How much April 2020’s changes to IR35 could cost contractors
Although polls (and headline-writers) are right to point out that in some pockets of the business community, awareness of April 2020’s IR35 changes may be patchy, there are some aspects of the incoming framework which ContractorUK readers would probably deem ‘well-known.’
Less well-known is the financial impact of these IR35 changes, writes James Foster, senior commercial manager at SJD Accountancy. In particular, if there are no changes to the draft IR35 legislation, what is the the income dent that contractors are looking at?
How big is that dent if they are declared inside IR35? And what does the bottom-line look like for a contractor who avoids IR35 by going PAYE internally, or externally such as through an umbrella company?
IR35 reform: the well-known
For now, let’s remind ourselves of the well-known.
The reforms will apply to all medium and large businesses, so not small businesses with fewer than 50 employees, less than £10.2m annual turnover or a balance sheet totalling less than £5.1million.
The responsibility of determining whether a contract is inside or outside IR35 will sit with the end-client rather than the contractor. The end-client must assess the status of off-payroll worker and produce a 'Status Determination Statement' outlining that assessment.
The end-hirer needs to pass this information down the supply chain as it is the ‘fee-payer’ who is responsible for deducting the PAYE/NIC. If the information is not passed on, the liability remains with the party which experienced compliance failure.
Do the IR35 changes financially impact me?
Theoretically, if your current contract and working practices are deemed outside IR35, you should not be financially impacted as you should remain outside IR35 after April 2020 too. The keyword here is 'theoretically' though, as although HMRC has said that 'reasonable care' should be taken, the legislation has not defined what exactly this constitutes.
Contractors fear that companies could prefer 'blanket decisions' regarding their use of Personal Service Companies because the process is arduous, unwieldy and risky. It ultimately sits with them as the end-hirer, meaning that they are liable if an incorrect decision is made.
That’s largely why we have witnessed many UK banks take this risk-averse approach, with HSBC, Barclays, Lloyds, RBS and Tesco Bank deciding not to work with contractors who provide their services via their own limited company, where avoidable. Situations such as this only further escalate contractors’ fears.
Therefore, even for those that remain confident their contracts and working practices are outside IR35, there is still the risk that your client's decision will not reflect this. Although there will be a 'client-led dispute' process, contractors may face an ultimatum of going PAYE, via an umbrella company or losing contracts altogether, before that dispute process gets put in place or can apply. With this ultimatum, the financial impact would be large.
Take-home pay approximations from April 2020
A contractor, depending on day rates, could achieve around 65-75% take-home pay through a tax-efficient combination of salary and dividends. This will undoubtedly reduce if the contractor needs to accept a PAYE or umbrella role because of the IR35 changes.
In a PAYE/umbrella role, your take-home could be closer to 60% because of tax rates and the loss of claiming tax relief on travel, subsistence, and other business expenditure. This is important -- if you have an accountant and you’re reading this as a limited company contractor, ask your accountant to compose a tailored breakdown down of your possible ways of working, as there are many variables to consider when estimating your take-home pay.
With much lower take-home expected, a lot of contractors will look to negotiate a higher rate of pay with their clients. However, pushing for a percentage hike may not be successful as the costs for engagers/employers won't remain the same either under the off-payroll framework. Companies will become responsible for additional costs, such as:
- Employer NI at 13.8% (plus an Apprenticeship Levy cost of 0.5% will also apply if the total wage bill is above £3million)
- The cost of Employee benefits, such as holiday pay, sick pay and employer pension contributions, which would become a mandatory cost for end-hirers.
Be warned -- the process of renegotiating rates can become lengthy and complicated, especially when everyone is at it and under pressure! In fact, employers will be looking to recover the costs of paying the employee insurance and benefits, while the contractor is going to be looking to retain a take home pay similar to what they earned when they were outside IR35.
If you were to go through an umbrella company, there's also a margin that the umbrella company will retain for administering the payroll. Unfortunately, this would reduce a contractor's take home-pay further.
Making informed decisions
With all of this in mind, contractors must make informed decisions regarding their future working arrangements before the legislation comes into play in April 2020. Speaking with a qualified accountant to assess the different options available is the best way to determine the right method to proceed.
Qualified accountants can help you to calculate what your take-home pay would be if you worked on contracts deemed outside IR35 through a limited company, versus if you worked through an umbrella company or as a PAYE employee. They can also advise on what you would need to negotiate to achieve the same take-home pay as you achieve currently. Gathering all of the information available is the only way to ensure contractors can make the most beneficial decision for themselves, financially.