Audit & Taxation Director Mark Caldicott provides his expert opinion on how IR35 rules will affect the private sector.
Several BBC presenters recently received a nasty shock in the post.
HM Revenue & Customs has written to them demanding PAYE (Pay As You Earn) tax and National Insurance (NI) from the personal service companies (PSCs) that hire them out.
The government will be arguing that these individuals are effectively employees and should not be limiting their tax and NI bills by providing their services as a freelance contractor via a limited company.
It shows how determined the government is to level the playing field over the employment status of individuals, despite recently losing two high profile court cases.
The tax authority lost similar claims against Kaye Adams, presenter of the television show Loose Women, and ITV presenter Lorraine Kelly.
According to Andy Chamberlain, the deputy policy director at the Association of Independent Professionals and the Self Employed, HMRC has lost five such cases that have come to tribunal since 2017.
Whether the government will win cases against the BBC presenters remains to be seen.
But freelance contractors and companies would be wise to avoid complacency because new rules are being introduced for the private sector from April 2020.
The IR35 rule
Those high-profile cases revolve around the so-called ‘IR35’ rule, which has actually been in existence since 1999.
Back then, HMRC was reacting to what it perceived as the avoidance of tax and NI by workers who were supplying their services to clients via an intermediary, such as a limited company, instead of going on the payroll like other employees.
As these workers were only offering services to one company they were, according to HMRC, ‘disguised employees’ who were arranging their affairs to avoid paying their fair share of tax and NI.
To highlight the point, they quoted the individual who “leaves work on Friday only to return on Monday to do exactly the same job as an indirectly engaged consultant paying substantially reduced tax and NI.”
The IR35 legislation originally applied under the following conditions:
- A worker provides their services to another person (the client)
- The arrangements for those services are made through a third party (known as the intermediary)
- If the arrangements had been with the client, the worker would have been treated as an employee of the client for tax and NI purposes.
As a consequence, if caught, the intermediary was required to pay PAYE and NI on income from “relevant engagements”.
IR35 was initially unsuccessful
On the face of it, the new IR35 rules seemed fair to most workers – unless, of course, you were a contractor using a limited company.
But HMRC didn’t have much luck enforcing them because they relied on people to self-police the system and decide on their own tax and NI position.
Not surprisingly, few contractors felt they ought to be paying the government more money!
Furthermore, on the rare occasions when HMRC did raise an enquiry, there was often no simple answer and protracted arguments over whether someone was employed or self-employed.
Rule change to win more cases
In an attempt to win more cases, HMRC went back to the drawing board and started again. In 2017, they tweaked the rules for the public sector and it’s these rules that are going to be extended to private sector workers and companies from April 2020.
Under the new 2017 rules, an IR35 case would apply under the following conditions:
- An Individual (the worker) personally performs services for another person (the client)
- The client is a public authority
- The services are provided not under a contract directly between the client and the worker but under arrangements involving a third party (the intermediary)
- The circumstances are such that if the services were provided under a contract directly between the client and the worker, the worker would be regarded as an employee
Changes made an impact
These changes made a difference and famously led to BBC Look North presenter Christa Ackroyd facing a bill of £419,151 in back tax and NI bills after a court ruling that she had a seven-year contract for what was effectively a full-time job.
This will no doubt have been a massive wake up call for all freelance workers in a similar situation, even though the victories for Adams and Kelly will have offered some relief.
New rules for the private sector
From April 2020, the new rules will be applied to the private sector – affecting both businesses and contractors.
A consultation document has been issued by HMRC seeking views on exactly how the rules should work, but the start date will not change. So, affected parties have around 12 months to seek professional advice and get their house in order.
Strangely, the consultation document states that small businesses will not be affected as the onus will be on the contractor to determine their status.
The document states that “for services for services provided to small businesses, the responsibility for determining employment status and paying the appropriate tax and NI will remain with the Personal Service Contractor (PSC). Small businesses will not need to consider the employment status or deduct employment taxes from the fees of people they engage in this way”.
“Small” for these purposes is likely to correspond to the Companies Act 2006 definitions, where two of the following conditions need to be satisfied during a financial year:
- Turnover of not more than £10.2m
- Balance sheet total of not more than £5.2m
- Less than 50 employees
This exemption for small companies seems strange, particularly as HMRC have always been very clear that is only fair that two individuals working the same way pay broadly the same income tax and NIC. So don’t expect HMRC to allow this exemption indefinitely.
No historic charges?
A big relief for those caught by the new legislation is that it seems they won’t be facing huge historic bills like Ackroyd.
HMRC has said it will focus its efforts on ensuring businesses comply with the reform rather than focussing on historic cases.
Moreover, it adds: “HMRC will not carry out targeted campaigns into previous years when individuals start paying employment taxes under IR35 for the first time following the reform …”
Perhaps after being stung by recent high court cases, HMRC is offering an amnesty: do things our way from now on and we’ll forget about what’s happened in the past.
However, there is some scepticism about whether HMRC will stick with this rule as it is currently chasing presenters for back tax.
An uncertain future
Of course, the new rules are not expected to make this area of taxation any simpler. In fact, the opposite is more likely.
The mixed bag of court case results that HMRC has had since 2017 show that it is rarely a black and white issue and there are sure to be lots of arguments about employment status with, for example, contractors arguing that they are different from employees if they are not receiving exactly the same benefits and holidays.
There seems little doubt, though, that this is a big area of concern for contractors.
Research earlier this year by Contractor UK, the website for IT contractors, found that 65% of UK contractors who responded to a survey were concerned about the new legislation and 62% believed they will face higher tax bills.
Whatever industry you are in, it makes sense to consult an expert if you think you may be caught by the legislation.
White Hart Associates are specialist accountants for the travel industry. Visit whitehartassociates.com or contact 0208 878 8383 for more information.