Contractors beware, IR35 change is coming
Nearly 12 months on from the IR35 reforms introduced into the public sector, we can now assess much more clearly the impact of the changes on the thousands of contractors affected.
That’s vital if we’re to get a good handle on what could be around the corner for the private sector tomorrow, writes Graham Fisher, managing director of Orange Genie.
Feelings were running understandably high in the first quarter of 2017, with much uncertainty and fear. Commentators calculated that public sector workers could be anything between 13% and 30% worse-off, if their contracts were deemed to be inside IR35 following the changes. We were among those who highlighted that the new legislation would, in effect, move the perceived problem from one of ‘false self-employment,’ to ‘false employment’ for contractors genuinely outside IR35, but deemed otherwise by ill-informed or risk-adverse end clients.
Adding to the rancour and confusion, HMRC’s online status tool (CEST) was continually criticised by many as unfit for purpose as it ignored some case law in favour of HMRC’s interpretation. HMRC has finally admitted that the tool ignores Mutuality of Obligation -- one of the essential tests used to establish if an employment relationship exists.
Over the last 12 months, we have witnessed the following impacts:
- An explosion of tax avoidance and tax evasion schemes using offshore companies, loans, and fake intermediaries. Despite HMRC publicising the illegality of these schemes, they continue to proliferate and will do so as long as HMRC fails to enforce legislation.
- Large numbers of public sector contractors deemed to be inside IR35 under so-called ‘blanket’ decisions made by their end clients, with very few able (or willing) to listen to reason and change their opinions.
- Contractors leaving the public sector both at the end of contracts and mid-term to seek alternative arrangements -- often in the private sector, in an attempt to protect income levels.
- A move by many public sector contractors to join PAYE umbrella companies. With the loss of the 5% allowance under IR35 (for administration fees) to run a PSC, combined with the changes to the Flat Rate VAT scheme since April 1st 2017, many saw fewer advantages to running a PSC
- Some success in contractors re-negotiating day rates, where they have taken up PAYE/umbrella employment, in order to compensate for their loss of earnings. Typically, we have found contractors were -- despite the 13%-30% projection cited earlier, between 14% and 18% worse off when deemed to be inside IR35. In a small number of cases though, day rate increases of these percentages have been secured.
Private sector contractors will read these five consequences with heightened interest, as they are now enduring an uncertain wait to find out if (and how) promised changes to IR35 in the commercial sector are going to affect them.
“Early indications are that public sector compliance is increasing as a result, and therefore a possible next step would be to extend the reforms to the private sector,” his Treasury wrote.
This is clearly not the case -- in our experience. The consequences of the public-sector IR35 reforms include an enormous increase in tax avoidance and evasion, and thousands of contractors overpaying tax and NI. One thing we have certainly not seen is an increase in compliance.
At the same time, Mr Hammond announced that the government would consult on how to tackle IR35 reform in the private sector, saying officials would draw on the experience of the public sector. To date, no consultation has been announced but speculation is rife that the government may use Tuesday’s Spring Statement on March 13th to announce this.
In the absence of details on how private sector reform of IR35 would be shaped, for now, we are assuming that – in the interest of simplicity for HMRC -- it will follow the same remit as the public sector. So, what can a typical private sector contractor expect, from a financial perspective?
The following table shows the predicted difference in monthly take-home pay between 2017/18 and 2018/19 for a private sector contractor who is deemed by his end-client in 2019 to be inside IR35.
|Day Rate||2017/18 - Outside IR35||2018/19 - Inside IR35|
Assumptions: Based on a ‘full-time’ contract, claiming 500 business miles per month, Flat Rate VAT 16.5% and a director’s salary equivalent to the NI Lower Earnings Limit. Figures include a monthly accountancy fee of £120 plus VAT and an insurance cost of £36 per month.
Like their public sector colleagues, private sector PSC contractors should fear a reduction in take home-pay -- between 12% and 18% we predict, if they are deemed to be inside IR35 and the new rules are applied to their payments, with PAYE and NIC deductions made from their gross invoice value.
What can PSCs do?
It is vital that all interested parties start to think about how they may respond to the governments consultation, and any proposed changes for the private sector. Contractors, end-clients and advisers need to work together to ensure that genuine self-employed contractors -- those in business on their own account -- are not adversely affected by any proposals.
We know that a loss of staffing resource was a major problem on public sector contracts – as evidenced by some recruiters’ financial reports. We anticipate that client companies will be really keen to avoid suffering the same fate, because of its adverse impact on their productivity and profitability. So contractors, we recommend that you talk to your end clients now and make sure they are aware of the potential changes.
We even recommend you consider preparing a “confirmation of arrangement” or a “statement of understanding” with them, providing a detailed picture of your working practices. This will document – precisely -- what you have been engaged to do and explain your commercial relationship.
Now more than ever, it is really important that contractors understand and can evidence their own IR35 position. If you have not already started, consider gathering a “compliance file”. The more evidence you have to support your ‘outside IR35’ status, the easier it will be to defend your position with an end-client or HMRC.
Developing a habit of gathering evidence of both your contract terms and day-to-day working practices will mean you can always demonstrate the nature of your relationship with your end-client. Let’s hope you’ll never need to call on it, but all the signs are that you will, should you be hoping to stay PSC contracting for a company post-April 2019.