HMRC Presses on with IR35 Reforms
Any hope that the Government would postpone the latest legislation to reform IR35 was ended with the publication of draft legislation on July 11th 2019, with the intention of bringing it into force in April of 2020.
The off-payroll working rules, or IR35, which date from 2000, attempted to ensure individuals using limited companies, where they were providing personal services usually via an agency, had to treat most of their income as PAYE. However, the flaw was that the determination as to whether an individual using a limited company in this way is caught by the rules, lies with the individual. They and their accountants often interpreted the circumstances in the way most favourable to themselves. This meant HMRC needed to look at each and every case if they suspected an issue. There was also an evidential issue in determining the actual nature of the work often long after the event.
Our view is that the principle of IR35 is wrong and contractors (including PAYE ones) should get a tax break for the uncertain nature of their work. However, HMRC do not agree; but as IR35 was more or less unenforceable, a kind of status quo existed. It has never made much sense for a legal structure intended for business should be used for a close relation of employment, but at the same time contract workers do not share the same benefits as permanent ones, so this should be reflected in the tax regime for them. But it isn’t.
This new legislation ends that informal status quo and is squarely aimed at targeting non-compliant individuals working this way. This is therefore NOT a tax rise and limited company contractors must be prepared to see a significant reduction in take home pay if they were not compliant before. In our estimation that means most limited company agency workers. This is likely to mean the former ‘Ltd company’ rate is reduced by up to 25% in real terms when comparing take home pay, depending largely on how far away from the HMRC interpretation an individual has been.
While there are cases where an agency worker might be outside IR35 they are rare, as the test for employment is now very tight. HMRC have devised a test which they say they will abide by (assuming the questions are answered honestly). This should be the first port of call for all limited company contractors.
The fundamental change that comes with the new legislation is that from April 2020 it will no longer be the worker who determines if he/she falls within the rules, but the ‘client’. However, it will be the ‘feepayer’ who will be liable if the determination proves to be incorrect. The client might be the end user, or it might be someone working as a supplier to the end user. The feepayer is the Agency (in most cases). This produces two outcomes. The first is that the party responsible (the client) will be much less inclined to settle on the most favourable taxation outcome for the worker, as the worker would for himself. The second outcome is that because the feepayer/Agency is ultimately liable for unpaid tax, they will almost certainly be disinclined to take any risks at all and may well withdraw themselves from offering payroll services to limited company contractors completely.
HMRC have come up with a ludicrously convoluted process, for determining and then appealing these decisions while failing to acknowledge the reality of modern supply chains. They have shown their naivety in failing to understand that ALL organisations will be hugely risk adverse with regard to potential liability. It’s almost certain that indemnities will be demanded by whoever holds the whip in these arrangements and these will be followed by demands for insurance to cover those indemnities.
HMRC have also muddied the water further, having first implemented this policy with public sector clients, they now intend to include only medium and large businesses and thus leave small business clients outside the legislation. Small is less than £10.2M turnover a net worth of £5.1M and no more than fifty employees. We expect this provision to go in another couple of years’ time.
This afterthought provides the opportunity for a potential loophole, as the identity of the ‘client’ referred to throughout the draft legislation is far from clear. If you work for a facilities management firm that is within the statutory definition of being small AND the relationship between that company and the end user is such that they are not just another intermediary, then the ‘old’ IR35 applies. If it is determined however, that the company is just another intermediary, the feepayer (agency) must operate the new rules. The information with regard to the relationship between an end user and a tier one or two service provider will probably not be available. Moreover, even when documents state unequivocally that the contractors are NOT employees of the end user in any circumstances, HMRC will and have argued that the end user is AUTOMATICALLY the client. So, everyone is caught – always.
Nevertheless, the presence of this distinction and the hazy nature of the relationship between supply chain members, may give rise to opportunistic organisations positioning themselves as a small company ‘client’ providing services to a large company end user. It would be a very unwise feepayer who allowed its limited company contractors to stay outside the new legislation in those circumstances.
Notwithstanding this kind of opportunism, generally speaking, given this huge lack of clarity and the substantial risks for everyone in what is after all, someone else’s tax avoidance, the most likely long-term outcome is a PAYE only offering. Doubtless umbrella companies will climb out of their coffins at this point. However, it should be born in mind that, if they are operating legally, they cannot now offer any advantage over any other employer operating a PAYE payroll, but they charge individuals for processing a pay cheque. Often £25.00 or £30.00 per week.
While the new legislation goes into excruciating detail to allow for individuals who are caught by the rules, but still want to bill through a limited company (but have all their income treated as taxable salary) it is hard to see why anyone would do this when they could be PAYE and receive some employment benefit instead. Equally it is hard to see why any ‘feepayer’ would want to jump through so many hoops to make payments this way.
The ridiculous thing about all of this is that if a PAYE only regime is the objective of HMRC, why not just legislate to say that if you are engaged via an employment agency, you have to be PAYE. This has always been their objective, but it seems they simply cannot understand the issues.
Of course, there is always the caveat that a new Chancellor may scrap or postpone this, but in all likelihood, no government is going to reverse a largely unknown tax squeeze, which is likely to come into effect with only very limited opposition.
Perhaps the only way to look at this reform is to concede that the advantage has been available for twenty years longer than intended, and nothing lasts forever. At least no one is talking about re-examining the correct operation of the rules since April 2000, if as we expect, many current limited company contractors decide to simply ‘bite the bullet’ and become PAYE.