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Preparations for the onset of the IR35 tax avoidance reforms in the private sector from 6 April 2021 are well under way, with many of the medium to large firms in-scope of the reworked rules already in the thick of working out their compliance strategies.
The reforms are set to usher in a sizeable change to where responsibility will fall within the extended end-client-to-contractor labour supply chain for determining how personal service company (PSC) contractors should be taxed from 6 April 2021.
Currently within the private sector, it is up to PSCs (or limited company contractors) to determine whether the work they do and how it is performed means they should be taxed in the same way as permanent employees (inside IR35) or as off-payroll workers (outside IR35).
From April 2021 onwards, however, contractors will cede control for determining how they should be taxed to the medium to large private sector organisations that engage them, as part of an ongoing anti-tax avoidance clampdown by HM Revenue & Customs (HMRC). This work has included the roll-out of similar reforms to the public sector in April 2017.
The tax collection agency is of the view that allowing contractors to decide for themselves how they should be taxed is a system that has been used and abused in the past by individuals who have sought to mis-classify their engagements as outside IR35 so they can minimise their employment tax liabilities.
According to figures jointly published by HM Treasury and HMRC in May 2018, the cost of non-compliance with IR35 within the private sector is on course to rise to £1.2bn by the 2022-2023 tax year.
The departments have also previously claimed that shifting responsibility onto private sector end-clients for deciding how contractors should be taxed will generate an additional £3bn in tax by 2023-2024.
IR35 reforms prompt private sector-wide PSC bans
The start date for the private sector IR35 reforms was originally pegged for April 2020, but the government delayed it for 12 months to give businesses more time to prepare, as the onset of the Covid-19 pandemic began to gather pace.
Before the delay was confirmed, private sector companies in various vertical markets had already begun to show their hand about how they were planning to approach the shift in responsibility that the reforms were due to usher in.
Indeed, Computer Weekly has published numerous reports over the past 18 months about firms that have responded to the incoming reforms by seeking to side-step the requirement to individually assess the tax status of every contractor they engage with by issuing blanket inside-IR35 determinations.
Others, meanwhile, have introduced policies that amount to a blanket ban on the hiring of PSCs. Typically, this stance comes coupled with instructions that if contractors want to continue working for the company, they must apply for a permanent position or provide their services in future through a pay-as-you-earn (PAYE) umbrella company.
Private sector firms enforcing IR35-related PSC bans
- With six months until IR35 tax avoidance reforms are extended to the private sector, a number of financial services firms are thinning out their contractor workforce – is that the way to ensure compliance?
- GSK contractors that have received “scaremongering” letters from HMRC, urging them to review their engagements with the company from an IR35 perspective, are being urged not to panic, as the missives have no legal basis, claim experts.
- Tech giant IBM has notified its personal service company IT contractors that they must switch to PAYE terms or use umbrella companies from the end of March, as the private sector races to achieve IR35 compliance.
- Lloyds Banking Group is to phase out its use of contractors that engage with the firm via personal service companies (PSC) in preparation for the IR35 tax reforms being extended to the private sector, Computer Weekly has learned.
- Despite notifying staff of its intentions to phase out contractors from its workforce in December 2019, IT contractors at the Bank of America are still awaiting clarification about what their future at the firm will look like, Computer Weekly has learned.
- Barclays is understood to have notified line managers via email on 30 September 2019 of its plans to phase out use of limited company contractors, ahead of the IR35 private sector reforms coming into force in April 2020.
- BP is understood to have begun notifying its self-employed workforce about its plans to terminate PSC engagements from 31 March 2020, in anticipation of the IR35 reforms coming into play the following month.
- Consultancy giant Deloitte confirms that contractors will only be able to engage with it via a third-party umbrella or employment agency after April 2021, as part of its IR35 compliance strategy.
This is because if a contractor is on the umbrella’s payroll, the end-client is no longer responsible for determining how they should be taxed.
While all this talk of blanket bans and contractor departures made headlines, there are many other firms out there that are following HMRC’s IR35 guidance to the letter by taking the time to individually determine the tax status of every contractor they engage with to ensure a fair assessment is carried out.
