In April of next year, the government will be applying the off-payroll working rules to the private sector. Without a doubt, this will cause difficulties for numerous contractors and business. Now is the time to review contracts and avoid tax disputes with HMRC or accusations of disguised employment.
The government introduced IR35 to combat PAYE avoidance. So-called ‘disguised employees’ would supply their services to clients via a limited company. In 2016 the government announced that they would move responsibility for determining when IR35 applies from the private contractor to the public authority engager. The announcement was the catalyst for a mass exodus of contractors from the public sector.
When calculating back-payments, the HMRC usually likes to look back to the very start of the engagement. Contractors within IR35, but who haven’t applied the rules, could face sudden and drastic tax and NIC liabilities.
From April 2019, it’s vital that every company that engages workers through PSCs understand the changes and ensure they comply.
The case law used for guidance rarely matches up with contractors’ real-life situations. This makes it increasingly hard for contractors to determine status. To make matters worse, there are two contrasting ways of testing IR35 status.
Contractors are advised to ‘paint a picture’, illustrating all aspects of their engagement. This will then be interpreted as either employment or self-employment.
In an attempt to simplify the decision-making process, HMRC has introduced a Check Employment Status for Tax (CEST) tool. Using a spreadsheet, the goal is to provide an objective verdict. However, it often fails to account for the full details of the individual’s situation.
It seems that HMRC approves both methods. However, HMRC will almost certainly side with its own CEST tool if the rules are found to apply. If you’re a worker who disagrees with the verdict, you may face the costs of attending an employment tribunal and persuading the courts of that IR35 doesn’t apply.
Contractors must choose their answers carefully. HMRC stresses that, unless a compliance check finds a flaw in the data used, it will stick with the CEST result.
Usually, it will be the end engager who decides whether IR35 applies. However, there are steps that contractors can take to help ensure a favourable verdict. Specifically, they must be sure that the contract demonstrates a clear business-to-business arrangement and doesn’t depend on a single organisation.
Employment or self-employment – a moveable feast
Contractors should check that how they work reflects the contract. Self-employment status may be stated but, is this always accurate? Over time, arrangements can change. Perhaps, due to familiarity or even laziness, elements of employment can creep in.
Where IR35 does apply, HMRC will deduct Income Tax and National Insurance before payments to the contractor – treating them as a PAYE employee.
Here’s an example –
This table illustrates the massive difference between the take-home pay for a private sector contract (outside of IR35) and that of a public sector contract, subject to PAYE.
|PSC not IR35 £||PAYE £|
|Gross contract value cost to client||100,000||100,000|
|Corporation tax payable||15,500||0|
|Income tax payable||11,600||24,000|
|National insurance payable||0||16,500|
|Net retained by individual||72,900||49,500|
For a contract of £100,000 cost to the end client, with annual travel and accommodation costs of £10,000, there is a difference in taxes and NIC of £13,400 between the two contract types. The problem is made worse because, for the PAYE contract, the expenses are not deductible. So, they are deducted from the employee’s net income.
For the purposes of comparison, it has been assumed that the client has passed on the costs of the employer’s NICs by reducing the value of the contract.
Contractors often enjoy more flexibility and remuneration than other types of employees. So, it’s unlikely that the IR35 reforms will herald the demise of the contractor. Instead, the rule should do exactly what it’s intended to do – catch out the false contractors.
Now is the time to become familiar with the imminent changes and to negotiate effective contracts with engagers. As a contractor in either the private or public sector, you’ll avoid costly HMRC investigation settlements. You’ll still be able to enjoy the benefits of contracting for many years to come.
This legal information is not the same as legal advice and you may not rely on our post as a recommendation of any particular legal understanding. Please, consult an attorney if you’d like to get an advice on your interpretation of our article.