From April 2020, the Government is set to extend its contentious IR35 rules to the private sector. The scheme is intended to stop employers disguising workers as contractors in order to gain tax breaks.
Are the new IR35 rules a good fit for the private sector? Or the public sector for that matter?
IR35 changes were introduced in April 2017
The changes to IR35 arrived to much debate, disruption and chaos – much of which has still not been resolved.
Historically, the contractor determined their own IR35 status and was liable for all taxes if later deemed by HMRC to have arrived at the wrong conclusion. That has now changed.
HMRC is attempting to crack down on what it refers to as “disguised employment” and, under the new rules, the status determination switches from the individual to the hiring body or the recruitment agency used by that hirer.
This comes with a new tax regime that increases the cost of hire for contractors deemed as covered by the new legislation. Grappling with these new assessment responsibilities as to whether a contractor is a “deemed employee” is no easy matter.
What the changes mean
The most significant difference brought about by the new rules concerns employer’s National Insurance (NI). Currently, under Chapter 8 of ITEPA, when a worker is deemed caught by IR35, employer’s NI is reversed out from their fees. However, under the new Off-Payroll rules, this tax – along with the Apprenticeship Levy – is to be paid on top of the worker’s earnings by the fee-payer – because the fees paid to the contractor have to be treated as employment income.
Though a recruitment agency will often qualify as the fee-payer, this extra cost would cause most of them to fold. Realistically, the hiring firm will have no choice but to cover this cost, unless they can renegotiate all their contract rates downwards by 20-25%. That seems unlikely.
Many people aren’t aware of this hidden tax bomb. Instead of clarifying the situation, HMRC and the Treasury have obscured matters through the entirely false reiteration that ‘the reforms do not introduce a new liability or extra tax’.
The stark reality is that this is a new liability which increases the cost of hiring ‘deemed employees’ – contractors assessed as ‘inside IR35’ – by 13.8% for employers NI and 0.5% for the Apprenticeship Levy.
Prevention of tax relief
The rules also prevent workers from claiming tax relief on expenses, which will prove costly for anyone who travels and stays overnight for work. Those affected, as we saw in the public sector, will likely seek to offset this by negotiating an increase in contract rates, clashing with the client’s wish to reduce fees to cover some of their new tax costs.
Either way, renegotiation is inevitable. Contractors who are assessed inside IR35 are unlikely to travel far afield, reducing the mobility of the flexible workforce and driving contract rates up even higher.
Our calculations show that, for a travelling worker who stays overnight four nights a week to receive the same take-home pay as before, the cost of hiring for the client could increase by up to 43%. By contrast, a client would need to reduce the contract rate by roughly 20% to ensure the same cost of hiring. Both parties are poles apart here – and a tug of war will likely ensue unless the contractor can continue to be hired as genuinely self-employed.
As an alternative, clients might decide to downsize their contingent workforce, using the sums saved to pay the tax bills due on fees paid to the remaining contractors. Essentially, this is damage limitation, enabling firms to retain some access to necessary skills without spiralling costs.
The risks for contractors and firms
The gravity of the situation is illustrated by the measures that some organisations in the public sector have reportedly taken. There have been widespread reports of organisations engaging contractors via umbrella companies. Through those companies, contract rates are falsely advertised to contractors – the fee-payers employment taxes are included.
This has resulted in unlawful deductions from agreed contract rates. We are beginning to see some litigation work its way through the civil courts as a result. Being completely transparent with workers is essential to avoid later complications.
The risk for both contractors and firms is large and the knock-on effects will be widely felt. Firms still seem to be blissfully unaware that they are going to be saddled with an additional 14.3% cost in extra taxation for hiring contingent workers. The reality is, of the extra tax due, around 80% of it is payable by the firm hiring the contractor.
Looking at the public sector experience, it is likely that those responsible for hiring contractors will overreact, try to force contractors to work on payroll, and treat them as full-time employers for tax purposes, while also trying to pass their new tax bills onto them. This means a large rate decrease for contractors – being treated like a “deemed employee” while not being given the rights and benefits that go along with employee status.
The impact on employers
Consider for starters the impact of telling a worker they are a disguised employee, not giving them rights, and then having that challenged at an employment tribunal. What better evidence for a contractor than a hirer’s IR35 assessment deeming them to be an employee? It’s no wonder many firms are reportedly clearing out their contractors prior to April 2020, for fear of what might happen.
The employer will have the added expense of paying National Insurance, sick pay, holiday pay and all the other associated obligations. In addition, there will be times when there is a surplus of staff and other times when there is a shortage, as workflow fluctuates. Employers may decide to take on less qualified freelancers to compensate for the extra cost when extra help is needed.
As the government plans to drag the whole contracting sector into the sorry saga of IR35 “reform” by 6 April 2020, this year will be crucial for the industry. The forecast is bleak. However, there is time to mitigate the effects by assessing the risks and taking appropriate preventive measures now.
Companies must prepare by assessing their situation to gauge the size of the challenge they are facing. They need a workable plan, ready to implement. Early action is essential if businesses what to retain access to existing skills and flexibility, avoid spiralling costs, protect existing projects and above all, prevent contractor walk-outs come next April.
For more tax-related articles:
- Off-payroll working in the private sector: the ticking timebomb
- Reverse VAT charge will shake up construction
- Opinion: What are the prospects for more devolved taxes?
- Will the UK become a tax haven after Brexit?
Dave Chaplin is a contributor for AT magazine.