The Fizz! Blog

I've been told my contract is inside IR35 - but what does that mean in practical terms?

Previously on IR35:

• The legislation informally known as IR35 was introduced 23 years ago.  It aimed to prevent those billing via a limited company whilst performing an employee-style role for a customer from benefiting from any of a limited company’s tax advantages; instead they were to pay full employment taxes.
• It didn’t work, because it was self-assessed, and turkeys rarely vote for Christmas.
• In 2017, as a result, the responsibility for making the call changed - if you worked for a public body, the public body would decide if IR35 applied.  If it did, full employment taxes would apply and you’d just be paid the net.
• In 2021 (having been postponed for one year due to COVID), this was extended to large customers - similarly, it became their call on IR35 and their risk if they decided not to account for employment taxes.

If you’re a contractor or freelancer working longish projects with big or public sector customers, it’s therefore quite likely you’ll encounter IR35 these days.  But, if a customer or agency tells you that a contract is inside IR35, what does this mean to you in practice?   This isn’t necessarily a simple question, as there are a number of routes that the customer may take, with the literal implementation of the IR35 rules being the least common by far:

1. They might just put you on PAYE.
2. They might pay you via an umbrella company (from your point of view, this is to all intents and purposes exactly the same as PAYE).
3. They just might actually implement the IR35 process - we don’t see it often, but we do see it occasionally.  If they do, then you’ll send them invoices from your limited company as normal, but they’ll pay the invoices net of tax and National Insurance relating to you personally.  This is obviously a very weird concept, and since all three routes are designed to get to the same split of the money between you and HMRC, the well-worn road of PAYE/umbrella generally looks much more appealing to all concerned.

If you get the choice, your accountant will thank you for picking #1 or #2!  We don’t need the hassle of #3 either.

Here are three practical points to be aware of:

1. Make sure you know whether a contract is inside or outside IR35 before you sign it!
2. Be aware that an inside IR35 contract will leave you with less money in your pocket than an outside IR35 one.  How much less?  That will vary depending on the bigger picture of your whole situation, but as a rule of thumb you might consider that you’d need a 25% day rate hike to stand still.
3. You should talk to your accountant at the outset of the new gig, not later on down the line - as well as the decision on whether to accept the contract, there will very likely be other actions to take too.  It might well be appropriate to pause salary or dividends from your own company whilst working on an inside IR35 contract, and that can’t legitimately be done retrospectively.

It’d be nice if everyone had a common understanding of what inside IR35 means, and the steps we’ll all take when that’s the case.  Until then, you’ll always need to press until you find out what’s actually going to happen in practical terms.

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Which umbrella company should I choose?

An umbrella company offers a simple service.

A business is going to pay an individual to do some work for it. The business judges that the individual’s role amounts to that of an employee, who should properly be paid via PAYE. The business doesn’t want the admin of doing that themselves. The umbrella company offers to employ the individual instead, and invoice the employer for the salary and the other associated employment costs (NI, pension).

Or, a business is going to pay an individual to do some work for it. The business, considering it to be an employment role but being unwilling to put the person on PAYE, tells the individual that they must invoice them via some other entity, most commonly a limited company set up by the individual themselves for that purpose. The individual can’t be bothered doing that, or knows that in the hands of her own company the income will fall under IR35 and be subject to full employment taxes anyway. Instead she decides to sign up with an umbrella company, who will receive the fees, operate PAYE on them, and pay her the net.

What’s in it for the umbrella company? A fee (most commonly suffered by the employee, even if the business insisted upon the arrangement, naturally!).

They’ve had a chequered history. You can see that in theory they’re simply a vessel to get fees from A to B, with the appropriate employment taxes paid. So they should all end up with more or less the same split of money between the worker and HMRC, with their commission being the only variable.

However, market forces meant that they began to compete with one another, to try and offer a bigger share of the split to the worker and less to HMRC. This was never achieved by legitimate means. A favourite trick was based on a wilful misunderstanding of the rules on something called dispensations. A dispensation was an arrangement with HMRC, where HMRC said - for example - “If you reimburse an employee for legitimately incurred and legitimately tax deductible travel costs of up to £30, don’t bother telling us about it, we don’t want to record it as both income and deduction for the individual, it’s a waste of time as it ends up at zero”. Then, regardless of whether any such costs were actually incurred or not (they weren’t) the umbrella company would include a tax deduction of £150 on every week’s payslip, with a consequential suppression of the tax deduction truly due.

Eventually, HMRC got wise to this. Those schemes were exposed and shut down. Any time you read anything promising you materially greater take-home pay than similar providers, it should always have been clear that this could not be achieved legitimately, but now - crossed fingers - we’re back to an acceptance that umbrella companies are machines that process the same inputs in the same way and should, consequently, churn out the same outputs.

