extract funds from their PSC
  4. If the engagement is inside IR35 the party paying the PSC will have to deduct PAYE and employees NIC, plus paying employers’ NIC in addition, before making the net payment to the PSC
  5. The worker will then receive credits against the tax that has already been deducted and they can draw the net funds out of their PSC as they see fit

It essentially means that someone working inside IR35 will become an employee of the party that pays their PSC for tax purposes only. They will not benefit from any employment or statutory rights and will continue operating through their own limited company.

What isn’t changing?

It is important to note that the status tests for IR35 are not changing, so cases will still be determined on the existing factors – substitution, control and mutuality of obligation. In theory someone genuinely operating outside IR35 at the moment should be able to continue doing so post April 2017.

These rules are also restricted to the public sector… for now. Public sector is defined as any entity that falls under the English and/or Scottish Freedom of Information Acts and is therefore fairly extensive in itself.

HMRC status tool

Throughout the consultation process HMRC has placed a lot of focus on a new online ‘tool’ they are developing. The tool will supposedly give a definitive opinion on a worker’s status (both IR35 and traditional employment status), and can be used by anyone anonymously.

My take on the tool:

  • The wording of the questions and the logic that determines the result will be based entirely on HMRC’s own interpretation of IR35 case law. We know from experience that this is not always right (our own record in IR35 investigations is 1,500 vs 3)
  • The test is not mandatory and individuals or engagers can take their own independent due diligence in ascertaining status
  • While HMRC may be using fairly advanced algorithms, I would warn against relying on a robot to give an accurate view on IR35 status. The circumstances of an engagement should always be considered in the round, ideally by someone with experience in handling IR35 enquiries
  • HMRC proudly states that it will stand by the result of the test (but only after thoroughly checking all of the answers are accurate)

There are also concerns about the timing of the release of the tool. While a basic private beta version exists and is being presented to selected parties, the public beta is unlikely to be ready until late February. Given there are tens of thousands of workers who will technically need to be tested prior to 6 April, it doesn’t give end clients much time.

What will actually happen?

As mentioned, the factors involved in determining status have not changed and therefore you would hope that those currently operating compliantly can continue to do so. HMRC believes that only 10% of PSCs who should be working inside IR35 actually are (which is in stark contrast to our own experience in working with public sector contractors).

However, the decision is now entirely in the hands of the public sector bodies engaging the workers. The concern is that some will adopt a risk averse approach and force all workers to go through PAYE.

This would come with significant problems though. Workers are already leaving the public sector ahead of these changes, fearful of being forced inside IR35 and ending up with a dramatic reduction in their net pay. For those that stay, the public sector will face a big hike in costs – someone has to cover the cost of employers NIC (and it won’t be the recruitment agency).

What I’m hoping for is a reasonable and pragmatic approach to the new process across the board. There are undoubtedly a number of individuals in the public sector who shouldn’t really be working through PSCs, and the reform should deal with those. It is vital, though, that a kneejerk reaction does not unfairly penalise those genuinely operating compliantly, of which there are many. If it does the ramifications will be extensive.

Ed Molyneux, chief executive of FreeAgent, said that the subjectivity of IR35 makes the decision as to whether an individual should be taxed as an employee or an independent contractor very difficult, but added pushing this burden on to public sector engagers did not seem like a useful way to resolve the confusion: “We have misgivings as to whether time-strapped, cash-short public sector engagers will simply enrol all contractors on to their payroll, subjecting these individuals to the worst of both worlds, since they will pay additional tax without being entitled to employment rights such as paid holidays and sick leave. 

“It is time for the government to accept that contractorship is often a lifestyle choice, rather than a tax-saving choice, and allow workers and their clients to have full control over whether they wish to treat a contract as a contract of service or a contract for services,” he said.

About Seb Maley

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By cfield
14th Dec 2016 10:23

It will all boil down to how desperately the agencies and clients need to fill the roles and the pool of available contractors. If their need is urgent and very few people have the necessary skills, they will bend over backwards to accommodate the contractor and try as hard as possible to come to a decision that they are outside IR35. If necessary, they will bump up the fees to compensate the contractor for the extra tax and NI.

