Contractor's guide to working inside IR35
Three months into the revised IR35 regime for the public sector and there seem to be more contractors caught by the Intermediaries legislation than ever before. And with speculation still rife that the April rules will be rolled out into the private sector, PSC owners can no longer afford to merely understand IR35.
Contractors must know what it means and looks like to be inside IR35 (or outside). They should determine their own status based on evidence; they must be prepared to argue their case if needed and they must select their options if those arguments fail, writes Helen Christopher, operations manager at contractor accountancy specialists Orange Genie.
Where we are now
Let’s recap. New legislation introduced in April 2017 moved the responsibility to determine a public sector contractor’s IR35 status from you (the contractor) to your end client -- the public sector body. Despite the legislation’s requirement that “reasonable care” be taken when making the IR35 assessment, initial concerns over practical difficulties and the application of a risk-adverse blanket approach to decision-making, have all been borne out.
Personal Service Companies (‘PSCs,’ but also known as limited companies) with contracts straddling the April 2017 ‘go live’ date were left confused. Contractors found themselves declared ‘inside IR35’ on a contract that they had previously determined for themselves to be ‘outside IR35.’ In many cases no review of the contract and/or working practices was undertaken, nor were discussions held with the involved parties. Decisions on IR35 statuses have been reduced, in many cases, to administrative tasks taken in a remote office of a public sector body -- decisions driven by ignorance of the rules or the fear of non-compliance.
With a wave of unhappy contractors and a barrage of bad press for end-users who made decisions in such an ill-advised way, we have seen some positivity from those decisions being reconsidered. Organisations such as TFL and the NHS have reversed their approach away from ‘blanket’ inside decisions, and confirmed that they will apply the rules on a case-by-case basis, as HMRC and its legislation intend.
We have also seen contractors successfully challenge their IR35 status with their public sector clients, and seen decisions reversed by end-users, in order that they retain precious resources and skills for their large and ongoing public projects.
But with the overall increase in public sector workers caught by IR35, HMRC is soon going to make the case that these changes to the off-payroll rules have been a success. Certainly the Treasury will agree, because whether you remain in a PSC and operate the new deemed payment rules, or move to umbrella employment, HMRC will increase its tax take either way. It is for this reason that many in the contractor industry still believe that the rules will be applied on private sector contracts.
While we’re on the worst-case scenario -- let’s imagine another. You, caught by IR35. What does that mean, in your monetary terms? How would no more 5% IR35 allowance in the public sector affect your bottom line? And what’s the damage, overall, since your VAT rate likely increased in April?
Caught by IR35: the tax position
Statute 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 if on a private sector contract.
But since April 2017, this 5% has been removed for public sector workers. In all cases, 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.
The situation has been further complicated because since April 2017, a public sector worker does not apply the deemed salary calculations themselves through their company. Instead, these are carried out by the “fee-payer.” Identified in the legislation, this fee-payer is defined as the organisation closest to the PSC in the supply chain which pays the invoices. In this scenario, invoices are paid net of the deemed employment taxes. Private sector contractors continue to apply the deemed salary calculations themselves, though their own PSC payroll RTI submissions.
To tot up what this all means, financially and in the real-world, let’s reintroduce IT consultant Ian, from our pre-April Inside IR35 guide.
IT consultant case study
Tech 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, under which (since April) he’s a ‘Limited Cost’ trader. He could find himself up to £750 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 £3,550 per month, whereas inside IR35 this could drop to £2,800.
Ian’s take-home pay when inside IR35 is comparable to that from a PAYE umbrella model, which would yield approximately £2,848. Before April 2017, there was a small advantage for him of being inside IR35 compared with using an umbrella company’s PAYE, due to the income earned from the Flat Rate VAT Scheme. Since April 2017 and the introduction of the 16.5% FRS category of a ‘Limited Cost’ trader, this advantage has now gone for many PSCs, positioning umbrella employment with full employment rights as the better option.
Being outside IR35 of course remains the most financially attractive option overall, but IR35 status is not a choice. It is determined on the terms and working practices of your individual contracts. Applying an incorrect IR35 status can be expensive. Declare a contract outside only for HMRC to deem you to be inside, and you will face additional taxes and potentially penalties depending on their view of culpability. Be found to be inside IR35 and your income will be greatly reduced.
Public and Private
So what options do you have? All contractors should consider their IR35 status before the taxman does (and before their end-client 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. You can then decide how to operate.
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. 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/status adviser is not willing to work with you and condone a deliberate flouting of the rules.
However, when working in the public sector, the IR35 decision sits with the public sector body and although you may feel that there is little you can do to challenge any ‘incorrect’ decision, you do have options.
Helping your public client decide correctly
You and your agency should ensure that a robust process is being followed and that decisions are being taken fairly. Many public sector bodies fear the loss of skilled contractors and resource as a result of the new rules and are willing to have sensible conversations around the IR35 status of a particular role.
It is important when trying to influence the decision that you base your arguments on fact and provide as much supporting evidence as you can.
Undertake an Employment Status review using HMRC’s new tool (the ESS). The tool has faced much criticism, but it is being used by public sector bodies and it is the only tool that HMRC has said they will stand by, assuming all information provided is truthful.
If your result supports the opinion provided by your public sector body, it is probably the right move to accept the assessment and consider how best to operate. If you disagree, you may want to provide further supporting evidence. Your agency will be keen to retain you and for the contract to run, so they too may assist with providing evidence.
But don’t stop at your agency to aid your position. A full contract and status review can be carried out with an external specialist. An IR35 review will involve more than the questions posed in the online tool, and will allow an adviser to talk to you, your agency and perhaps your end-client too, about both contractual terms and working practices. The outcome of such a review, based on evidence pooled from many sources, can prove powerful.
Inside IR35 inertia
If the public sector body has determined that your current role is inside IR35 and won’t budge from deeming it ‘caught,’ you will now have realised that you’re going to be taking home less money. So you are faced with a choice. Firstly, before accepting the ‘inside IR35’ role, consider negotiating an uplift to the pay rate, either through your PSC or an umbrella solution.
Secondly, how are you going to operate? You can of course continue to use your PSC. Private sector contractors would apply the deemed salary rules appropriate to them, and report these through the PSC’s payroll RTI submissions. Public sector contractors would have their deemed salary taxes deducted at source, by the fee-payer (as outlined in the ‘nuts and bolts’ section) prior to the payment of their invoices. Alternatively, you can join an umbrella. Or if not, you must look at ‘Agency PAYE.’
It is still early days under the off-payroll legislation and there are still many questions and scenarios yet to be tested. Contractors and temporary workers remain a vital part of the economy and are already adapting to the new legislation. Flexible solutions to allow switching between a PSC and umbrella company on a contract-by-contract basis are available. Contractors are re-negotiating rates to go umbrella, allowing them to retain the same take-home pay while others are gearing up to legally challenge their IR35 status.
Whatever your scenario, you need to remain alert. Understand who is making the IR35 status determination and how they are doing this. Be aware of the implications of each outcome and continue to gather evidence to support your view of your status. Lastly and perhaps most crucially for the future of contracting as a whole, be forewarned that the IR35 changes in the public sector may be extended to the private sector because then you’ve an optimal chance of being forearmed.