The Chancellor’s Budget for 2018 confirmed many contractors’ and their client companies’ worst fears – IR35 will be coming to the private sector within the next two years.

The new way of determining IR35 status has been operational in the public sector for the last eighteen years. This infamous and complex legislation has been increasingly popular in the press with a number of high profile court cases overruling HMRC’s decisions.

But what does the recent expansion really mean for those in the private sector? In this article, the TFMC team will guide you through everything you need to know about the change.

What is IR35?

IR35 – also known as the ‘off-payroll working rules’ – is a tax legislation that was designed to combat tax avoidance by self-employed workers.

The main goal of IR35 is to uncover what HMRC calls ‘disguised employees’. Self-employed contractors generally enjoy much more attractive tax reliefs than normal company employees. Because of this, HMRC has had trouble in the past with workers carrying out the duties of an employee under the guise of working through their own personal service company (PSC).

HMRC say that many people appear to be leaving their desk on Friday afternoon as an employee, then return on Monday morning as a contractor; doing the same job for the same people while benefiting from self-employed tax reliefs.

To clamp down on this costly practice, HMRC introduced the ‘tests of employment’ through IR35 in 2000. If found to be working as a ‘disguised employee’, contractors could be made to pay all of the additional tax they had avoided – as well as some hefty penalty fines.

IR35 in the public sector

Having realised many disguised employees continued to take the risk of being caught under IR35 – with only one in ten people using IR35 correctly – the government later reformed the legislation in the public sector in 2017.

The change shifted the responsibility of defining employment status from the limited company (the worker) to their end client – and applying PAYE and National Insurance Contributions (NICs) accordingly.

This meant that if the organisation responsible for paying the worker did not deduct NICs and income tax from the pay, and the worker was found to be inside IR35, the employer would be liable for all unpaid tax during that time.

Was the previous IR35 reform successful?

While the reform was not popular, the government argue that it was effective.

Not only could companies hiring disguised employees be made to pay many thousands of pounds owed by the worker, but they could also suffer a great deal of reputational damage in the process. This was often enough to force businesses using contractors to thoroughly assess the IR35 status of all of their workers for each assignment.

However, in practice, it seems that the IR35 reform had some unexpected consequences.

Recruitment firm Harvey Nash revealed that IR35 has had a “very negative” impact on 80% of contractors in the public sector.

Since the changes were brought in, 50% of PSCs have noticed a reduction in the number of available contracts in the public sector – with many employers opting to take employees onto their payroll instead.

In addition, there has been a shortage of contractors in the sector. ContractCalculator claim that contractors could lose up to 25% of their earnings in tax if found to be working inside IR35.

As a result, almost half of all self-employed workers in the survey said they actively avoid taking public sector contracts to avoid risk-averse ‘blanket assessments’ deeming them to be employees even when a role may fall outside.

Potential impact of IR35 in the private sector

When the IR35 reform is extended to the private sector, it could result in a significant drop in the number of private sector companies accepting contractors, and in the earnings self-employed workers can make.

Many fear that those in the private sector may become overly cautious, as has been seen in the public sector, whereby companies class all of their contractors as inside IR35 to avoid fines from HMRC. This results in many contractors being forced to pay NICs and income tax when they may not be legally required.

Harvey Nash claim there could be a “huge rise” in contractors’ fees when the change comes into effect, as many attempt to offset the knock on their incomes.

The future of the private sector

Much to the relief of those in the private sector, the extension of IR35 to the private sector has been delayed by a year until April 2020.

EY’s Autumn Budget predictions noted that “with the UK economy facing uncertainty post-Brexit, the new rules could make it more difficult for off-payroll workers in the private sector to operate flexibly”. The delay gives companies and contractors in the sector time to prepare and adapt their businesses for the upcoming change.

Dave Chaplin of Contractor Calculators believes that a 2020 rollout “is still premature until the full facts of the public sector impact have been established, which won’t be known until the middle of 2019.”

“By then we expect to see evidence that the reforms have been damaging to the public sector, raised costs, and effectively resulted in a net loss.”

The government has also announced that small private sector companies will be exempt from the changes in 2020. That means contractors working on contracts for firms that fall under the definition of a “small business” will remain responsible for determining their own IR35 status.

It is expected that the criteria for ‘small businesses’ will be similar to that in the Companies Act 2006, which is as follows:

  • Turnover of no more than £10.2 million
  • Balance sheet no more than £5.1 million
  • No more than 50 employees

There are concerns that there may be changes to the Companies Act 2006 following Brexit next year, but this is yet to be confirmed.

Unsure of your IR35 status? Speak to TFMC

With high penalty fees now at stake for companies and contractors in both the public and private sector, you can’t afford to leave IR35 to chance.

To learn more about how the upcoming changes could impact on your business, speak to the Financial Management Centre team today on 0800 470 4820.

Kass Verjee
Kass Verjee

Kass is not only a qualified bookkeeper/accountant but he is also a Fellow of The Institute of Chartered Accountants in England and Wales and has a full practising certificate.