Those who work in the public sector will be only too well aware of the additional scrutiny on the use of freelancers and how they operate their tax affairs.
Over the last year, we have received calls from clients who have been asked to provide assurances about their IR35 status and tax affairs.
Our advice has been:
- Ensure your contracts are reviewed for IR35 – we would suggest this is carried out by independent expert providers rather than using the HMRC helpline and,
- Assuming this review concludes they are operating outside of IR35 – then using a mixture of salary and dividends for extracting funds out of a limited company remains a robust and effective mechanism for achieving tax efficiency.
What happened in the Autumn Statement 2016?
New legislation called “off-payroll working in the public sector: reforming the intermediaries’ s legislation” will affect those working in the public sector. New proposals mean that it will be the end client or the recruitment agency who will now have to determine whether a contract is in or out of IR35. To be fair, this makes sense as the engager will be ideally placed to understand the working arrangements of the contractors.
If the contract is deemed to be within IR35 then it will be the responsibility of the engager (either the end client or the agency) to deduct tax and NI from the earnings and submit this to HMRC via RTI (Real Time Information).
The existing IR35 deemed payment which calculates the tax and NI due on earnings allows for a 5% deduction for notional expenses. This is not going to be available for public sector workers so there will be no tax relief for the costs of running your limited company/pension contributions or travel expenses when calculating the tax and NI.
HMRC are in the process of developing an online tool (employment status services or ESS) that will ask a series of questions about the nature of the engagement and provide an opinion on the IR35 status. The working practices will still be important here so whilst the contract wording may be deemed to be within IR35, the actual day to day arrangements may mean that the contract is caught.
Unfortunately, this tool is still under development with the latest estimated release date being just a few weeks before this new legislation is effective.
Caution advised! In the past, such HMRC employment indicator tools have not been based on employment law and IR35 case law so that it leads to a bias result.
Are there any benefits to remaining to trade through a limited company if you are caught by IR35?
- Contractors can still register for VAT meaning they can claim VAT back on costs incurred. From April 16, the use of the flat rate scheme is unlikely to be beneficial for many.
- In terms of fees, many umbrella companies will charge more than your accountancy fees to run the limited company. Umbrella fees typically range from £1,300 to £1,560 per year.
- You have the option of running a contract through the company that is outside of IR35
- All monies received (after the tax and NI are deducted) are paid into the company bank account whereas the payment from an umbrella is to an individual – so if the umbrella goes bust you stand to lose your money!
- Pension contributions and expenses incurred by the limited company will still qualify for tax relief in the normal way
- Capital allowances on equipment purchases can still be claimed to reduce corporation tax payable
Possible Consequences
There is speculation that this new legislation will lead to an exodus of skilled and specialist contractors out of the public and into the private sector. This will severely impact on these organisations delivering key projects and potentially incurring more cost as they seek to replace the resources lost.
Contractor UK state that there are over 500 Brexit projects underway by government departments. Many of these will be resourced with short term highly flexible specialists. There is a high risk of failure should vital resource leave the sector over the next few months.
There are potential employment right issues here – contractors will be taxed as if they are employees but without the rights that come with this status. Nor will contractors enjoy any occupational pension provisions – they are still expected to make their own arrangements.
HMRC claim this measure will bring in around £400m into the Treasury but with around 20,000 workers in this sector, this suggests additional tax per head in one year being £20,000! Unlikely I would suggest from our own experience of what contractors are earning.
Common Questions
1.Help – my agency/contract has deemed my contract to be caught by IR35 – what can I do?
Get an independent review of your contract and liaise with your end client to ensure that working practices are consistent with any “outside of IR35” opinions.
Collate evidence which supports that you are an independent contractor: insurance and equipment costs, loss on projects, additional hours worked and not billed, sent home if there are IT failures, proof that you have worked autonomously and from various sites or at home.
Public sectors are not obliged to accept/use the HMRC tool so make sure your clients are aware of this.
You can refuse the contract and seek work elsewhere if possible. You may be able to go back to the engager and ask for a review of your pay rate – you will need an increase of around 20% to safeguard your take home pay.
