Who will be affected by the changes?
IR35 was first introduced in 2000 to stop individuals who would otherwise be employees from operating through a limited company to gain a more tax-efficient way of being paid. The 2000 legislation (Income Tax (Earnings and Pensions Act) s 48) required the construction of a hypothetical contract between the individual undertaking the work and the end client. If that hypothetical contract would have been a contract of employment if it were not for the existence of any intermediaries, IR35 would apply and the limited company would have to operate the deemed payment calculation when paying the individual.
When the government first consulted on the legislation, the original intention was that the end client would be liable for any tax and national insurance for non-compliance. This approach was abandoned however after lobbying and pressure on the government from large corporations and, as such, the limited company ended up being the party liable under IR35.
Fast forward 19 years and HMRC’s record of challenging companies under IR35 is poor at best. In the author’s opinion, a lack of resources, inadequate training, mismanagement of cases, along with limited options for the recovery of liabilities all led to IR35’s demise in its current form.
HMRC estimates that the cost of non-compliance with IR35 will reach £1.3 billion by 2023-24 if no further action is taken to address the perceived non-compliance.
Public sector change
The first step in the government’s plan to correct IR35 was implemented in 2017 in the public sector, when new provisions were added to the existing legislation which moved the onus of determining IR35 to the public sector body with the entity paying the limited company, being the party responsible for applying the deemed payment where necessary. The government has said that this change raised over £550 million in revenue during the first year.
The apparent logic for it being only introduced in the public sector to start with was that the government has a duty to the taxpayer to ensure their own sectors operate correctly. Being cynical, it was more likely that this was the path of least resistance, as public sector bodies cannot really argue against this change and, by introducing it first in the public sector, the doors are then open to roll it out in the private sector once the changes have been in place and the government can address any issues and reduce complaints about any changes being ‘unworkable’.
Private sector change
Lo and behold, after one year the government announced in 2018 that it would consult on changing IR35 in the private sector so that it was in line with the public sector (in the interests of being fair and just). Following two consultations, the draft legislation to amend IR35 was released on 11 July 2019 and the new revised legislation will now mean that all medium and large organisations in all sectors will be responsible for assessing whether IR35 applies or not for individuals working for them through their own limited companies. The old IR35 rules will remain unchanged where services are provided to ‘small’ clients outside the public sector (for now).
During the consultation process there were concerns raised about the ability for smaller organisations to adapt to the proposed changes because of time, training and cost pressures. The draft legislation therefore brings small companies, as defined in the Companies Act 2006, outside the scope of the changes and the existing IR35 rules will apply where an individual works in the private sector and the client is deemed to be small. The Companies Act 2006 states that a company is small provided it does not satisfy two or more of the following:
· the annual turnover is not more than £10.2 million
· the balance sheet total is not more than £5.1 million
· the number of employers is not more than 50.
The government believes that this will result in 1.5 million organisations being classed as ‘small’ and outside the scope of the changes. Those 170,000 additional individuals will now be paid within IR35 where, up until now, they have been incorrectly classifying themselves outside the scope of the legislation. It also claims that 230,000 individuals will benefit from not having the cost and administration hassle of determining IR35.
One notable problem with this approach is that the individual may not be aware of whether the client fulfils the criteria for being small. This could lead to ambiguity over who is responsible for the decision with individuals assuming the client is small, when in fact, it is not. It would be prudent for contractors to ask all clients for confirmation of whether they are medium or large organisations as a matter of procedure, no matter how obvious the answer may appear.
The government has addressed concerns about clients changing between being classed as medium/large and back to small again, which could mean the personal service company becomes liable without any knowledge. The proposal is that the client will have a duty to notify workers and fee payers if it changes to be a small company and any failure to notify will result in the client continuing to be considered as a medium/large company.
Once everyone has got to grips with small companies being outside the scope of the new changes, it is quite likely that the government will remove the small company provisions from the legislation as the summary of responses from the 2019 consultation has already acknowledged that having separate rules for small companies adds complexity and should be reviewed once the legislation has bedded in.
|Authored by Kye Burchmore, ‘Off-Payroll Tax Handbook’ is due to publish in October 2020. For more information, please visit our website.|