Upcoming IR35 changes for contractors

The recent Autumn statement confirmed some major changes to the way that IR35 will be applied, in particular to the public sector.

Here we will remind you what IR35 is about, what is changing and why there is a fear that the new reforms will leave a critical skill shortage of contractors in this sector.

IR35 is a tax legislation that attempts to capture tax lost where individuals have set themselves up as limited companies supplying services to a client but where the relationship and the working practices are more akin to being an employee.

Historically, those workers offering their services through a limited company (also known as personal service companies or PSC) benefit from paying less to HMRC by combining a low salary and dividends which are not subject to national insurance.

Three key employment tests are currently used to determine the status for IR35. These concern the way the worker is controlled, whether their personal service is required or they can send in a substitute should they wish and mutuality of obligation.

These are not, however, straight forward tests. Many other factors including the wording in contracts and the reality of the working relationship need to be considered. The complexity of this area has generated much uncertainty in the contractor market especially as any worker will be liable for the deemed tax/NI lost should HMRC be successful in claiming that IR35 applies.

As you read this it may be December but the latest reform doesn’t bring much Christmas cheer to contractors working in the public sector who are already paying higher taxes on dividends as from 1st April 16.

So, what it going to happen with the reform of IR35?

As we have mentioned, the present situation is that the contractor will be personally liable should they fail the IR35 test and not subject their earnings to tax and NI.

From April 17, The Government will be moving the liability to pay the correct employment taxes away from the worker to the public sector body or agency / third party who has engaged the contractor.

The fear is that public sector bodies, many of whom are already facing budget cuts, will reduce their use of contractors if they now need to pay employer’s NI which is currently 13.8%. As for the contractor, they will see a reduction in take home pay as NI will be applied to all their earnings which previously have been free from this cost.

A recent poll of IT contractors which totals around 18,000 individuals returned results saying at least 54% will leave the public sector*

It gets worse……From April 17, any PSC deemed to be within IR35 will also lose the 5% tax allowance allowed to cover expenses incurred in running their company.

HMRC state that they will develop an online tool to help contractors and agencies in determining IR35 status but in the past these tools have been overly simplistic and open to giving misleading outcomes.

To illustrate this a company with a turnover of £100,000 (net of VAT) would have been able to claim £5,000 under the 5% rule saving it £1,000 in corporation tax. From April 17, if found to be within IR35, this £1,000 saving in tax is lost.

Seb Maley, Director of IR35 experts Qdos had this to say about the IR35 reform “The proposed new rules do appear complex and cumbersome, and the biggest question will be how agencies and public sector bodies will react. The development of an online tool will also be interesting, particularly if the same tests for IR35 remain in place in April 2017.” **

For now, our advice is that all contractors should ensure that each new contract won is reviewed independently for IR35. See here for a list of expert providers. For those with contracts that fall within scope of IR35, additional tax and NI will need to be paid but the 5% expense allowance will only be available until March 31st 2017.

As always C&M Accountants are on hand to answer any questions you have about these reforms. Feel free to call us or pop into our office for some friendly impartial advice.