IR35 reforms: HMRC urged to correct clause in off-payroll rules that could ‘kill off’ umbrella firms

HM Revenue & Customs (HMRC) is facing calls to urgently tweak the incoming IR35 tax avoidance reforms, following the discovery of an “errant clause” within its wording that calls into question the need for IT contractors to engage with clients via umbrella companies in future.

With six months to go until the revamped IR35 reforms come into play for the private sector, concerns have been raised about the inclusion of this clause within the off-payroll legislation that experts claim, if left unchecked, could prove hugely problematic for IT contractors who provide services to clients via umbrella companies.

This set-up is frequently favoured by contractors who want to outsource the administration and accounts work involved with operating as a freelancer, with the umbrella company taking responsibility for invoicing the clients the contractor works for and ensuring the correct tax deductions are taken from their salary each month and paid to HMRC.

However, a change introduced to Chapter 10 of the Income Tax Act 2003 by the Finance Act in March 2020 has the potential to upset this dynamic and render the role of umbrella companies in this process irrelevant by effectively misclassifying such firms as “intermediaries”.

HMRC defines an “intermediary” as an organisation that arranges for contractors to work for a third-party client, and within a typical contractor set-up, that role is assigned to the recruitment agency tasked with sourcing freelance workers on behalf of their client.

In its current form, the legislation effectively expands the intermediary definition to include any company involved with making a “chain payment” to a worker, which is a duty typically performed by an umbrella company.

Under the terms of the off-payroll legislation, the deduction of employment taxes must occur before payment passes to the intermediary, which means the umbrella company’s payroll management responsibilities now effectively fall under the remit of the recruitment agency.

According to Dave Chaplin, founder and CEO of contractor-focused tax compliance specialist IR35 Shield, these changes risk rendering the role that umbrella companies play within the contractor-to-client supply chain surplus to requirements.

“These changes are potentially disrupting for umbrellas and the agencies that rely on them,” he said. “Many agencies legitimately use umbrella companies to avoid operating their own payroll, and may now need to bring their payroll in house – for which many providers also offer a service.

“We are unsure what the specific purpose of the change [to the legislation] was intended to achieve, but we find it hard to believe that the plan was to shut down the entire umbrella industry.”

Chaplin added: “It is hard to believe, without any announcement, that legislators have decided that agencies should be responsible for all tax deductions, thereby removing payment intermediaries from the supply chain.”

HMRC has sought to clear up the confusion through the publication of a note addressed to IR35 stakeholders in recent days, in which it states the changes were not intended to broaden the definition of intermediaries to include umbrella firms.

“HMRC is actively engaging with stakeholders on this issue and continues to work closely with them,” said the note, seen by Computer Weekly. “HMRC is considering what action is required to ensure the off-payroll working rules apply as intended in order to provide certainty to those affected by the reform.”

Concerns about the wording of the legislation are known to have been circulating for some time among contracting stakeholders, as Computer Weekly understands IR35 Shield’s Chaplin first contacted HMRC privately in mid-September 2020 to make it aware of the potential implications for the contractor supply chain if the legislation were to come into force in its current form.

The repercussions of the move were also shared in writing with the agency, in form of a technical paper from Chaplin, that was also circulated to various contracting stakeholders.

On 8 October 2020, Chaplin went public with his concerns over the contents of the legislation. Computer Weekly contacted HMRC for its response to his claims.

HMRC is known to have held a meeting on Wednesday 14 October with members of the IR35 Forum external stakeholders group, which included members of the Freelancer & Contractor Services Association (FCSA), to discuss the potential risks involved if the legislation were to come into force in its current form.

In a statement, the FCSA – whose CEO attended the session – described it as a “very positive and constructive meeting”, during which HMRC “accepted there is a clear problem with the legislation” in it current form.

“HMRC will be working swiftly to address the issues and share our view that primary legislation via the Finance Bill is almost certainly the route to doing so,” the FCSA statement said.

“HMRC are treating this matter with urgency and we have come away with a very real sense of confidence that the matter will be resolved in advance of the IR35 changes next year.”

In a follow-up statement to Computer Weekly after the 14 October meeting, HMRC reiterated: “We have engaged with stakeholders to understand their concerns about part of the off-payroll working legislation and reassure them that the policy intention remains in line with our published guidance.

“We continue to work closely with stakeholders on this issue and are considering what action is required to ensure the rules apply as intended.”

In response, Chaplin said it was good to see HMRC commit to taking “swift action” to address the issues flagged up in the IR35 Shield technical paper, but it needed to get moving to ensure any corrections to the wording are in place before the legislation comes into force in April 2021.

From that date, medium to large private sector companies will assume responsibility for determining whether the contractors they engage with should be taxed in the same way as permanent employees (inside IR35) or as off-payroll workers (outside IR35) based on the work they do and how it is performed.

Currently, contractors are responsible for self-declaring their own tax status, with an inside-IR35 determination meaning they are liable to pay the same national insurance contributions and employment taxes as permanent employees, without being eligible to receive standard benefits, such as paid holiday or sick leave.

Chaplin added: “The challenge now, however, will be drafting an amendment to the legislation that can be enacted into law before April 2021 when the new off-payroll rules come into effect.”