A rather long-winded way of saying - it shouldn’t matter, they should all be pretty much the same!

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IR35 isn't relevant to sole traders!

Next month, an important aspect of IR35 changes.  For big companies engaging with a contractor via the contractor's own limited company, the responsibility and risk of deciding whether it's an employment-like relationship and employment taxes should therefore be paid falls upon the customer, not on the contractor.  That's it.  That's the change.

 

For a sole trader, IR35 is objectively of no relevance of any sort, as it relates specifically to that situation where someone is working and billing via an entity that sits between them and the end user.  But what's becoming very clear is that agents, recruiters and employers are often attempting to deal with the IR35 change without having a basic understanding of what IR35 even is!

 

In particular, we're seeing multiple instances of sole trader freelancers being told that they need to go on PAYE or via an umbrella company (also PAYE) because of IR35.  It's often going to be the case that those people should indeed go on to PAYE.  It hasn't got anything to do with IR35, though.  It's just basic employment tax rules that have been in place for decades.  People were always at risk by engaging sole trader permalancers - an HMRC PAYE inspection would give them a massive and expensive problem if it emerged that they were failing to put people who were really employees on PAYE.  It's for the best that they're addressing that issue - but they're doing the right thing for the wrong reason!

 

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IR35 isn’t being introduced in April

IR35 was introduced in 2000, so it's going to be 21 this year.  In a nutshell, IR35 says that, insofar as your limited company’s revenue comes from you really being a pseudo-employee of an end-client, you can’t use the tax and National Insurance efficiencies of dividends – the company’s got to pay more or less all of that revenue out to you under PAYE.

Simple in theory, a complete failure in practice.  A company’s director had to make the call on whether IR35 applied and whether far more tax and NI should be paid, so there was a big financial incentive to argue they were outside it, and HMRC lacked the resources to police the rules in any meaningful way at all.  And, in any case, the question of what represents an employee-esque relationship is often impossible to answer with certainty.  In the modern world, countless people sit in that grey area somewhere between employment and self-employment.

So, IR35 was to all intents and purposes a failure.  In 2017, the government changed it a little.  If your customer was a public body – an NHS Trust, for example – then the decision was taken out of your hands, and the public body would decide if IR35 applied.  If they decided it did, they’d effectively take your company’s invoice, work out and deduct full employment taxes, and pay whatever remained, to put you more or less on a par with a PAYE employee.  This was effective in one sense – a lot of public bodies did apply the rules in that way – but had the unintended consequence that many of the better contractors just decided to move into the private sector and work there instead.

As a result, the government had a second idea.  From April 2020, those same rules would apply to big private sector companies too – they’d have to make the IR35 call themselves, at their own risk, and if they paid pseudo-employees via a limited company gross then the risk of employment taxes not being paid would be their own risk, not that of the contractor.  This was actually quite effective, and a bunch of big companies stopped using contractors entirely, either putting the workers on to PAYE or just outsourcing that PAYE processing to an umbrella company (technically they could go down that previously described route of deducting employment taxes from your company’s invoice, but there’s no real point, PAYE is an easier way of achieving the same result).

Then COVID happened, and the April 2020 introduction was postponed by a year.  The big companies who’d played ball and got ready for the new world found they could have got away with another 12 months of using contractors.  The big companies who buried their heads in the sand did get away with it.

But the change is still due to come in this April instead, so hopefully those latter companies have removed their heads from the sand and are getting ready to engage with it.  There’s a chance it could be postponed again, of course (the government have form over the last couple of years of very short-notice postponements of changes that businesses have spent a lot of time and money preparing for, even prior to COVID), but it seems unlikely, and it’s clear that it’s being talked about more this time round.  However, what that means is that you do hear a lot of things being said about it that aren’t accurate at all, such as:

• “IR35 is being introduced in April”.  No it’s not.  IR35 has been around for more than two decades.  All that’s happening is the responsibility of non-compliance is being shifted from the contractor’s company to its customer, if the customer is big.
• “You can’t take on a contract if it’s under IR35”.  IR35 has never had anything to say about whether a contractor’s company can accept an engagement or not.  It’s legislation about how a contractor must get paid by their own company.
• Crucially – “It’s more risky to be a contractor from April”.  There might be fewer contracts around, that’s true, with more of those gigs being offered on a PAYE basis instead.  But if you’re a contractor working for a big company, and they’re content to continue paying your company’s invoices in full, there’s *less* risk than before, as the customer now bears the burden of non-compliance.  There may well be some ultra-cautious contractors who decide to declare under IR35 anyway, even if their customer is happy to pay gross, but HMRC are going to be going after the end user in the first instance, not the contractor.  Anyone in that situation will clearly be at less risk than they were before, not more.
• End users of contractors telling contractors “there are some changes coming in April, you should look into them.”  Er, no, *you* should look into them.  This is a transfer of risk *from* contractors *to* end users.  The end users are the ones who need to understand what’s happening.

