April 2020: How the Private Sector is Changing for Contractors

IR35 has undergone several changes since its original roll out in 2000

Conceived as a way to crack down on tax avoidance by low paid workers who wanted to avoid paying national insurance, IR35 has evolved into the foremost legislation with which HMRC generates additional tax revenue from higher earning contractors. In April 2020, they will adapt it once again to cover the private sector and thus affect more contractors than ever. Our comprehensive guide is here to cover the history of IR35, how it will change next year, and what this will mean for you and your business.

A brief history of IR35

IR35 was first created in 2000 as part of the Finance Act and is also known as ‘intermediaries legislation.’ It was put in place to separate genuine contractors from ‘disguised employees’ who were essentially pretending to be self-employed in order to gain a tax advantage.

The reason these employees were disguising themselves as self-employed workers is that both they and their employer stood to benefit significantly from the tax rules around contractors using limited companies.

Although Ltd Companies were originally meant to be vehicles through which enterprising individuals could produce, buy or sell physical goods, contractors can also use them to sell their personal services. While this doesn’t generate a tax advantage, the benefits of owning a Ltd Company mean that you can pay yourself using a small salary and high dividends. Dividends are separate from PAYE (pay as you earn) calculations and even have their own tax-free allowance, meaning you can pay less tax overall.

With a wave of people leaving full time employment on a Friday and returning on the Monday in the same role but as a contractor with a Limited Company, the government recognized that they stood to lose significant tax revenues. As a result they quite reasonably took action to prevent this type of tax avoidance by introducing IR35.

However over time, the government started to widen the scope of IR35 to class normal contractors, those who were legitimately selling their services through Limited Companies, as “avoiding tax” too.

The issue with IR35 in turn became proving that you are a genuine contractor and keeping yourself out of “scope” for the legislation entirely.

Inside or outside IR35

IR35 compliance comes in two forms; “inside” and “outside”.

If you’re ‘outside IR35’ or ‘IR35 compliant’ it generally means that you are deemed to be a real contractor. You can use a Limited Company or more accurately benefit from the reduced tax rates that come with them.

If you’re ‘inside IR35’ then you’re effectively a disguised employee and while you may be self-employed, for tax purposes you must process your payroll as if you were an employee of your end client. In reality this means that if you operate a Limited Company you must process 95% of your income through PAYE and will not be able to use the dividend or expenses mechanisms to reduce your tax bill.

Factors that can determine if you’re inside/outside IR35 can include:

Obligation – Genuine self-employed workers can work project-by-project without any obligation to continue after a project ends. In this instance clients also are not obliged to provide any further work after this time. Employees on the other hand are expected to receive tasks from their single employer on an indefinite basis.

Control – Genuine contractors can dictate how they work, where they work and when they work. This is not the case for employees who are told the above by their employers their working hours and must agree in advance their holidays.

Hiring power and substitution – If you own a limited company, you have the ability to expand your business and hire other people. Additionally, those outside IR35 can state in their contracts that someone else can complete their work for them. Those inside IR35, or ‘disguised employees’ do not have this power.

How IR35 changed in 2017

Until 2017, it was the responsibility of the contractor to ensure they had the correct IR35 status and declare it to HMRC. However in April 2017 this rule changed for contractors working in the public sector.

The change meant that the responsibility for deciding a contractors IR35 status and paying the correct taxes shifted away from the contractor. It became the responsibility of the end client to prove that the contractor was genuinely self-employed. If they were found to be inside IR35, contractors would be taxed at the higher rate of employees and the end client would be liable if those taxes were paid incorrectly.

As a result, the majority of the public sector controversially blanket declared all contractors inside IR35 regardless of their true working situation. This created uproar in the contractor community with many losing take home funds as a result of loosing their tax advantage.

How IR35 will change in April 2020

In essence while IR35 may have started as a legitimate curbing of false employees, the government now doesn’t agree with any contractors (legitimate or otherwise) paying less tax than regular employees.

Therefore the IR35 changes of 2017 will be replicated onto the private sector from April 6th 2020. The onus of responsibility to prove authenticity will be placed on private clients instead of the worker. It is widely expected that the majority of private sector clients will declare their contractors inside IR35 or stop using contractors altogether.

What this means for you

The changes depend on how you work now. If you are the owner of a limited company or are a sole trader in the public sector, then you should already know your IR35 status and pay the correct taxes (most likely inside IR35). You will be used to what is expected of you and your clients by HMRC and should make sure your contracts are IR35 compliant.

If you currently work in the private sector, then you will face the changes. You won’t have to prove that you are not a ‘disguised employee’ anymore, but instead as this will become the responsibility of your client will have your IR35 status dictated to you.

This alone is controversial because many end clients do not know if you work for one or more clients!

We envisage a world where being inside or outside IR35 becomes a selling point for agencies and end clients, with those offering outside IR35 contracts being able to attract the very best contractors.

Unfortunately if you’re unable to secure an outside IR35 contract, even if you use a Ltd Co now, you will have to change how you pay yourself so that you process 95% of your earning through PAYE.

How to avoid IR35

If IR35 seems like another complication that you would rather avoid, you can always work through an umbrella company. Umbrella companies take away the issue as they treat you as one of their employees. This means that you can provide your services knowing you are covered, and the umbrella company will calculate and deduct your tax at source.

Umbrella Companies are also extremely competitive on fees, making using a Limited Company a time absorbing exercise in comparison for no financial benefit.

Not sure where to start with choosing an umbrella company? Umbrella Supermarket lets you compare them all, and you can get a quote in two minutes to help you get up and running in no time.

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