Autumn Statement 2016: Contractor Case Study

Contracting in the public sector next year, but plan to keep operating outside IR35 from April 6th?

Well, it’s better off knowing roughly how much tax you’ll pay if you are deemed inside IR35, in a year when both the 5% expenses rule on IR35 will end, and a new, higher rate on the VAT FRS will begin.

With yesterday’s Autumn Statement having something to say about all three of these distinct possibilities, Duncan Strike, a director of Intouch Accounting crunches the numbers.

Meet Connie

Connie is a project manager working via her limited company, C Limited. Based in London, C Limited contracts via an agency working at the NHS. Connie’s rate is an annual equivalent of £80,000; she incurs annual expenses of £4,280 and believes that she falls outside IR35.

Connie takes a salary of £11,000 and the balance of profits after tax as dividends. The Employment Allowance is not available. C Limited is registered for VAT on the Flat Rate Scheme at 14.5% (note; the new rate announced for FRS users with ‘limited costs’ is going to be 16.5% from April 2017).

When Connie’s outside IR35

C Limited and Connie, who is operating outside IR35, have their affairs concluded on the following basis.

  2016/17 2017/18
Turnover  £80,000 £80,000
Flat Rate benefit £2,080 £2,080
Salary  £11,000 £11,500
Employers’ NI  £399 £460
Expenses £4,280 £4,280
Profit £66,401 £65,840
Corporation Tax £13,280  £12,510
Dividend £53,121 £53,330
National Insurance  £752 £860
Income Tax on salary  - -
Dividend Tax £8,889  £8,583
Total tax  £22,921 21,953

Yesterday’s confirmation in AS2016 that the IR35 reforms for the public sector will become effective from early April 2017 concerns Connie. But what would be her position?

When Connie’s deemed inside IR35

Under the IR35 proposals approved yesterday by the chancellor, her agency will be called upon to assess whether they believe Connie is subject to IR35 and if they do, the agency must deduct tax and national insurance before paying C Limited.

The agency makes enquiries with the NHS but gets a less than satisfactory response and therefore decides to rely on the new digital tool from HMRC. The tool provides an outcome that the agency believes places Connie as a deemed employee and within IR35.

The agency will calculate deemed payment deductions on £80,000; they do not accept the costs are allowable as a deduction and, under yesterday’s AS, there is no 5% allowance. The deductions the agency make before paying C Limited are as follows:

   2016/17 (Theoretical only) 2017/18
Employers' NI £7,718 £8,711
Employees NI £4,759 £4,946
Income Tax £17,713  £17,216
Total deductions £31,190 £30,873

This is a major cash flow problem for Connie. The amounts she receives from the agency are much less than normal and the amounts taken in tax are far greater than she would normally expect. In fact, in 2016-17 while outside IR35, her bill to HMRC was £22,921; being inside IR35 puts that bill up by more than £8,000. It would go up by almost £9,000 in 2017-18.

Inside V Outside IR35 – Connie paid in tax

  2016/17 2017/18
Tax deducted under IR35 £31,190 £30,873
Tax deducted non IR35 £22,921 £21,953
Overall increase in tax £8,269 £8,920

Five per cent relief goes, as potentially higher FRS rate arrives

As you can see, the overall tax suffered increases. But Connie may also have to suffer an additional sum for IR35 deemed payment deductions on the VAT flat rate benefit via the company’s own PAYE scheme and RTI submissions. The agency would not normally make this deduction at source.

That is, of course, if she is still entitled to it following the announcement in AS 2016 of the ‘limited costs’ FRS rate category. Fortunately, her expense qualifies and C Limited retains use of the 14.5% flat rate. Had she fallen within the new category then her VAT FRS benefit would fall by £1,920, from £2,080 to only £160.

But another of the chancellor’s announcements has also caught her. The overall cost arising from the announced loss of the 5% allowance (the fixed expenses deduction under IR35) for workers in the public sector, in this case, of £4,000 (5% of £80,000) has caused an additional IR35 tax liability included above of £1,962 compared with workers within IR35 in the private sector.

Connie’s conclusion

Connie must decide whether to claim a deduction via her accounts for her actual expenses. She decides she is entitled to claim a deduction under IR35 because they are genuine employment expenses, but she must also include the VAT FRS benefit within her revised IR35 calculations. However, Connie still believes that she falls outside IR35 and must therefore present accounts on that basis, ignoring IR35 based calculations and then make a formal tax repayment claim.

Unfortunately for Connie, HMRC believes their digital tool is effective as a status measure and refuses the repayment. Connie is strong in her determination and intends to fight her status. But realising that the cost of a tribunal hearing is likely to run to more than the tax liability she might recover, Connie decides to cut her loses, to settle her tax affairs on the basis of IR35 and to leave working in the public sector at the earliest opportunity.

Final Thought

Connie decides that she needs to fully evaluate her way of working to manage and counter falling within IR35, and to understand how the tax liabilities will change if she can modify her working practices. Consulting a specialist accountant would certainly help her unravel the conundrum of how the reforms to IR35 and the VAT FRS will impact her.