If their need is not urgent and there are plenty of fish in the sea, they will play safe and pay tax on an IR35 basis.

For the contractors, the reverse situation applies. If they are in demand, they will go for whoever offers them the most money (all other things being equal) net of tax. If their bargaining position is weak and there are few other opportunities, they will just have to take the hit.

The actual IR35 position will probably be secondary to all this.

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to cfield
14th Dec 2016 10:36

Spot on. That's exactly what happened around April 2000, when I was an IT City contractor. Rates were bonkers high (ah, the good old days!) and clients and agents did whatever they could to ensure things were outside IR35 - and succeeded quite nicely. Then the crash came and rates halved within a year (the bad old days!) and contractors had no bargaining chips really. But with rates halved unsurprisingly very few of them put their hands up and decided to take a further 20% cut in net pay by self-assessing themselves inside IR35.

There aren't many experienced IT programmers out of work these days, so HMRC cannot expect a complete rollover.

I think we will start to see quite a few substitutions happening, just to ensure there are cast iron defences. Amusingly we may see HMRC try and rule that a substitution doesn't count if the client made them do it!

I shall continue to break the ice at parties over Xmas with these IR35 tales.

Dave Chaplin
CEO, ContractorCalculator

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14th Dec 2016 10:58

Great article.
IR35 will never work because the main criteria of taking away limited company status is wrong.
As long as the "contract for services" is adhered to then HMRC haven't got a leg to stand on whatever robotic maths they try and use.
It really is about time HMRC butted out of employment status and concentrated on investigation and collection.
I have said time and time again (and it will happen) leave the admin to us.

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to johnjenkins
14th Dec 2016 11:55

Agree John. I've lost count how many times you've said this too!

If the tax differential between employed and self-employed/PSC was the other way around then HMRC would be chasing "disguised businesses". I wrote about this in an April fool a few years ago "10,000 HMRC inspectors being hired to target ‘disguised businesses’" to highlight how bonkers the concept of a "disguised employee" actually is. It's a notion invented by HMRC to collect more tax. Period.

Freedom to contract should be honoured by HMRC.

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14th Dec 2016 11:07

I think the analysis for PSCs looks about right. The worry though is that the legislation isn't written with a definition of PSC in it - it's a two stage test around analysing the relationship with the worker (which is the complex employment status aspect) and the characteristics of the legal entities in the chain(be they company, partnership or individual).

Provided the public sector body can prove that it's not contracting with a body which is an "intermediary" as defined in respect of the worker, then it is at zero risk. If it does engage with an intermediary then it gets into risk, analysis and mitigation around employment status.

The worry is that any SME providing any service which could have once been taken by a direct employee of the council/school/department will have to show that the intermediary test is passed - except that the public sector may look at the risk & aggravation of doing all those tests vs the cost of simply contracting through one plc outsourcing firm and decide that Capita, G4S etc are suddenly a more attractive prospect for maintenance, web-design, catering services etc...

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14th Dec 2016 11:18

Much of the problem with IR35 stems from successive Government spending cuts and the desire to cut employment costs with all the related add-on overheads. Gov depts have been busy cutting costs by switching to contractors. Now the Treasury has worken up to the apparent loss of revenue. Duh!

I have very few contractor clients who wouldn't prefer a permanent employment contract with the security that brings, not to mention paid holidays, sick pay, training, pension, etc.

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By IANTO
14th Dec 2016 11:21

"without being entitled to employment rights such as paid holidays and sick leave."

No doubt that statement will be challenged in the courts in due course!

It has always been my contention that if HMRC prove that the engagement is employee like and therefore "disguised employment", then those arguments would be valid in the ET or EAT and likely result in a judgement in favour of the individual.

