If you are contracting through your own limited company then you will most likely be affected by the upcoming changes in the IR35 legislation. In this IR35 News update, we explain what is changing and how this will affect you.
Background.
IR35 or the intermediaries legislation is designed to combat tax avoidance by workers and the firms hiring them who are supplying their services to clients via an intermediary such as a limited company but who would otherwise be an employee. Such workers are usually referred to as deemed employees.
If caught by the legislation, they would pay income tax and National Insurance Contributions (employees and employers) as if they were employed. This can result in a significant drop in a workers net income.
IR35 was first introduced in April 2000 and has faced heavy criticism from all quarters for being poorly conceived and badly implemented. The Government has responded by introducing new rules to bolster the original legislation, first in the public sector in April 2017 and now the private sector in April 2020. These new rules are designed to do what the original legislation failed to do, in taking away any tax advantage of operating through a limited company. The Government argues these rules are needed to level the playing field however, many have argued that they take no account of the same risks faced by contractors that are faced by any other small business.
Determination.
Whether this legislation catches a worker depends on several factors, and it is most likely that HMRC would look at the entire relationship between worker and client; however, the key factors identified by HMRC are:
- Substitution.
Does the work have to be done by a particular individual rather than any qualified individual sent by the intermediary? - Mutual Obligation.
Is there an obligation for the client to provide the worker with work and does the worker have to accept work? - Control.
Does the client have control over how, when and where the worker carries out the work?
If the answer is yes to these questions will indicate a quasi-employment relationship.
Who will be affected by the changes?
All medium and large-sized private sector clients who pay contractors through an intermediary such as a limited company. HMRC defines a medium or large-sized client as meeting two or more of the following criteria;
- An annual turnover of more than £10.2 million;
- A balance sheet total of more than £5.1 million;
- More than 50 employees
If you are contracting through your own limited company, often referred to as a Personal Service Company (PSC), for an end client that meets the criteria you need to be aware of the new rules and how they affect you.
IR35 News – What’s changing?
Changes made to the rules in April 2017 that affected the public sector are being extended to the private sector. The responsibility for determining the status of a worker is shifting from the worker themself to the end client.
This means that the worker will have little say in the determination which is predicted to mean many workers currently using a PSC will have to either become employees of the client or provide their services through an umbrella company as any benefit of using a PSC will have been removed.
Example (based on 2019-20 rates).
Day rate: £250 per day
Annual income: £65,000
| Outside of IR35 (using a PSC). |
Inside IR35 (using an umbrella company). |
|
| Income | £65,000 | £65,000 |
| Expenses | £25,000 (Including salary & travel) |
– |
| Profit | £40,000 | – |
| Corporation tax | £7,600 | – |
| Dividend tax | £1,990 | – |
| Income tax | – | £13,500 |
| National Insurance | – | £5,264.16 |
| Monthly take-home pay | £4,617.50 | £3,852.99 |
How will it work?
The end client must confirm the status of the relationship with the worker by providing the worker and the agency with a status determination statement (SDS). This needs to be in writing and set out the reasons for reaching the conclusion as to whether the contract is within or outside of IR35. If the determination means the contract is deemed to be within IR35 the fee payer (most likely the agency) will be responsible for deducting the correct amount of tax and national insurance as if the worker was an employee.
What if the worker disagrees with the determination?
It’s the responsibility of the end-client to establish arrangements to consider any disputes from PSCs about the SDS. The legislation does not specify how such arrangements should work in practice but does state a time limit of 45 days to respond, in writing, to the PSC with the outcome of the review of the dispute.
Other Considerations.
CEST.
This is the online tool created by HMRC to allow workers to determine their own status by answering a series of questions based on the key factors identified above. This has been heavily criticized for being inaccurate and inconsistent. HMRC have indicated that they will be updating the online tool to allow it’s use by clients in the determination process.
5% Allowance for PSCs.
HMRC have confirmed that the 5% allowance for PSCs caught by IR35 will be removed from April 2020 ensuring that no benefit remains from operating a PSC.
Outlook.
Many large companies including Barclays Bank, Lloyds Bank and RBS have already communicated that they will use a blanket approach by stopping the use of contractors all together from April 2020. All workers using PSCs will be given the opportunity to continue to provide their services through an umbrella company with some being offered the option of employment. It is likely that the majority of other companies caught by the legislation will follow suit and it will be interesting to see if any do not and how HMRC will challenge this.
The unknown is whether this change will lead to a shortage of workers in key industries such as finance and IT as flexible working arrangements change to permanent employment. The other unknown is how companies will react to this, will they up their pay rates to compensate for the workers lost revenue and attract them back?
Umbrella Company.
An umbrella company is simply an intermediary through which a worker provides their services to an end client. The umbrella company is responsible for collecting the correct pay from the end client, deducting the right amount of tax and national insurance and paying the worker. Working through an umbrella company means all rights of employment are retained, including holiday pay and statutory payments such as sick pay. However, taxes and national insurance contributions will be due as if the worker is an employee which will be much higher than if a PSC was operated.
Umbrella companies usually charge a percentage of the gross pay for their services and administration, these charges range from 5-10%.
Closing a PSC
From April 2020 if a worker is deemed to be within IR35 then there is no longer a need to continue operating a PSC. Closing a PSC can be a complicated process that may or may not need the involvement of a liquidator. In most cases, the company will need to be dissolved or go through a members voluntary liquidation (MVL). Tax planning is also crucial at this stage as any amount earned to date can be subject to further taxes on the shareholders of the company.
We at Sigma Chartered Accountants offer a bespoke service that ensures all available allowances and reliefs are maximized when closing a PSC and helps you navigate this complex area. For advice or to be kept up to date with more IR35 news, get in touch.