Even so, it is fair to say that all this has left the IT contractor community in a state of flux, as they grapple with making sense of the new rules, and the options open to them if, for example, they disagree with the status determination their end-client hands them, or find themselves having to consider working through an umbrella company post-April 2021.
Computer Weekly has fielded emails and tweets from contractors asking for clarification about various IR35-related issues during its coverage of the private sector roll-out, and has enlisted a panel of contracting experts to answer them on our readers’ behalf.
As times goes on, Computer Weekly will add further questions to this list. So if you have a concern or query about the IR35 reforms, feel free to get in touch.
With just weeks to go until the IR35 reforms come into force in the private sector, what steps should contractors take now if their client has announced their compliance plan?
Seb Maley, CEO of insurance provider Qdos Contractor, said: “Most contractors will have an idea of their client’s plans for IR35 reform, but if you are a contractor who hasn’t heard anything, my advice is to contact them and the agency, if involved, to find out how your status will be assessed.
“The sooner you know, the sooner you can decide whether to stay put, attempt to negotiate a revised rate or, in the worst-case scenario, consider looking for a new contract.”
Maley added: “Contractors would also be wise to have a compelling case to show clients – if they feel they might need to – that their engagement belongs outside IR35 before a decision is made.
“An independent IR35 status review carried out by an objective third party may prove vital in demonstrating to a client that a contract is genuinely outside IR35 – as it also could when looking to overturn an incorrect IR35 decision.”
HMRC’s recently published IR35 guidance stipulates that end-clients must take “reasonable care” when assessing the tax status of their contractors. What does that mean?
Dave Chaplin, CEO of contractor tax compliance software specialist IR35 Shield, said: “Although there is no legal definition of ‘reasonable care’ within tax legislation, there is a considerable body of case law around the topic to learn from. Exercising ‘reasonable care’ means not being careless or negligent, so it is important that the firm conducting the assessments has a proven reputation in the complex IR35 arena.
“To give you a simple example: if you sought advice about buying a chainsaw and asked a chainsaw engineer in a garden machinery shop, and they directed you to buy a cheap dangerous fake online, you could say they were acting somewhat negligently.
“Whereas, if you yourself were an engineer and you took advice from a bloke down the pub who knew nothing about chainsaws, that would not be exercising ‘reasonable care’.”
HMRC’s IR35 guide for private sector firms states that ensuring end-clients take “reasonable care” when applying the rules and “meeting the responsibilities” they will confer upon them will form part of its compliance checks.
Introducing the private sector IR35 reforms: The countdown to April 2021
- November 2017: The government has confirmed it is preparing to consult on whether or not to roll out the controversial IR35 tax avoidance reforms to the private sector.
- October 2018: As the government confirms the IR35 reforms will be extended to large and medium-sized businesses in the private sector from April 2020, campaigners claim the move risks destabilising the UK’s flexible workforce.
- February 2019: Research from IR35 consultancy Qdos suggests contractors lack confidence in the ability of private sector firms to adequately determine how they should be taxed after April 2020.
- January 2020: Government honours pledge to embark on a review of its plans to extend the IR35 off-payroll rules to the private sector that will focus on ensuring the changes are introduced in a “smooth” way in April 2020.
- March 2020: HM Treasury confirms roll-out of IR35 reforms to the private sector will be halted for a year to ease the pressure on businesses in the face of the coronavirus outbreak.
- February 2021: As the countdown to the IR35 reforms being rolled out to the private sector continues apace, HMRC issues compliance guidance for firms in-scope of the new rules.
End-clients and deemed employers will be expected to demonstrate “reasonable care” when assessing the tax status of contractors, and when deducting the correct income tax and national insurance contributions (NICs) from their gross pay.
“We will not charge a penalty if you took reasonable care to apply the off-payroll working rules correctly but still made a mistake, including making mistakes in status determinations,” said HMRC in its compliance guide.
