WHAT IS IR35
You may have heard the term IR35 before, but do you know what does it stands for, or more importantly, what it entails? It is legislation designed to deal with tax avoidance by workers who are providing their services through intermediaries such as a limited company, who otherwise would have been an employee if no intermediary was used. HMRC refers to these workers as ‘disguised employees’.
THE RULES AND REGULATIONS
The law applies to contractors such as city bankers, IT specialists, electricians, construction industry workers and many more. Special rules are implemented for ensuring that tax is deducted properly under the IR35 schemes.
- An agency hiring a worker should identify the current status of the contract and whether it is operating inside or outside the scope.
- When the agency confirms that a contractor is working inside the rules means the agency has to deduct National Insurance contributions (NIC) and Income Tax before paying the contractor’s fees
- Individual contractors operating inside scope will also now not get a 5% expense allowance, which they were once entitled to. Contractors impacted by this rule will have to pay tax like an employee. In addition, their employment status does not change so they do not receive any rights and benefits that go with employment
REASONS FOR IMPOSITION
Simply put, IR35 is in place to increase the tax receipts for the government. HMRC deem that many contractors working through intermediaries are taking advantage of the perceived tax benefits of working through a limited company and pay less tax than a similar worker who is employed under Pay As You Earn (PAYE).
HMRC are not only targeting individuals with IR35, but employers who are taking on workers outside rather than via employment. If a company takes on a worker via employment, they are not only collecting and paying over income tax and NI to HMRC, but also paying Employer NI at 13.8% on qualifying earnings, whereas paying someone through an intermediary such as a limited company incurs no Employer NI. This imbalance is what HMRC is looking to rectify
FINANCIAL IMPACTS
If anyone is caught ignoring IR35, they have to pay National Insurance Contributions (NICs) and income tax as if they were employed. It has a significant financial impact.
- The net income of a worker can get reduced up to 25%. Much of it is due to the employer’s NIC being due on top of their own liabilities. This leads to a top marginal tax rate of more than 50%.
- After getting caught to determine how much extra tax must be paid, one can begin by using the “IR35 calculator” available online. This calculator provides the value of financial impact on your net income and used to assess the consequence.
- The penalty is usually 30% if HRMC is convinced that the contractor was unmindful. However, the penalty can jump to 70% and sometimes 100% even, if the contractor is caught deliberately avoiding payment despite knowing.
- Contractors may have to pay 25% extra tax and NICs if they are caught being a disguised employee. This rule allows only a 5% allowance for expenses and the rest of a contractor’s gross earnings being subject to income tax and NICs, seriously penalising those contractors affected.
- HRMC launched a digital tool that can test the status of contractors. It is a series of questions that provides a determination whether an engagement is inside the statute.
- Legal experts can be hired to deal with any issues in a contracting sector. Moreover, a major concern is that HRMC can go and research last six years’ worth of records and evaluate past contracts to see if the legislation was followed.
- If caught, HRMC can demand income tax and NICs, including penalties and interest
CONSEQUENCES ARISING FROM IR35
With all the complexities involved, it’s not surprising that IR35 reform, when rolled out to the public sector have resulted in various problems. Several public sector organisations have been negatively affected as many contractors preferred to leave ongoing projects to seek work in the private sector rather than continue working with the increased tax burden
- Contractors of the National Health Service (NHS) trust had abandoned an ongoing £16.5 million health service IT project, after being declared inside.
- Recent surveys also show that the biggest-taxpayer projects of UK will be destroyed by a mass walkout by contractors.
- Limited company contractors forced into these rules would face a huge cut in their net pay. The UK labour market will be seriously affected.
- The government will lose treasured specialists in key areas such as IT. It would disrupt the high-profile public sector projects
- As key workers have left their public sector roles, the public sector bodies have had to hire replacements for those vacancies from a reduced talent pool, often having to pay a higher-than-market-rate to avert projects grinding to a halt
- The government may have to consider paying talented workers more in order to convince them to stay. Long-term, this is a very harmful scenario and the IR35 reforms may lead to severe skill shortages and affect innovations in future
Whilst there is merit in the Government trying to increase the tax yield by cracking down on what they believe to be tax avoidance, there seems to be a lack of understanding of the risks that contractors take by not having job security or the rights enjoyed by their employed counterparts.
Contracting has always been a flexible method for business to take on workers and the balance of risk and reward for workers kept the equilibrium in place. To conclude, we believe that the future is bleak for the contracting industry and if the IR35 reforms are rolled out to the private sector, it will mean effectively killing off contracting as an industry.
