If you currently work as a contractor, are considering becoming a contractor or own a business that hires contractors, IR35 is something that you should be familiar with. In this piece, we highlight some the key 2017 changes for practicing contractors to review. Since this time, there have been new changes and new strategies are need: What is IR35 and how does it apply to contractors now?
The way that contractors work in the public sector is always changing and it is important to be aware of how these changes could affect you.
From 6 April this year, IR35 status for public sector contractors will be determined by the client, not the contractor. This means that the clients or agencies will become liable if they make the wrong determination, and as such it is thought that they are more likely to take a risk-averse approach and decide to apply IR35.
If the client does decide that IR35 applies, the contractor company will be taxed at source, exactly as if it were an employee. And although contractors impacted by this measure may have to pay tax like an employee, their employment status will not change, so they will not receive the rights and benefits that go with employment.
IR35 digital tool
HMRC has launched a digital tool designed to test contractors’ IR35 status. Essentially this is a series of questions which when completed gives a determination of whether an engagement is inside or outside IR35.
The pre-programmed series of questions fluctuates what’s asked based on the user’s responses, and the questions stop once the tool believes it has collected enough information to reach a decision on IR35 status.
Although the tool was initially meant just for end-clients(companies hiring the contractors) the first question does ask the user to select whether they are a worker, end-client or agency. It is thought that public sector organisations will use the results of this to make an assessment of a contractor’s IR35 status and ultimately to determine the tax treatment of payments.
Limited company or umbrella?
Many contractors supplying the public sector are considering moving from their personal service company (PSC) – otherwise known as a limited company – to an umbrella company.
As their assignments are likely to be subject to the new IR35 rules, and take-home pay is their sole driver for using a company for their income, an umbrella PAYE payment model may come out on top.
Running a limited company and working outside of IR35 is normally the most tax efficient way of working. However when working inside IR35 contractors adopting the umbrella model are likely to pay slightly less than they would if they continued using a PSC.
Due to the PAYE calculation which will apply to IR35 in the public sector no longer allowing the 5% deduction for general expenses, and changes to the Flat Rate VAT Scheme (FRS) for labour-only businesses, tax deductions then start to level out between PSC and umbrella PAYE.
The key distinguishing factor between PSC and umbrella will therefore be the costs incurred by the contractor. For limited company users, this will include accountancy fees and insurance; whereas for umbrella workers this will just be the umbrella margin which is likely to be lower than accountancy fees.
Working via an umbrella company also means that the contractor doesn’t need to take on any of the director’s responsibilities, such as ensuring accounts and tax returns are submitted on time and the correct amounts of tax are paid, as these are done by the umbrella company.
However being inside IR35 but still running your own limited company does allow you to benefit from being VAT-registered; using the FRS and undertaking other tax planning such as through pension contributions.
Retaining your PSC also provides flexibility, and since IR35 is assessed on a contract-by-contract basis, you may find that your next contract is outside IR35 and more tax planning opportunities will present themselves.
Who will this affect?
These rules will hit teachers, local authority, social and care workers, NHS workers and all UK and local government workers providing their services via their own limited company. There is no limit to the nature or scope of services provided, so it doesn’t matter whether you work in IT, project management, financial services or anything else for that matter.
In January, Transport for London became the first public sector body to react to April’s IR35 reforms by imposing a blanket ban on workers who operate through their own limited company, of which there are reportedly over 2,000. Ministry of Defence bodies UK Hydrographic Office and Defence Equipment & Support have too threatened their PSC contractors with termination if they fail to abide by a new policy pre-emptively put in place to comply with April’s off-payroll rules.
Many public sector bodies may be in trouble as contractors are opting for self-termination rather than working inside IR35. Thirty contractors have already abandoned an overrun £16.5million health service IT project after an NHS trust said it would declare them all inside IR35 from 6 April. Rather than stay and accept the trust’s decision, or avoid it but pay more tax by becoming PAYE umbrella staff, the 30 are set to move as one team to an end-user outside of the rules.
According to a recent survey more than 9 out of 10 contractors say that the UK’s biggest taxpayer-funded projects will be damaged if PSC workers walkout over the public sector’s 6 April off-payroll rules. Central government will be the biggest casualty of such a walkout, warn almost half the contractors, followed by the NHS (26%), MoD (13%) and ‘other’ projects like HS2 (12%).
Private sector contracting
As we have seen with the NHS project, public sector contractors are considering moving over to the private sector in order to preserve their income, as the changes coming into effect from April will have no major impact on private sector contractors. In fact, there are currently not even any plans to extend these rules to the private sector.
As public sector contractors move into the private sector, the demand for each job will become even more competitive. However if you are able to bag yourself a contract in the private sector, it will likely see you continue to benefit from a full range of tax planning opportunities through your company as a PSC worker.
It will also mean that your IR35 status will remain your own responsibility and the risk of getting it wrong is ultimately yours. You should therefore continue to get regular IR35 reviews, which are offered by professional service providers, to ensure you are complying with the legislation and are taxed accordingly.
For more information visit ContractorUK’s guides on public sector contracting.