IR35 reform: Weighing up National Insurance liabilities post-April 2020
As the comments, confusion and complaints about National Insurance liabilities relating to IR35 private sector reform in 2020 hit ContractorUK and its Forum, let’s run through which taxes HMRC will collect from you while fulfilling your contract through an agency, a PAYE scheme or a limited company.
As the consensus leans towards operating through an umbrella company due to the simple nature of automatic tax deduction, we’ll also explore alternative ways to run your IR35-caught contract, taking into consideration the increase or decrease in National Insurance Contributions (NIC), and additional benefits which translate into cost savings.
As a contractor or self-employed professional, you could be subject to any of the four classes of NIC, all of which are mitigated by your level of income and previous NIC track record, writes Jon Munnery of UK Liquidators, a specialist firm of licensed insolvency practitioners offering advice on Creditors’ Voluntary Liquidation (CVL) and Members’ Voluntary Liquidation (MVL).
National Insurance Contributions – Quick Refresher
The class of National Insurance applicable to you very much depends on your working practices. These are the four classes of National Insurance: Class 1, Class 2, Class 3 and Class 4.
Employees earning more than £166 a week and under State Pension age - they’re automatically deducted by your employer. This is made up of Employees’ National Insurance Contributions which is deducted from the contractor’s pay and the Employers’ National Insurance Contributions which is paid for by them.
If you are operating as a contractor through your own limited company, Class 1 National Insurance will be applicable. However, you will only suffer National Insurance deductions on your salary if it is over the Primary Threshold, currently set at £8,632 for the 2019/20 tax year. The most tax-efficient way to draw funds from reserves in a limited company would be through taking a dividend as this is not subject to National Insurance deductions.
Class 1A or 1B
Employers pay these once a year directly on the expenses or benefits of employees. The rate for the 2019/20 tax year is 13.8 per cent. Class 1A or B would only apply to a contractor if they are receiving benefits in kind from their limited company (the employer). For example, if the director has a company car or medical insurance paid for by the company.
Self-employed individuals - you do not have to pay if you earn less than £6,365 a year, but you can choose to pay voluntary contributions to fill any gaps in your National Insurance record. If you earn over £6,365, you will have to pay class 4 in NIC, working out as £3 per week.
Voluntary contributions - you can pay them to fill or avoid gaps in your National Insurance record. This is primarily done to ensure eligibility for the State Pension.
Self-employed individuals - if your profit exceeds £8,632, Class 4 National Insurance applies. You will pay 9% on profits between £8,632 and £50,000 and 2% on profits of over £50,000.
Following the reform to IR35, if a contractor is caught by IR35, the engager will deduct the applicable tax and National Insurance from their pay. The onus falls on the engager to ensure the correct deductions (Class 1 National Insurance and PAYE Tax) are made and paid to HMRC.
National Insurance Contributions for Umbrella Company, Agency or PAYE
As a contractor operating through an umbrella company, the umbrella company will be required to deduct Employees’ NIC, income tax and Employers’ NIC before making payment to the contractor. If you’re operating through an umbrella, the fee owed to the brolly will also be deducted before you are paid.
If you turn to this operating structure, your umbrella company will become your ‘employer’ which is where the requirement to pay Employers’ NIC factors in.
As a result, you may be eligible for employee rights and benefits, such as holiday pay, maternity/paternity pay and sick pay which could outweigh the monetary difference, in terms of take-home pay, between a PSC and umbrella company. If caught under IR35, you will be subject to NIC and income tax which makes working through an umbrella company a suitable solution following the April 2020 reform to IR35.
It’s vital to ensure that the correct take-home pay rate is advertised by your end-client after taking into consideration the necessary deductions. The rate of the contractor is typically ‘uplifted’ so when the end-client makes payment to the umbrella company, this covers the likes of Employers’ NIC, holiday pay and pension contributions, for example. Depending on your role and daily rate, this option could prove lucrative following April 2020.
National Insurance Contributions for Limited Company Contractors inside IR35
Working as a limited company contractor can reap tax savings, such as savings on income tax and National Insurance Contributions. However, if you are caught by IR35, you will be subject to PAYE tax treatment, similarly to a permanent employee but without the employment rights or benefits. If post-April 2020, you’re expecting to work inside IR35 on a private sector contract, it’s important to calculate your expected take-home pay before instantly writing off your limited company. If you do decide to take the limited company route, take into consideration your tax obligations, including income tax and NIC.
A limited company contractor can typically structure payments by taking a basic salary lower than the National Insurance Primary Threshold (currently at £8,632 for the 19/20 tax year). Additional funds can be extracted through dividends which are not subject to tax or National Insurance Contributions providing you stay within your tax-free dividend allowance, which is £2,000 for the 2019/20 tax year.
If you are looking to work through an umbrella company but would like to keep your limited company on the back burner, you may consider company dormancy to reach this halfway point. Note that your limited company take-home pay will vary to using an umbrella due to ongoing operating costs, accountancy fees, pension contributions, company insurance and taking into account allowable expenses.
National Insurance Contributions for Sole Traders
IR35 legislation is intended for limited companies and partnerships and therefore doesn’t affect sole traders. Although the IR35 private sector reform will not affect sole traders, if they are disguised as employees and match up against the key employment status indicators of Supervision, Direction or Control (SDC), it’s more than likely that HMRC will come knocking on the door to recover the correct amount of NIC and income tax. If the true nature of your working relationship with the end-client is that of an employee and employer, HMRC will be well-positioned to query payments made by your client to you.
What’s the role of the Engager?
Following the April 2020 off-payroll rules, the engager will be responsible for the status determination as they will be best placed to understand the role and responsibilities of the contract in question – or so HMT/HMRC has decided. This will apply to private sector contracts in which the end-client is a medium or large business.
As a result, the engager will be directly determining whether the contractor will be liable for NIC and PAYE deductions, playing a pivotal role in the level of income generated by the contractor, and with the potential to reduce net income significantly. The engager is responsible for taking “reasonable care” in producing a Status Determination Statement (SDS), ensuring that the correct tax treatment is in place. The SDS reflects a mutual understanding between the engager and the contractor on IR35 status; however, this can be disputed if it does not accurately reflect the working conditions of the contractor.
As the reform shifts the liability from the contractor to the end-client, the determining factors of Control, Substitution and Mutuality of Obligation remain the same. In the run-up to April 2020, non-compliant blanket decisions continue to injure livelihoods and big-name organisations once providing rewarding opportunities are, en masse, cutting such contracts. It may be wishful thinking to expect a last-minute policy change or deferral announcement at the 2020 Budget, but one can hope the rushed in legislation is forced out, just as fast.