“If we see that you have made a mistake, we will support you to understand how to apply the off-payroll working rules correctly. We will encourage you to self-correct errors before we consider if we need to intervene further, unless there is reason to suggest you are being deliberately non-compliant.”
On this point, HMRC has confirmed that no penalties for inaccuracies relating to roll-out of the reforms will be issued within the first 12 months of their introduction, unless there is evidence of deliberate non-compliance.
Also, if reasonable care is found not to have been taken, companies could face penalties – in the form of having to pay any outstanding tax or NICs owing as a result.
There are numerous anecdotal reports of end-clients not taking ‘reasonable care’ by issuing ‘blanket determinations’ whereby all of their off-payroll workers are classified as inside IR35. What are companies that take this approach risking?
“If a business blanket places all contractors inside IR35 without ‘reasonable care’, they are guilty of non-compliance,” said Qdos Contractor’s Maley. “Not only that, but these businesses will risk walkouts and, in turn, skills shortages, given in our experience that the vast majority of contractors belong outside IR35 – 91%, to be exact.
“Alternatively, if a firm decides that it will only engage contractors on the payroll – whether via umbrella companies or on employment contracts – the likelihood is that they will also find it hard to retain their contractor talent.”
The reasons for this are many and varied, as detailed in this February 2020 report by Computer Weekly. The affected contractors might decide to leave in pursuit of an outside-IR35 role or may not be keen on the idea of having to forgo their limited company status to keep working where they are, so opt to jump ship.
Should contractors that have previously self-declared their status as being outside IR35 worry if their end-client now rules their engagement to be inside IR35?
There are concerns among outside-IR35 contractors that the scenario above could prompt HMRC to investigate their tax affairs to see if they are among the individuals it claims have used the system of self-declaration to mis-classify their working arrangements to artificially minimise their employment tax liabilities.
In its recently published guidance, HMRC said any information it acquires about how contractors operate as a result of the reforms will not be used to open enquiries into their financial affairs before the 2021 to 2022 tax years, unless there is reason to suspect fraud or criminal behaviour.
Another factor contractors need to bear in mind in all this is whether the client’s assessment of their tax status is correct in law, said IR35 Shield’s Chaplin. “If it is, then the contractor should pay the tax that is due under the original intermediaries legislation,” he said.
“If a contractor believes the client is wrong in law, they should seek a robust third-party opinion, and if it confirms findings contrary to the client, they should dispute the status assessment and also gather enough evidence and file it away.”
This is because HMRC has powers to investigate cases going back up to 20 years where it suspects deliberate non-payment of tax has occurred, and this includes seeking the tax from company directors personally, said Chaplin.
“We have come across a few contractors who think they can buy a tax loss insurance policy and avoid paying the tax that is due, expecting the insurer to pay out in the event HMRC catches up with them. That is an exercise in gross stupidity,” he added.
“It’s not possible to insure against deliberate non-payment of tax, because the policy would simply be voided by the insurer.”
What options are open to contractors should they disagree with the status determination handed to them by their end-client?
“Step one is to check the status determination statement (SDS), which will not only explain the IR35 decision, but the factors that contributed towards this determination,” said Qdos Contractor’s Maley. “If the information is inaccurate – or so a contractor thinks – they may have a strong case to challenge the assessment.
“I would recommend getting a second opinion from an expert. Armed with objective advice, a contractor will be better placed to put forward a credible and well-formulated argument for working outside IR35.”
After this, contractors need to prepare a credible challenge to the status determination they have received if they are unhappy with the result, said Maley
“To do this, contractors should get in touch with their client and explain why they specifically disagree with the determination, making sure to save any email exchanges and correspondence that could be used as evidence,” he said.
“Under the incoming reform, a business must respond to an appeal within 45 days of being informed of it. However, the initial assessment will stand until the client changes their stance, assuming the challenge is successful.”
IR35 Shield’s Chaplin said contractors need to prepare and deliver their challenge to the client in the same way a judge would structure their response.
“Focus on the facts first, then lay out the applicable case law, apply the law to the facts, then conclude with a list of bulleted reasons, each of which the client will need to address,” he said.