However, to date we have not seen one individual, when judged "caught" by HMRC, take their case to the ET, let alone get a judgement. I contend that the establishment would not like to be seen as foolish, by one court determining a different employment status from the other.

So any statement regarding the absence of employment rights is pure speculation at the moment. The accounting World should refrain from making such statements as it is bolstering HMRC's position.

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to IANTO
14th Dec 2016 11:48

It won't even get to court.
Because of the EU it has already been proven in the employment tribunal that the self-employed (under the EU "worker") are entitled to holiday pay. So employment rights really aren't an issue.

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By IANTO
to johnjenkins
14th Dec 2016 12:00

"the self-employed"

Those potentially caught by IR35 are not self employed. They, like me, are employees of their own limited company.

If the client creates an "employee" like engagement, then given the shift in emphasis of employment tribunals into looking at all aspects of the engagement, and not depending entirely on the written contractual situation, then an individual so "caught" could, if they wished, take the issue to the ET.

I repeat that it's always been my contention that the ET would not come to a different conclusion from the tax Commissioners as to do so would make the establishment look like they were arguing with themselves.

But as I keep repeating, all this is speculation until such a case is brought.

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to IANTO
14th Dec 2016 11:51

IANTO wrote:

It has always been my contention that if HMRC prove that the engagement is employee like and therefore "disguised employment", then those arguments would be valid in the ET or EAT and likely result in a judgement in favour of the individual.

However, to date we have not seen one individual, when judged "caught" by HMRC, take their case to the ET, let alone get a judgement. I contend that the establishment would not like to be seen as foolish, by one court determining a different employment status from the other.

James vs Green which [2008] - Agency worker failed to claim employment rights.

It might be possible under the new Agency Workers Regulations [2010] for an agency worker inside IR35 to make a claim that they should receive the rights as per AWR after 12 weeks. But they won't get full employment rights. Any thoughts on this employment law experts?

In reality though I find it hard to believe that any contractor will agree to be inside IR35 and use the complex RTI process with their PSC. Instead they will go umbrella, hike their rate, and expect rights under AWR.

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By IANTO
to davechaplin
14th Dec 2016 12:22

"James vs Green which [2008] - Agency worker failed to claim employment rights."

So, was this individual an employee of their own limited company and had been judged a disguised employee by HMRC under IR35 in the Commissioner's courts. I don't believe so.

Many individuals have brought cases to the ET claiming employment rights, independent of IR35 and have lost.

I did just that in December 2002. Check out J.M.Willams v's Hewlett Packard judged by Mr. Justice Elias. He ruled that the provisions of the contract over-ruled the actual reality of the engagement and pronounced that I was not an employee of the client. Which is the outcome I required.

Note that after this judgement, HMRC did not proceed with their intended investigation of me under IR35. So I have personal experience and case law for myself, which support my opinion.

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By NeilW
14th Dec 2016 11:59

Since Public Sector bodies are effectively paying themselves, it would be much better all round if they were just required to hire everybody on a Contract Of Service and then paid the tax back to central government from the money they receive from central government.

Recruitment agents can then act as agents for a fee rather than sitting in the middle getting paid for doing nothing.

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to NeilW
14th Dec 2016 12:08

Correct. The VERY easy answer here is to say all PSBs can only hire contractors on fixed-term employment contracts.

They could legislate for 10% tax, 50% tax, or 95% tax - they only really "pay" whatever net amount ends up in the contractors pocket.

Any actual rate hike by the contractor who falls inside IR35 to then get the same net pay will be effectively neutral for the Government. They will still be paying the same overall.

Makes you wonder why they are bothering eh? Here's a clue: HMRC estimate non-compliance of IR35 costs them £440m in lost tax each year. But they say the public sector is responsible for £25m of that. So they are still £415m down. Call me cynical, but it might look like they are using their own people to dry test a rollout into the private sector.

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By MattH
14th Dec 2016 12:00

Am I right in thinking that there is no kind of "appeal" process should the PSC be deemed to be inside IR35 by the "end-user" for the sake of their simplicity and attitue to risk when there is evidence that they would fall out.