Claim your rights under the Agency Workers Regulations (AWR) – these are available after 12 weeks and mean you have holiday pay and access to company facilities.
2.I am in the public sector and my agency is telling me I need to use an umbrella from April 17.
If your contract is deemed not to be within IR35 then you can continue to trade through a limited company as you have been doing. Do not accept a general approach by your end client/agency to push everyone down the umbrella route. If your contract is outside of IR35, using an umbrella is going to significantly reduce your take home pay.
Where there is evidence or an IR35 review has deemed that the contract is caught then it is the responsibility of the end client/agency to operate and deduct tax and NI on the VAT exclusive earnings. Many agencies are outsourcing the tax and NI compliance to umbrella’s rather than take on this work themselves.
If you already have a limited company, you can continue to invoice/submit self-billing timesheets as you are at the moment and receive your income into the bank account after tax and NI has been deducted.
An umbrella company may choose to employ you the worker directly – if this is the case then the new off payroll legislation will not apply as all earnings will already be fully taxable and subject to NI. This relieves the end client/agency of any additional responsibilities which is why we are seeing this option being pushed onto many contractors in this sector.
Note that an umbrella company should offer you pension contributions under auto enrolment as you will effectively be an employee.
3.I’ve heard nothing from my agency/end client – what do I do now?
The end client should inform the agency or the worker that the contract is within or outside of IR35. If no communication has been made, then the worker should ask for clarification in writing. The end engager should also provide details of how they have reached their conclusion as to the contract status. The public-sector client is obliged to reply to these requests within 31 days.
4.What about expenses I have incurred?
Any materials used in the performance of the services and any expenses that could be claimed were the worker an employee can be offset against the earnings so this will typically be travel expenses. Our understanding at the moment is that these expenses will be claimed as company expenses only and that no expenses will be deducted from the earnings subject to tax and NI.
5.How does this affect my personal tax return?
All income from engagements within IR35 will be shown as employment income with tax duly deducted on your personal tax return.
6.Is the private sector next????
Although the legislation just applies to the public sector it is of course conceivable that it will at some stage be implemented into the private sector thus potentially ending a valuable source of specialist and flexible labour to these areas as many will simply seek full time employment.
Remaining Technical Issues
The end client will be deducting and paying over tax and NI on earnings as if the worker were an employee but making the net payment to a limited company. Student loan deductions are not taken through the payroll as these are dealt with on the worker’s self-assessment tax return. It is not clear how the internal payroll systems are going to cope with such arrangements where there is in effect no net pay.
It is not clear how HMRC will reconcile tax and NI being deducted on an individual basis to amounts shown and paid in the accounts of the limited company.
The employment status tool is currently under testing but is under pressure to be robust and reflect both employment legislation and IR35 case law – this is where previous tools and tests (the Business entity test for example) have failed and been discredited and not widely adopted.
It is not clear what needs to be shown in the limited company accounts – these will continue to show the income net of VAT but there may be additional expenses to be declared such as tax and NI suffered and deemed wages. As all earnings will be subject to tax and NI, it is conceivable that such accounts will show no profit so no corporation tax is payable. This simply means HMRC have moved corporation tax revenue to income tax revenue and have gained on the NI charged! Again, this brings into doubt the HMRC claimed income generation from this legislation.
Finally, what about family companies with partners/spouses who are shareholders and employees? Here again this simple and effective tax planning seems obsolete if all the earnings are subject to tax and NI by the main worker as there may be no corporation profit to accommodate these additional family member costs.
Summary – What Are The Options?
- Accept It – take the umbrella route. Your take home pay will go down and you will have no employment rights. The umbrella company will also charge you for processing your payroll.
- Fight It – make sure you have an independent IR35 contract review and evidence so you can show your contract is not caught. It is highly unlikely that the end engagers have the time or specialist knowledge in employment law to be able to take an expert view and may simply therefore wish to protect themselves by forcing all workers down the umbrella route. Remember the use of the new HMRC ESS tool (when it becomes available!) is not mandatory.
- Go Employed – if you choose this option, do get in touch so we can advise you on a tax efficient extraction of funds out of your limited company.
- Move to the Private Sector – easier said than done for some but may be a possible option and opportunity to gain experience in a new environment