Don’t underestimate the IR35 reform underdog
There’s a sense that whatever the contractor sector says about IR35 reform, HMRC will still go ahead -- regardless, but I like to think that my article for ContractorUK at least pushed HMRC to show its hand, writes Andraste Accounting boss Carolyn Walsh, a former umbrella company director and ex-tax official.
To recap, the article was published by ContractorUK on May 16th, and the Revenue broke its long-held silence around extending the reform to the private sector on May 18th.
In doing so, HMRC deemed a ‘Withholding Tax’ as out of the question which, among other things, means that somewhere inside HMRC, a decision on IR35 reform in the private sector has actually been made already. The consultation really is just going through the motions, as others have correctly pointed out.
The main ‘choices’ tabled by the taxman are:
- Abandon IR35 and allow the reformed off-payroll working rules to become universal; or
- Retain IR35 but bring hirers in scope by virtue of a penalty regime, similar to those suffered under the RTI and CIS regimes.
My article properly looked at this second option -- clearly ‘the underdog’ of the two (in terms of its likelihood of winning out). The article did this before it was even identified as an option in HMRC’s formal consultation.
For a moment however, let’s stick with the favourite: reform IR35 in the private sector in the same way as the public sector. Should HMRC go down this route, the old legislation (introduced in 2000) will cease to exist. Believe it or not, this route has three advantages.
- No worker will be forced to set up a limited company when seeking agency work ever again, and there will be more direct paid work available with all the attached employment rights.
- If IR35 as it stands no longer exists, contractors will no longer suffer a tax liability if they have failed to consider the legislation or have got it wrong.
- If hirers bear the responsibility for making the decision on whether workers are hired on a business contract basis, HMRC can no longer get involved, freeing contractors and hirers from the burden of an HMRC intervention (except in the case of deliberate avoidance measures being deployed).
One big con
These three ‘pros’ need to be pitted against one big ‘con’ -- a huge liability on all UK businesses whenever they engage workers who are being paid through their own limited company.
That big burden for businesses arises because, under an extension of the kind of IR35 reform which hit the public sector last year, the private sector hirer would have to make IR35 decisions and also pay the PAYE liabilities if IR35 applies.
Where IR35 applies, hirers will surely prefer to engage limited company contractors who are paying employment taxes under the legislation. Or hirers will simply disengage with contractors who refuse to comply. The alternative would be to see an increased adoption of umbrella companies operating in the labour supply chain, which brings additional risks of claims being made to Employment Tribunals which, in turn, may impact on hirers, even potentially with them being ‘named and shamed’ in the media.
Under an IR35 reform similar to the one that hit the public sector, we would see commercial companies suffering a liability for making PAYE deductions on payments to limited company contractors, or they will take the risk that recruitment agencies will make the deductions on their behalf.
Everyone likes an underdog
Let’s now explore the IR35 reform consultation’s second scenario, the underdog. Here, hirers would no longer need an agency where limited company contractors were engaged and were complying with IR35, other than to source and introduce the contractors perhaps.
There is benefit in this second scenario for contractors too. The majority of limited company contractors use an accountant, and if a hirer should decide that a contract falls inside IR35, the accountant who should have gathered evidence of his or her client’s right to operate outside IR35, will be able to represent all their clients in the event of a dispute. While IR35 remains in force, the CEST tool will also help and without IR35 being reformed in the same way as for the public sector, HMRC will be able to offer advice on contracts.
If contracts do fall inside IR35, there is no choice but for limited company contractors to operate IR35. At the moment, it’s down to the contractor or the accountant to decide -- but they don’t create the terms of the contract.
Next year, if the hirer doesn’t want to take on the administrative burden of making the decisions on IR35 and monitoring the limited companies engaged in the labour supply chain, they can opt to replace agencies with a third-party for the management of the new regime. This market-based development should still increase compliance.
There will no doubt still be some blanket decisions made which may deem contractors ‘inside IR35’ in error. But in most cases, an accountant can rectify this when filing clients’ accounts to obtain a refund for ‘Wrongful Deductions.’
Where hirers issue contracts and there is a genuine right to substitution, then IR35 does not, cannot apply. Umbrella companies are petrified of false substitution clauses, so will not get involved in cases where the right to send a substitute exists in a contract, leaving contractors who are willing to operate on that basis to operate direct with hirers. Fewer intermediaries in the labour supply chain will increase compliance. And it’s not insignificant that HMRC mentions the issues caused by multi-level intermediaries involved in IR35 enquiries in the consultation as a reason for the need for IR35 reform. So other than the taxman himself, who knows? This underdog might just end up receiving his backing on reform day.