However, contractors must be prepared for the fact that their detailed defence might not be responded to in kind by the client.
“Under the legislation, the clients don’t have to give detailed responses if they disagree with the dispute, they just have to give ‘reasons’,” said Chaplin. “That said, firms that get a reputation for dismissing contractors’ concerns will find themselves at the back of the queue when contractors are deciding on their next engagement.”
Can end-clients compliantly introduce policies, ahead of the IR35 rules coming into force, that state they will only engage contractors from April 2021 that work via umbrella companies?
“Insisting that all contractors work via umbrella companies – as opposed to classing all of them as inside IR35 regardless of their true IR35 status – is compliant,” said Maley. “In this scenario, IR35 no longer becomes a consideration because it doesn’t apply to those engaged as employees.”
This is because when a contractor starts providing their services through a PAYE umbrella company, they effectively become its employee, and subject to the same income tax and NICs as one of their end-client’s permanent employees.
“Even so,” said Maley, “forcing contractors to work PAYE – irrespective of whether its compliant or not – is a short-sighted and needless decision that could well backfire at a time when firms need the skills, flexibility and cost-efficiencies offered by independent professionals more than ever.”
What are the benefits for contractors of working through an umbrella company?
One of the reasons why contractors opt to provide their services via an umbrella company is because it enables them to offload a lot of the day-to-day admin work that comes from running their own limited company, as the umbrella assumes responsibility for invoicing their clients and ensuring they get paid correctly, for example.
Andy Chamberlain, director of policy at the Association of Independent Professionals and the Self-Employed (IPSE), said the reason why some end-clients have a preference for contractors working through umbrellas is because it absolves them from having to make IR35-related status determinations. This is because the contractors are already on the umbrella’s payroll.
“Also a lot of employment agencies don’t want to have lots of contractors on their payroll because its too much hassle and they don’t have the resources in-house to manage it, so they bring in an umbrella company,” said Chamberlain.
“That is what the umbrella company is there to do. They effectively say to the agency: we recognise that it’s a bit difficult to manage payroll, so we’ll step into the contractual chain and provide that service for you.”
Can an end-client insist or mandate that contractors only use a specific umbrella company if they want to continue working for them?
Crawford Temple, CEO of payment intermediary compliance assessor Professional Passport, said end-clients are well within their rights to stipulate that contractors can only work through umbrella companies that they have vetted for compliance reasons.
“Various pieces of legislation place obligations on the supply chain to ensure it operates compliantly,” he said. “Where this is not the case, any debts arising can be passed back up the chain [to the end-client]. For this reason, many end-clients and recruiters will restrict the umbrella companies they will contract with.”
This is why it is general practice within the industry for end-clients and employment agencies to give contractors the option to choose an umbrella company from either a pre-prepared and vetted preferred or approved supplier list, said Temple.
“A preferred supplier list is typically a short list of providers that are promoted to contractors that currently have no relationship with a provider,” he said.
“The approved supplier list is a much more comprehensive list of providers that would be accepted where a worker has an existing relationship in place.
“We would always suggest that all providers should have a compliance accreditation before being allowed on any list, but the approved supplier list should have as broad a range as possible.”
Concerns about non-compliant umbrella companies that operate as a front for tax avoidance and disguised remuneration schemes are rife within the contracting community. How can contractors ensure they are signing up to a compliant firm?
On this point, Temple said contractors would be advised to read up on HMRC’s official guidance on this matter, which advises people against joining umbrella firms that are marketed as tax complaint while claiming their employees benefit from take-home pay rates in excess of 80%.
The only way such high take-home pay figures can be obtained is through employing some creative accounting techniques. These include only processing a small fraction of the contractor’s salary through the company payroll to minimise how much they pay in PAYE tax.
“If contractors are paid using a loan or credit of investment payment, and the company claims this isn’t subject to income tax of the NIC variety, this is tax avoidance,” he added.
Are there any other due diligence checks contractors should do before deciding which umbrella to go with?
There are other markers that contractors should look out for when weighing up which umbrella company to sign up with, said Temple.