Would like to be wrong.....

Agree that the best way to deal with IR35 is to put more resources into investigations which have become non-existent rather than fiddling around with new legislation and online tools,

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14th Dec 2016 13:12

Inevitably there will be, I suspect fairly early on, a legal challenge to the ability to tax an individual as an employee without their having recourse to employee conditions.
Although the interplay of 'the administration' and 'the jusrisprudence' of the UK is bound to fall in the direction of minimising cost to the 'Administration', this will not be black and white.
The thought of contractors accumulating Civil Service rights, such as pension entitlement, 'by the day' looks to me like a lot of work.
I suppose, too, that all CS contractors will be entitled to understand their equivalent CS Grade, for each contract, and accrue all the accorded benefits over time. Allocating these by engagement across grades will be interesting.
As ever with HMRC, they have only thought about, not thought through.

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By IANTO
14th Dec 2016 13:23

"Inevitably there will be, I suspect fairly early on, a legal challenge to the ability to tax an individual as an employee without their having recourse to employee conditions."

Agreed! The outcome will be very interesting. Let's hope the case is supported by an influential body!

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By vstrad
14th Dec 2016 13:36

So, a limited company invoices a public sector client for services rendered (+VAT) and the client deducts income tax from the payment he makes. How is that going to work?
If the client refuses to enter into a contract for services and insists on putting the worker on the payroll, how is that not a contract of service, with all the entitlement to holidays, sick pay, auto-enrolment etc. that implies?

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14th Dec 2016 14:42

Extract above
"More recently dozens of BBC news presenters have been investigated for operating in a similar manner."

Nobody at the BBC should be allowed to use PSC to avoid paying the right amount of tax, we fund the BBC through the licence, its not as if when I get caught for not having a TV licence I claim ' well I dont claim to understand it but my TV set is actually registered in Finland, where there is no TV licence, its very complicated and its all done through an internet provider for £35.

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14th Dec 2016 13:50

"So, a limited company invoices a public sector client for services rendered (+VAT) and the client deducts income tax from the payment he makes. "

Nope - a Ltd. company must invoice the nominated agency intermediary for an amount + VAT.
The intermediary bills the 'Department' and receives rate less paye tax less NI.
Department pays Employers NI [to what entity?]
Heavens knows what Intermediary pays to Ltd.Company.
Ltd Company pays Salary to employee - less paye tax less NI.

At minimum there is double taxation
or a hellish reconciliation chain around
a. paye
b. NI
c. employers NI
d. VAT
... and that's assuming only one level of intermediary !!

Plus this will all be reported withing the simultaneous transfer to ill-thought Digital Tax fiasco.

LOL

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to dgilmour51
14th Dec 2016 14:01

dgilmour51 wrote:

Nope - a Ltd. company must invoice the nominated agency intermediary for an amount + VAT.
The intermediary bills the 'Department' and receives rate less paye tax less NI.
Department pays Employers NI [to what entity?]
Heavens knows what Intermediary pays to Ltd.Company.

Not quite. The intermediary/agency is responsible for all tax. They will bill the department the full rate plus their markup. The department pays this over and the agency then deducts PAYE & NI before paying the PSC...then pays over employers NI in addition.

It will all run through the agency's payroll and RTI (as an aside it's unlikely many agencies will have a payroll system that can cope with this).

Obviously in PS engagements there are often more than three parties in the contractual chain, so it gets even more complicated.

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By vstrad
to dgilmour51
15th Dec 2016 14:21

What if there is no intermediary? It's perfectly possible for a PSC to contract directly with the client - I've done so many times myself.

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to vstrad
15th Dec 2016 15:12

vstrad wrote:

What if there is no intermediary? It's perfectly possible for a PSC to contract directly with the client - I've done so many times myself.

Then the end user would have to deduct PAYE and NI if inside IR35. They would become the 'fee-payer'.

