IR35 reform: What the future holds
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.
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:
- The end client decides whether engagement is inside or outside IR35
- 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
- If the engagement is outside IR35 the worker can continue to operate as normal and decide how to extract funds from their PSC
- 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
- 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.
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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.