“It is very important to choose a compliant umbrella firm, which has been rigorously assessed by one of the recognised standards in the market to ensure they are operating ethically and within HMRC’s tax rules as well as complying with other government legislation,” he said. “The contractor’s recruitment agency and end-client should also provide them with a list of approved or preferred umbrella firms to choose from.”
Umbrella company compliance concerns
- The proliferation of websites offering comparison site-like services for umbrella companies has prompted tax experts to warn IT contractors of the financial risk posed by firms offering ‘too good to be true’ take-home pay rates.
- Contracting stakeholders are calling on the government to do more to regulate umbrella companies ahead of the IR35 private sector reforms coming into play, to prevent more contractors falling into the scope of the loan charge.
- 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.
- 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.
Temple said it is also worth bearing in mind the following questions during the selection process:
- Are you likely to have expenses and will the umbrella you are looking at be able to deal with these?
- Do you want to make significant contributions into your own pension scheme? Make sure the umbrella can handle this for you as there are some real benefits when this is done correctly.
- Do you have no special requirements and just want to be paid safely? If so, it is worth selecting one of the cheaper compliant umbrellas as there is little point paying higher costs for no benefits.
- Will your agency deal with the company?
- Are you happy with the person you spoke to and how things were explained? Service levels can be a large part of the selection process.
If contractors opt to provide their services through an umbrella company, or decide to quit contracting altogether, what steps should they take to wind up their limited company?
John Bell, director and founder of licensed insolvency practitioners Clarke Bell, said that regardless of the reasons why a contractor might decided to close down their limited company, the most tax-efficient way of doing so is likely to involve embarking on a members’ voluntary liquidation (MVL), particularly if the assets of the company exceed £25,000.
“An MVL is an HMRC-approved process and a licensed insolvency practitioner must be appointed,” said Bell. “While it may have a negative-sounding ring to it – with terms like ‘liquidation’ and ‘insolvency practitioner’ – there is nothing negative about it. Quite the opposite, in fact. By placing a company into an MVL, it is a clear illustration that someone has been running a successful company.
“An MVL allows a contractor to draw any remaining profit as a dividend, paying income tax on the dividend amount. With the help of a licensed insolvency practitioner who will liquidate a company, the reserves can then be distributed as capital, which are then subject to capital gains tax [CGT] at either 18% or 28%.”
The contractor may also be able to tap into further tax benefits by going through this process if they qualify for Business Asset Disposal Relief (which pre-April 2020 was referred to as Entrepreneurs’ Relief), because it can reduce the amount of CGT due.
Bell added: “If someone qualifies for this relief, this can mean that CGT will be paid at a rate of 10% on qualifying assets, which can translate into considerable tax savings. Each shareholder of the limited company could also benefit from a tax-free allowance of £11,000 – the Annual Exempt Amount. If there are multiple shareholders, this can be highly efficient.”
When is the best time for a contractor to wind up their limited company?
According to Bell, this is a matter of personal preference. “The key consideration is normally determined by the question of when you want to extract the money from the company and have it transferred into the bank accounts of the relevant shareholders of the company,” he said.
“Clarke Bell would recommend that you discuss this with your accountant, as they will be able to advise you on how the distribution will be taxed and make sure that whatever actions you take fit in with your overall tax planning.
“They will also be able to advise you on how to close your company – ie whether to dissolve it or put it into an MVL, usually when the assets of the company are over £25,000.”
If a contractor does not want to wind down their limited company, what other options do they have?
“If there is a chance that you may return to contracting in the future and will need your limited company it might be more cost effective to keep the company open and thereby avoid some of the administrative costs that come with liquidating and reforming again at some point in the future,” said Bell.
“As the director of your company and keeping your company 'open', you will still have the ongoing administrative duties that come with running a company, such as accountancy and filing costs albeit of a dormant company. A company can remain dormant indefinitely provided you fulfil the necessary filing and reporting obligations as required by HMRC. However, by opting to make your company dormant, you won’t receive Business Asset Disposal Relief.”