Working inside IR35: a guide for April 2017 and beyond
With Autumn Statement 2016 less than a month away, the prospect of being caught by IR35 is getting much closer for many public sector contractors, assuming unpopular IR35 proposals get rubber-stamped on November 23rd.
So now more than ever, PSC contractors being declared inside IR35 looms large as an unenviable yet unavoidable reality, writes Helen Christopher, operations manager at contractor accountancy specialist Orange Genie.
Why ‘inside IR35’ declarations are set to soar
Before exploring what ‘inside IR35’ entails, let’s recap. From April 2017, new legislation will move the responsibility to determine a public sector contractor’s IR35 status from you, the contractor, to the end-client, recruitment agency or other third party closest to your limited company in the supply chain.
There has been much comment on the practical difficulties of these proposals and their workability, but for now it is safest to assume that it is a ‘done deal’ and the new rules will apply. There is therefore a real risk that end-clients and agencies finding themselves in this unprecedented position will apply a risk-adverse approach. That means they will deem many contracts to be inside IR35, where perhaps before those very same contractors had thought of their assignments as being outside IR35. So let’s look at what being ‘inside IR35’ – caught by the Intermediaries legislation -- really means.
Caught by IR35: the tax position
Statue dictates that if a contract is inside IR35 a deemed salary calculation should be run to declare PAYE and National Insurance on 95% of the contractor company’s income, allowing up to 5% to cover the costs of running the company. Certain specific deductions can be made for items such as pension contributions but since April 2016, no allowance can be given for Travel & Subsistence costs. So what does all this mean, in real terms?
Well; IT consultant Ian is paid a rate of £200 per day, travels 2,000 miles per month and is registered for the Flat Rate VAT scheme. He could find himself up to £700 a month worse off, if declared inside IR35. Outside of IR35, Ian may choose to take a salary equivalent to the personal allowance and then dividends. In this scenario he could take home around £3,580 per month, whereas inside IR35 this could drop to £2,884.
Ian’s take-home pay when inside IR35 is comparable to that from a PAYE umbrella model, which would yield approximately £2,800. The small advantage for him of being inside IR35 compared with using an umbrella company’s PAYE is down to the income earned from the Flat Rate VAT Scheme. Overall though, being outside IR35 is clearly the most financially-attractive option.
But remember, IR35 status is not a choice. It is determined on the terms and working practices of your individual contracts. Choosing to ignore this, operating ‘outside’ when in reality you are ‘inside’, can be a costly mistake. If HM Revenue & Customs investigates and win their IR35 case against you, the monies earned that have not been taxed under the deemed salary provisions will incur substantial PAYE and NI bills, along with interest charges. Steep penalties can also be added and will be harsher if HMRC feels that there has been a deliberate and wilful decision to operate ‘outside’ when the contract was clearly ‘inside.’ It is not unheard of for a contractor to be made bankrupt through this process where he or she has lost their argument with HMRC over IR35 status.
Disagreements, refusals and PAYE
This is why contractors have -- since IR35 was introduced -- been widely advised to strongly consider their IR35 status before the taxman does. Taking advice from an IR35 specialist can help you assess and protect yourself against potentially costly, drawn out investigations. A thorough review of your contract and working practices will give you peace of mind as to your status, assuming an ‘outside’ determination is made.
At times, contractors disagree with the recommendations given by IR35 specialists. Bear in mind; if you are working on a private sector contract, your IR35 status is YOUR responsibility and the risk of getting it wrong is ultimately yours. There is talk about the public sector IR35 proposals (which make ‘the paying agent’ and not the contractor responsible for the legislation), being extended to the private sector. At the time of writing, this is still just speculation. So currently, if you choose to ignore the advice of an IR35 specialist, because you believe your status to be outside IR35, you will need to be certain that you alone can support your case and argument should HMRC investigate. On the other hand, if you agree with the IR35 contract review but decide to ignore the reviewer’s advice and take the risk, you may find that your accountant and/or tax adviser is not willing to work with you and condone a deliberate flouting of the rules.
As to where public sector contractors shun the advice they receive post-April 2017, the situation is unknown. Will offers of contracts be withdrawn if contractors don’t accept the status determination of the end-client or agency? Will you be able to appeal the decision to HMRC? Answers to these questions would ideally feature in any comment the full Autumn Statement report has to make about IR35 on November 23rd.
So for now, what can you do if you think your contract is inside IR35? Well; you can continue to operate your limited company and apply the correct deemed salary rules. Each month the tax and national insurance calculations will need to be run and a return submitted to HMRC. Although traditionally shied away from by contractors, this process has the advantage of you knowing that at the end of the tax year, you will have no further taxes to pay. You will not have any status concerns or fears of an HMRC investigation about your status. Being inside IR35 but still running your own limited company also allows you to benefit from being VAT-registered; using the FRS and undertaking other tax planning such as through pension contributions.
Retaining your PSC also provides flexibility. In fact, since IR35 is assessed on a contract-by-contract basis, you may find that your next contract is outside IR35 and more tax planning opportunities will therefore present themselves. Post-April 2017, you may decide that working in the public sector is not an option and that you will only accept private sector contracts. This decision will likely see you continue to benefit from a full range of tax planning opportunities through your company.
Alternatively, you may feel that running a company is no longer for you. There is the option to join a PAYE umbrella company or the end-user’s / agency’s payroll. In both scenarios you would become an employee and all your earnings will be subject to tax at source. You will no longer be your own boss. The upside of joining the payroll is peace of mind that taxes are paid throughout the year and that you have employment rights and/or protections, such as statutory payments and holiday pay. As its supporters often point out, the umbrella employment model provides continual employment, as it is transferable to numerous contracts and end-clients, whereas an end client or agency payroll option will only suffice for the period of the particular contract with that particular agency or end-user.
If you do decide that a limited company is no longer for you, you will need to consider what to do with your company. Closing it down is an option, but needs to be done with some thought and is determined largely by the value of the funds held in the company. Careful tax planning is needed to ensure you maximise the funds on cessation. Some contractors choose to leave their companies in a non-trading status, filing minimal returns with HMRC and Companies House. This may be a good option if you think you may want to return to the limited company or want to protect the company name in some way, especially if you have built up a recognised brand or reputation.
With six weeks to wait until the draft legislation is announced that will enshrine the IR35 proposals in the public sector, much remains uncertain. What we do know, however, is that the UK has -- and will continue to have -- a strong appetite for contractors and temporary workers. As a group, you have faced changes to legislation before; the change to the tax on dividends for example, but you are a resilient group and whatever happens you and your advisers will adapt.
What can you do now? Well; just consider the options and understand the implications of each. It has always been important to determine your IR35 status carefully and to collect evidence. This is even more important now as third parties may be relying on it. If you currently contract only in the public sector you will need to consider if continuing to do so is still right for you post-April. Private sector contractors may think they are ‘safe’ for now, but you too should take heed and ensure you can support your status. Only time will tell what the new rules will look like and how far they will reach.
Editor's Note: This article was composed and published BEFORE changes were announced to the Flat Rate VAT Scheme, with effect from April 2017. Unveiled at Autumn Statement 2016, the changes are significant and affect the calculations, case studies and analysis in this article. Tailored advice from a knowledgeable accountant should therefore be strongly considered before acting in this area.