As feared by many, the government is extending the reach of the dreaded “IR35 rule” to the private sector. It’s likely to lead to higher tax bills for many freelancer workers in the UK.
It came about halfway through the Chancellor of the Exchequer’s budget speech to the House of Commons on 29 October and took up just 100 words or so, but the few sentences which Philip Hammond uttered about the off-payroll working rules – commonly known as IR35 – hold a great deal of significance for freelance workers in the UK.
Put simply, these rules are designed to stop someone from paying less tax than they should by pretending to be a contractor when they are, for all intents and purposes, a full-time employee. They are also designed to stop businesses unfairly benefiting from lower national insurance contributions. The system was first introduced in the 1999 budget, delivered by the then Chancellor Gordon Brown, but have been undergoing significant reforms over the past couple of years. Since April 2017 all public sector employers have had to decide on the IR35 status of freelancers and contractors they work with, determining whether they should deduct income tax and national insurance at source. Before then, the liability had been with the contractors themselves.
According to Hammond, the changes introduced last year “were designed to ensure fairness, so that individuals working side by side in a similar role for the same employer pay the same employment taxes.” It sounds uncontroversial, but in reality it has led to confusion, with some workers suddenly finding they had lower take-home pay and some public sector employers struggling to fill their vacancies.
Such problems have not altered the thinking inside 11 Downing Street, though. The chancellor reckons that “widespread non-compliance also exists in the private sector” and so, as predicted (and feared) by many, he is now extending the changes to cover private sector employers as well. There was one small caveat, though, which gives everyone a bit more time. “After listening carefully to representations made during the consultation, we will delay these changes until April 2020 and we will only apply them to large and medium-sized businesses,” said Hammond.
The consultation exercise he referred to ran from 18 May to 10 August this year and garnered 275 responses, ranging from individuals to business, charities, law firms and tax professionals. According to some observers, the government has essentially ignored the inconvenient views it received through this process. “It is very worrying indeed that in the face of unanimous responses to HMRC’s consultation and despite there being no compelling evidence to support an extension into the private sector, that the Chancellor has decided to press ahead with reform,” says Dave Chaplin, founder of ContractorCalculator.
The statement the Chancellor gave at the House of Commons dispatch box was brief, but since then others have had plenty more to say about the changes. A few have suggested Hammond is being too timid. Shadow industrial strategy minister Chi Onwurah has criticised the decision to delay the rollout of IR35 to the private sector to April 2020, saying it showed the government was “refusing to take tax avoidance seriously. By pushing back those reforms to 2020, the government are denying themselves much-needed revenue, which could be used to properly fund our schools and the NHS, or to pay workers a decent wage.”
Most other observers, however, have been critical of both the government’s handling of the IR35 reforms to date and the plans to extend it to the private sector. In a House of Commons debate on the budget on 31 October, Stephen Hammond, a Tory backbencher at the time who has since been appointed a junior minister at the Department of Health and Social Care, said the track record of Her Majesty’s Revenue and Customs (HMRC) when it comes to applying the IR35 rules has often left much to be desired.
“No one will quibble… with the Chancellor’s claim that everybody should pay the tax they owe, but HMRC’s application of IR35 rules is often retrospective, unresponsive and unfair,” said Hammond. “I understand the need for the rules, but there is an issue with the certainty and consistency of their application.”
Others dealing with contractors on a daily basis also say HMRC should be doing better. Seb Maley, chief executive of Qdos Contractor, an insurance firm which specialises in providing cover for contractors, says the main tool developed by HMRC to help employers and workers understand if they should be taxed at source or not – known as the Check Employment Status for Tax (CEST) service – “is incapable of assessing status accurately”. He also flags up HMRC’s poor track record in IR35 disputes that have been taken to tribunal, which he says “demonstrates that HMRC struggles to understand the very legislation it created.”
The latter criticism is given some support by official statistics. According to Mel Stride, financial secretary to the Treasury, the government has taken twelve cases involving IR35 to tribunal over the past ten years and lost nine of them. In the past twelve months there have been three tribunal cases and HMRC has lost two of them.
That record does not offer much comfort to the freelance community. Anyone who has had to try and navigate the questionnaire on the CEST website will understand how complex this can be and why cases can end up going to tribunal. A freelancer who has been fortunate enough to avoid it before now can look forward to a dense thicket of ambiguous questions and little obvious consistency in the final result. CEST is “a tool intended to support hirers, but which creates even more uncertainty instead,” according to Chaplin.
“Introducing these changes and CEST to the private sector in their current format would prove catastrophic for UK plc and the economy overall,” he adds. “HMRC does not understand IR35, does not understand employment status case law and is not capable of effectively enforcing the legislation. How can HMRC be expected or trusted to educate the private sector to assess the employment status of workers when they cannot even get it right themselves? If this goes ahead it will be a complete car crash.”