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By vstrad
to Seb Maley
16th Dec 2016 16:01

Which brings me back to my original question: how can the end user deduct income tax and NI from a business-to-business invoice for a fee + VAT? It can only possibly work if the worker agrees to be on the payroll of the end user, in which case stand by for litigation in which the worker claims paid holidays, pension contributions, sick pay etc. It's going to be a complete mess.

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By Robbo
14th Dec 2016 15:45

All very interesting but the real news is the dividend tax will raise tax from PSC's, This was touted 20 years ago (NI on dividends paid by close companies) watch out for further hikes.

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14th Dec 2016 15:56

Can't see that this is going to make things much clearer. Most government departments use a high number of 'contractors' and presumably do so because that's the route that suits them. HMRC apparently acts as the agency 'employer' for many departmental employees, so they will be aware of similar roles dealt with by employees.
Seems contractors will lose out on various fronts: not legally employees so no rights, but taxed as employees by the end client and having a double charge to ERs NI - once by the end client and again by their own PSC. Renegotiation the likely solution?

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14th Dec 2016 16:39

Seb Maley:
"The intermediary/agency is responsible for all tax."

In a chain, which one?

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to dgilmour51
14th Dec 2016 16:48

dgilmour51 wrote:

In a chain, which one?

Always the one paying the PSC. HMRC now refer to them as the 'fee payer'.

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14th Dec 2016 17:06

It wouldn't be so bad but I know HMRC are using a shed load of contractors on Making Tax Digital!
All magically working outside IR35, no doubt.

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14th Dec 2016 17:25

Given the hammering PSC users are taking at the moment with the new dividend tax, new VAT FRS rules and changes to T&E, I struggle to see the point in HMRC spending yet more time and taxpayers money on this deeply flawed legislation. There now seems very little incentive for any higher rate tax payer to incorporate since it would seem that one is paying more tax operating through a PSC than as an employee now HMRC have "levelled the playing field" as they so disingenuously and inaccurately put it. Of course the unfortunate truth, which again seems to escape those making the laws, is that many of us are forced by agency rules to have limited companies - ironically with the object of protecting the agent and end clients from being assessed as employers under IR35!

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By adjadj
to cereus77
14th Dec 2016 20:13

So how does auto enrolment fit in with this? Where is the revenue stream for the PSC to pay the employer contribution on the basis they are only receiving the net pay?

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By adjadj
to cereus77
14th Dec 2016 20:13

So how does auto enrolment fit in with this? Where is the revenue stream for the PSC to pay the employer contribution on the basis they are only receiving the net pay?

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By adjadj
to cereus77
14th Dec 2016 20:14

So how does auto enrolment fit in with this? Where is the revenue stream for the PSC to pay the employer contribution on the basis they are only receiving the net pay?

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16th Dec 2016 10:43

This could open up a huge minefield of complaints of discrimination too. Can you imagine it: pro Brixiteer racists in charge of determining status, claiming one set of 'white, males' are outside IR35, whilst the rest are not, or fudging it to ensure only certain profile types are given outside IR35 work whilst the rest are cast into 'inside' roles on employee without rights terms. There is far too much amunition for abuse and it will happen to when you consider that outside IR35 status, was traditionally, viewed as something that only happened to high daily fee earning 'professionals' doing specific cerebral jobs. This is nonsense, of course, if you start your own 'freelance' business as a sole trader you could be offering secretarial services just as easily as software programming ones. I feel for contractors now. I would not bother and do something else or stay within the private sector. The whole area is farcical and how can there be a set 'status ' of outside and inside IR35 if it as determined by sector who may well just apply a blanket ban on outside IR35 contractors, irrespective of their working practices.

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By myke
27th Feb 2017 15:22

Pls help, I need guidance. Clients (directors of the PSC) that fall within the IR35; agencies/umbrella companies deduct PAYE, Er's & Ee's NICs at source and pays the net to the PSC directly. Obviously, PSC account for the income and what are the allow deductions that can be made in the PSC financial statements and to avoid double taxation to the client (director of the PSC)???

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