What is certainly true is that some contractors are going to find themselves taking PAYE jobs instead.  And what’s also true is that many of those people will find themselves earning less money than they used to.  Some of them will be able to ask for, and get, a bigger daily rate in order to make up for it, if they have particular bargaining power for some reason, but many won’t, as their fundamental value to their client/employer hasn’t changed.

There are two ways of looking at it, really.  Some contractors will be phlegmatic about it, considering they’ve done well for a while, and that now finding themselves with a tax burden on a par with that of an employee isn’t the end of the world.  And some contractors will not be phlegmatic about it at all, especially if their life involves overheads more or less equal to their present net income.  But it is what it is, and even if the change is postponed for a second time, it will come.  The tax system isn’t fit for 2021 in many respects, and the vast number of contractors using limited companies simply wasn’t contemplated when the fundamental levers of corporation tax, income tax and National Insurance were first created. 

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A Fizz March update - further business measures (including IR35)

We send out an email update to all our clients each month; we don't usually post it here, but this is an update to this month's news that we sent out this morning...

We thought we’d be following up our Budget email with some further updates pretty soon, and here we are.  There were some more announcements last night.  On the lending and Business Rates items, there’s no detail yet about how things will work in practice, but we wanted to let you know about them as soon as we could.  If you’ve got immediate concerns about payment of tax due to coronavirus, HMRC have set up a helpline for businesses to call them (although we imagine you can expect a lengthy queue):

https://www.gov.uk/government/news/tax-helpline-to-support-businesses-affected-by-coronavirus-covid-19

At the moment, the people who don't really have much in the way of specific support are the self-employed, consultants, freelancers and the like, especially if IR35 wasn't a problem for you and you rent your home.  The Chancellor did say in the Budget that the government would make claiming Universal Credit "quicker and easier" (from which one would logically conclude that if and when things settle down they'll revert to making it slow and hard), but that's about it.  Supposedly there will be more announcements soon though, in which case we'll be emailing you yet again.

So, last night’s news.  The first thing is that the IR35 changes due to come in from 6 April have been postponed for a year.  This will not be of any help to contractors who’ve already switched to PAYE status in anticipation of the change, or end users like HSBC and Vodafone that had already stopped using contractors entirely.  But there are still plenty of contractors and freelancers wrangling over status and day rates with clients and agencies, so it’s one fewer thing to worry about for them.  Of course, IR35 still exists, and contractors remain responsible for determining their own status and paying employment taxes if they consider it appropriate.  But the compulsion for medium and large customers to make the call, which in practice they’ve largely been dealing with by forcing contractors on to PAYE or into umbrella companies (which is also PAYE) has been put back until 2021.

Next, the reduction in Business Rates for retail and leisure business was extended.  None of them will have to pay Business Rates at all in 2020-21.  Local authorities are supposed to get guidance from that from the government on Friday, probably you’ll hear from them some time after that.  Plus, the £3,000 cash grants that were to be given to similar businesses occupying commercial premises but not paying business rates to begin with have been increased – up to £25,000 in some cases.  And businesses in other sectors who similarly have premises but pay little or nothing in rates will also now get (smaller) grants.  Funding for that is supposed to be provided from some time in April, so don’t expect any money to appear in your bank account right now.

The announcement with a big number in front of it was £330bn of loans and loan guarantees to be made to businesses.  It’s said that these loans will be on attractive terms, but there’s no definition of what that represents right now.  This funding will supposedly start to become available next week.  Big companies will get money from the Bank of England, but you can expect most businesses to be getting such loans through more usual lenders.   Of course, a loan isn’t a grant, and in the long-term it won’t save a business that has been fatally compromised by the outbreak.  But for sound businesses that will be able to get back on their feet, but in the meantime need help to bridge a gap and cover wages and overheads, this is likely to be an attractive route to take.

And, on the domestic front, homeowners who are struggling to pay their mortgage will be eligible for a three-month payment holiday.  Note, though, that this isn’t a cost saving – interest will still be building up on the amount you owe, and you’ll still have to pay it all back in the end.  So it’s a cashflow break, but in fact you’ll wind up paying a bit more over the life of the mortgage as a bit more interest will be building up.  You wouldn’t just automatically take the holiday if you’ve got the ability to pay.

There’s some more info – and a recap on the things we’ve already told you about on Statutory Sick Pay and the like – here:

https://www.gov.uk/government/publications/guidance-to-employers-and-businesses-about-covid-19/covid-19-support-for-businesses

We hope that’s of some help and interest.  We’re happy to hear from you if you’ve any questions about it – but, again, do bear in mind that nobody can answer the question “how exactly will this work?” at this point, because that information isn’t available yet!

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So, what's going on with IR35?

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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