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IR35 reforms put IT contractors at risk of 'second wave' of loan charge-like tax bills, experts warn

Concerns raised over re-emergence of umbrella firms targeting IT contractors with loan-based remuneration schemes ahead of the private sector IR35 reforms coming into play

The onset of the IR35 private sector reforms could result in a second wave of IT contractors facing life-changing loan charge-like tax bills in the years to come, it is feared.

A resurgence in the number of umbrella companies offering to remunerate contractors for the work they do via non-taxable loans has prompted several contractor community stakeholders to speak out and warn people of the dangers of aligning with such organisations – particularly those offering “too good to be true” take home pay rates in the region of 90%. 

“There is absolutely no problem with contractors using umbrella companies, as long as it’s a standard pay-as-you-earn umbrella,” Phil Manley, a director at tax consultancy PMTC, told Computer Weekly.

“But I would strongly advise staying away from anybody saying they can get you 85% or 90% net pay. Stay away by a mile, because it’s only going to cause you much bigger problems later down the line.”

This is in reference to the contractor community’s past use of loan-based remuneration schemes, which is currently at the centre of a controversial, retroactive disguised remuneration clampdown by HM Revenue & Customs (HMRC), known as the loan charge policy.

Under its terms, the tax collection agency is now seeking £3.2bn in previously unpaid taxes it claims 50,000 users of such schemes owe for work they did over a two-decade period to 5 April 2019, leaving some IT contractors with six-figure tax bills to pay by 31 January 2020.

This is because, according to HMRC, the loan payments contractors received through these schemes should have been classified as income, meaning participants are now liable to pay up to 20 years’ worth of national insurance and pay-as-you-earn (PAYE) tax contributions.

As previously reported by Computer Weekly, these schemes were legal to use, but the way they were marketed to contractors at the time has recently prompted a 200-strong group of cross-party MPs to describe the situation as a “mass mis-selling” scandal.

The number of these schemes is known to have sky-rocketed around the same time as the original IR35 tax avoidance legislation came into play at the turn of the century, and the same thing appears to be happening now. 

“IR35 only applies to contractors who operate via limited companies, so the firms claimed [these schemes] removed the threat of IR35,” Dave Chaplin, CEO of tax advisory firm ContractorCalculator, told Computer Weekly.  

“Many of [these schemes] were backed by QC opinions, and many had Disclosure of Tax Avoidance Scheme numbers [from HMRC] and were marketed as ‘HMRC approved’, which was misleading.”

There are also concerns that a second wave of IT contractors could end up exposing themselves to huge unpaid tax bills in the years to come by engaging with umbrella companies offering loan-based payment schemes in the interests of reducing their individual tax burdens.

“I’ve had a few contractors email me recently with pay illustrations that have been produced by [these] schemes, so we can expect another loan charge-type problem to occur again because of this new legislation,” said Chaplin.

Beware of sharks

Umbrella companies are typically used by contractors who want to outsource many of the day-to-day business processes associated with running a limited company or (personal services company) PSC, while also providing a means of ensuring participants are compliant with the IR35 rules.

Any work the contractor does will be paid by the end-client directly to the umbrella organisation, which will extract their fees and pass on the remaining sum as a salary to the individual, who will be liable to pay PAYE and national insurance contributions on the income they receive.

Accordingly, one of the drawbacks of these schemes is that contractors often end up with a higher tax liability working this way, compared to operating via a limited company, but – on the upside – they also reduce their administrative burden.

Ahead of the private sector IR35 reforms coming into force, high-profile companies, including Lloyds Banking Group, have committed to phasing out their use of limited company contractors to effectively absolve themselves from having to decide if the contractors they use should be taxed in the same way as permanent employees (inside IR35) or off-payroll workers (outside IR35), post-April 2020.

In some cases, this means offering the contractors the opportunity to take a permanent role at the company, or to continue on working with the firm via an umbrella company. 

If lots of private sector companies favour this approach, there may well be an rush of contractors looking for umbrella companies to sign up with, but they need to exercise caution before doing so, said Andy Chamberlain, deputy director of policy and external affairs at the Association of Independent Professionals and the Self-Employed (IPSE).

“History may be repeating itself a little bit, and our fear is people will be shoved into the arms of the what we call snake oil salesman, saying [these schemes] are all perfectly legal, and a few years down the line, those entities having taken their cut will disappear into the wind,” said Chamberlain.

“And then contractors will be left fending off the attentions of HMRC when they start asking why they haven't paid enough tax because they made use of one these arrangements.”   

PMTC’s Manley holds similar concerns, having witnessed a number of questionable new schemes arrive on the market ahead of the private sector IR35 reforms coming into play.

“I’ve seen people bringing out new schemes, saying it’s not a loan, it’s annuity scheme. If contractors go anywhere near that, they will be going back into the problems many of them are running into now with the loan charge. But whenever there is a lot of money involved in anything, the sharks will circle,” he said.

“While HMRC may have been incorrect in the past by not clamping down correctly [on these schemes], they have a right to clampdown on things proactively. So my advice would be don’t get involved. It won’t end well.”

Read more about the loan charge and IR35

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