He is not the only one warning of negative impacts for the wider economy. For many recruitment professionals, the changes mark a retrograde step. Colin Morley, professional services director at Harvey Nash Recruitment Solutions, says that “IR35, in its current state, will hurt innovation, productivity and ultimately the economy. We hope HMRC will take this period to reflect upon the deeply flawed regulation and make the necessary adjustments to support, not hinder, the UK’s business and contractor communities.”
That view is echoed by Karen Field, chief executive of recruitment firm Curo Talent, which works closely with IT giant Microsoft. “Contractors are often moving from one project to another consistently,” she says. “The skills that come from working across different sectors and companies like this, are the sort of skills that will make the UK a leader – particularly in areas which are experiencing shortages of skills, such as IT and computing. This way of working should be encouraged, not discouraged due to complexities and changes in legislation.”
Such arguments are unlikely to hold much sway in the Treasury, which is looking forward to more tax revenue. The government says the changes made in the public sector have already brought in an additional £550m in income tax and national insurance contributions in the first year, but the private sector could provide an even greater windfall – HMRC estimates that the cost of non-compliance will reach £1.3bn a year by 2023/24. While the government has made plenty of U-turns on its budget announcements in recent years – most recently in relation to fixed-odds betting machines – it seems unlikely to back down on this policy. So what can freelancers expect once the IR35 reforms come into force for private sector employers in April 2020?
At its most basic level, contractors will no longer be able to determine their IR35 status themselves. Instead, their clients will do so before any work is done – assuming the client is defined as a medium or large employer. The budget statement did not spell out the definition of such companies, but the government says that the smallest 1.5 million businesses in the UK will not be covered by the rule changes. Another consultation exercise is due to be held in the coming months which might offer some more clarity.
“If you’re outside IR35, it’s business as usual,” says James Poyser, chief executive of InniAccounts, which provides accounting for contractors. “If your engagement falls inside IR35, your client or your agent will collect tax and national insurance on your behalf and pay your fee net of these deductions.”
This will inevitably lead to a sharp jump in tax bills for some people, but not everyone will be negatively affected. Poyser points out that “HMRC has stated that at least two-thirds of those working via their own personal company are legitimately outside IR35. In many industries, the proportion outside IR35 will be much greater. For example, the general view from the IT industry is that over 80% of engagements will continue to fall outside IR35.”
Nonetheless, for those captured by the changes the effects will be unwelcome. While some employers may try and bring regular freelancers onto their permanent payroll, others will simply offer the same pay but with the higher taxes. Vivek Madlani, co-founder of freelancer financial planning service Multiply, suggests it could reduce a contractor’s net income by up to 25% and some people may also need to make backdated payments. “The vast majority of legitimately self-employed people risk being stung with huge bills that they’re unprepared for,” he says.
Others warn that the amount of work available may also fall away. “A roll-out of the off-payroll reforms could mean that hirers will simply not engage freelancers and contractors at all which will defeat the whole purpose of a flexible freelance workforce that enables businesses to be agile,” says Julia Kermode, chief executive of the Freelancer & Contractor Services Association.
However, the decision to delay the introduction of the changes to 2020 at least gives freelancers some time to prepare. The first step to take is to find out if you will be covered by the reforms. Anyone working exclusively for small companies will not be affected, but if you carry out work for medium or large companies you will be caught.
“I would advise that self-employed people use the extra time the Chancellor has allowed to seek professional legal guidance on their IR35 status and also ensure they are building a contingency fund just in case they fall foul of the new regulations,” says Madlani.
Others may find that it makes sense to change how they go about offering their services, particularly for those that currently operate as a limited company. Poyser says that if a contractor expects to do work outside the remit of the IR35 reforms in the future (e.g. by working for a small company) then using a limited company structure will probably still be the most cost and tax efficient way to operate. On the other hand, if they think all of their work will be captured by the IR35 changes then it might make sense to switch to a so-called “umbrella” company, which essentially acts as an extra step between a client and a contractor.
However, this will not necessarily suit everyone. “Check the fees involved because for all but the lowest paid the running costs of an umbrella can be staggering and can quickly outweigh the costs of running a limited company,” adds Poyser.
There are some things that freelancers and contractors should probably not do, though. One thing to avoid is giving in to the temptation of using some dubious tax evasion schemes, which could come back to bite them in the future. “We have seen an increasing number of employers hiring workers under the guise of false self-employment and employing exploitative working practices,” says Kermode. “We will undoubtedly see an exponential proliferation of tax avoidance schemes as an inevitable consequence, as we have seen in the public sector.”