New IR35 tax changes will come into force in the private sector in April 2021. As a result some self-employed workers, and the businesses that hire them, will have to pay tax differently. Are you one of the 170,000 ‘contractors’ who may have to pay more tax? Are you worried that you don’t know how this will affect you?
You’re not alone. Research by EY TaxChat has identified that more than 30% of self-employed workers are still unaware of the changes. A further 30% said that they were aware of the changes but didn’t understand how they themselves would be impacted.
It is estimated that affected contractors could lose up to 20% of their income as a result of the changes. So you need to understand if the new IR35 changes will affect you, and why.
Why is this happening?
The new policy is largely aimed at contractors with a Personal Services Company (PSC). HMRC believes that some of these contractors should be regarded as employees, and they should be paying the same amount of tax as employees. The new rules are a way for the Treasury to make more money through National Insurance contributions and income tax, as:
- Self employed contractors pay less National Insurance contributions than employees;
- Employers do not have to pay employer’s National Insurance contributions for self-employed workers;
- Those who operate through their own Personal Services Company (PSC) can also reduce the amount of income tax that they pay – as a Director of a PSC many pay themselves a mix of dividends (which attract a lower rate of income tax) and a low salary as a perfectly legal way to reduce their tax bill.
However the Government has said that these rules will not affect people who work as genuine freelancers and self-employed workers.
What is IR35?
It refers to the off-payroll working rules that aim to ensure that both contractors and the companies that they are working for are paying the correct level of National Insurance contributions.
From April 2021 medium and large companies in the private sector will become responsible for judging whether their contractors fall inside or outside of the scope of IR35. Prior to April 2021 this was the responsibility of the worker.
The changes in IR35 will be implemented from 6 April 2021 for private sector contractors. This brings the private sector in line with the public sector which implemented the change in 2017. The private sector reform was due to happen in April last year but was delayed due to the Covid-19 pandemic.
The change will affect both contractors and the companies that hire them. It only applies to medium to large private sector businesses, those for which:
- The number of employees is greater than 50;
- Annual turnover is greater than £10.2 million;
- The balance sheet total is greater than £5.1 million.
Note that there is no change to the rules for contractors who provide services to small private sector businesses.
If a contractor provides services to a medium or large private sector client, they will need to obtain an employment status determination from the client. They should also be given the reasons behind that determination. They do have the opportunity to dispute the determination if they disagree with it.
How do they make the determination?
There are three main tests which can determine if a self-employed worker falls within the scope of IR35 rules:
- Who has control over how the work is completed?
- Is there a continuing obligation to provide more work to the worker?
- Does the worker have to personally complete the work in the contract?
HMRC have a service where you can find out if you should be classed as employed or self-employed for tax purposes. This runs through all sorts of different questions including whether you have to use your own equipment, and if you can decide your own hours and place of work.
It is down to the company hiring the individual to assess whether they fall inside or outside the IR35 rules. There are potentially significant costs if they get this decision wrong. HMRC penalties are a percentage of the Potential Lost Revenue (PLR) to the Treasury, which is the total of all the taxes that have gone unpaid. This includes employer National Insurance contributions at 13.8% and the income tax unpaid (the difference between the income tax as PAYE compared to PSC dividend-based taxation). These figures would be a huge burden to the companies hiring staff incorrectly.
The Treasury has previously estimated that non-compliance could cost more than £1.3 billion a year by 2023-24 if this issue isn’t addressed.
Will the new IR35 changes affect me?
If you have worked through the HMRC employment status check and you are worried that you will be impacted then make sure you talk to your client. If they haven’t already provided you with an employment status determination then ask if one is needed. It may be that your client doesn’t meet the definition of a medium or large business, so the changes in the IR35 rules don’t apply.
If the employment status determination means you are deemed to be an employee under IR35, you will have to pay income tax and National Insurance contributions as if you were employed. Make sure you understand the reasons why that result was given. If you disagree then document why and ask your client to review their decision.
If you are deemed to be an employee then you may be asked to go onto the payroll, or to operate via an umbrella company. There are additional benefits to being an employee, such as paid holiday, sick pay, and additional company benefits such as pension. But your take home pay will likely be lower as an employee and that is something that you will need to negotiate with your employer before you sign on the dotted line.
What will the implications of IR35 be in the long run?
These new rules will mainly affect IT workers, management consultants, building, civil engineering and trades and the labour market. It is hoped that the change will close the tax avoidance loophole that many contractors have taken advantage of and will result in less lost revenue for HMRC.
Private sector businesses will have to be more thoughtful when engaging contractors, and some companies will inevitably be more cautious about taking on contractors in the future. Some may see the advantage of hiring more salaried staff instead of temporary workers. If you are a contractor looking for a new role you may have to be more flexible with what you are prepared to take. 50% of freelancers have spoken about how IR35 will change the way that they work, with 24% thinking of moving abroad to work, 17% looking for an employed role, and 12% intending to end their freelance career completely.
It would be a shame if the new rules lead to an exodus of professional workers in the UK, reducing the talent pool available to businesses.