From April, as many contractors with limited companies will know, there's a significant change coming to IR35. Those are the rules that say that if your limited company's income is really derived from you doing an "employee-style" role, you're not supposed to take advantage of the tax efficiencies a company offers and instead must pay more or less full employment taxes. At present, unless you're working for a customer in the public sector, it's your initial call as to whether IR35 applies. Given the bigger tax and National Insurance burden it generally imposes, and the grey area between modern employment and self-employment which means that employment status for many people is genuinely unclear, few contractors choose to declare under IR35.
From 6 April, if your customer is a medium or large private sector company, it's going to be their call, not yours. Many contractors are going to find their customer deducting full employment taxes (including two lots of NI, both employer's and employee's) before receiving what's left. And many others have already been told by their customer that they need to become a member of PAYE staff, or use an umbrella company (which amounts to more or less the same thing in tax and NI terms).
There's a process for disputing your customer's assessment, and maybe it'll work sometimes. But fundamentally the idea is to shift the risk of non-compliance from contractors to customers, to encourage the customers to play it safe. And at the moment it's clearly working to at least some degree - HSBC and Vodafone, for example, hitherto massive users of contractors with limited companies, have said they won't use them any more - it's PAYE or an umbrella company (i.e. also PAYE) if you want to work for them.
So, what might this mean to you in financial terms?
To do a very basic comparison:
- If someone invoices £80,000 through their company in a year (imagining zero expenses to keep it simple), then if they extract as much money as they can, as tax-efficiently as they can, they'll end up with about £58,000 in their bank account after tax.
- If their customer decides they'll only pay them via PAYE, and their budget is £80,000, then the person will be given a gross salary of about £71,000 (as the employer is going to have to pay Employer's National Insurance on top of it of about £9,000, making their total outlay £80,000). On a gross salary of that amount, take-home pay after tax and Employee's National Insurance would be about £50,000. So the second person is £8,000 worse off than the first one.
It's much more nuanced and complex than that. The limited company owner, for example, might well delay or reduce tax further by *not* taking as much money as they could, leaving some in the company for the future, making a limited company even more beneficial. They might be able to avoid repaying Child Benefit that way too. And they might be able to split their income with a spouse, saving much more. On the other hand, the second person would be getting paid holiday and pension, and might feel more secure. There are lots of other aspects too. But you can see that at the very least it'll result in a substantial reduction in take-home income.
Some people are saying that contractors should simply demand an increased day rate so that their take-home remains unaffected, but that's obviously likely to be wishful thinking for many people, though in the medium term perhaps supply and demand means that customers/employers will have to pay more. But right now, if a contractor could command a higher fee, then they should be doing that anyway. Changing tax regimes are just a fact of life that we need to be prepared for, and your utility and value to a customer is unchanged.
At present, the important thing is to be informed. You'd be sensible not to agree a long-term contract running beyond April 2020 without certainty as to how you'll be paid.
The government are doing a last-minute review of the rules, and we've got a Budget coming up in March, so some people are holding out hope of the changes being postponed. A year ago we'd have thought that was a futile hope, but since the ludicrous last minute postponement of new VAT rules in the building industry, anything's possible. But if it doesn't come this year, it'll come soon (and it will probably come this year).
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