Unless you’re living under a rock, you’ve probably heard the news about a government crackdown on IR35. If assessed as inside IR35, contractors could owe HMRC thousands, if not millions, of pounds like BBC presenter, Christina Ackroyd, who must now pay back £419,151.

What is IR35?

Initially established in 1999, the IR35 is tax legislation that aims to stop individuals from avoiding tax by supplying their services to clients through an intermediary, like a limited company. Also known as ‘disguised employees’ by HMRC, these individuals, for all intents and purposes, look, act and are employees. However, rather than being on the payroll, they’re registered as limited companies, so they pay less tax.

Employing individuals as “contractors” can save the business a significant amount of money as they no longer have to pay employers’ National Insurance Contributions (NICs) or provide employment benefits like paid holidays, pensions or sick leave. Making it a win, win for businesses and contractors.

What does inside IR35 mean?

Inside IR35 is HMRC’s term for individuals registered as limited companies that act like employees and are in violation of this regulation.

What does outside IR35 mean?

Companies that do not violate IR35 are known as “outside IR35” and won’t face any additional fees or penalties. Even if they’re a one-person business, these companies operate independently from their clients and choose when, where and how they work.

How will your status be determined?

As of April 2020, every medium and large business will be responsible for setting the tax status of its contractors. If this tax status is deemed incorrect, the company will be responsible for any fees and penalties, making it very important to get it right.

HMRC can examine the contractor’s tax status at any time. When evaluating whether someone is inside or outside IR35, HMRC will disregard the written contract and instead consider the contractor and business’ relationship to create a ‘notional contract’.

They will consider the three following factors:

• Control. How much power does the business have over what, how, when and where the contractor completes the assignment? The more control, the more likely the contractor is inside IR35.
• Substitution. Can someone else complete the assignment or is it contractor and person-specific? You’re more likely to be inside IR35 if the latter applies.
• Mutuality of obligation. Is the business obligated to provide work? Must the contractor accept it? If the answer is yes, then you’re probably operating inside IR35.

HMRC will also consider the type of contract, any financial risks for the contractor, their role in the organisation, and whether the company provides the equipment.

Why the crack-down?

The IR35 has existed for almost two decades. Up until 2018, it was mostly ignored and fell by the wayside. Contractors choose whether the IR35 applied to them and charged accordingly. The problem was that many, if not all, contractors decided that they belonged outside IR35. This way they could reap the benefits of full-time stable work without having to pay any taxes.

HMRC estimates that contractors by setting their own IR35 status avoided £1.3 billion in taxes each year as 90% of individuals classed themselves as outside IR35. Whether these contractors knew and chose to ignore the legislation or were unaware remains up for debate.

What impact will it have on contractors?

If assessed as inside IR35, contractors will need to pay the same income tax and NICs as if they were employed. However, they still won’t get any employment benefits, like paid holiday or sick leave, from the managing business.

Being assessed as inside IR35 can have a serious financial impact on the contractor and reduce their net income by up to 25%. Even worse, HMRC can go back at least six years and evaluate all contracts within this time to see if the legislation applies. As a result, contractors could end up owing hundreds of thousands of pounds.

As you can understand, many contractors are unhappy about the crack-down in IR35, and it could have a significant impact on the private sector.

How IR35 changes have already impacted the public sector

The UK government implemented stricter IR35 regulations in 2017 resulting in a mass exodus of contractors. A study conducted by CIPD and IPSE, the association for independent professionals and the self-employed, into the impacts of the governments IR35 crackdown in the public sector reported that over 50% of public sector hiring managers thought they had lost skilled contractors while 71% were struggling to retain their contractors. Successfully recruiting contractors in the public sector now requires more time and financial resources.

If the proposed changes to the IR35 for the private sector goes ahead, reason stands that private companies could face similar challenges. These concerns have added fuel to the fire, so to speak, and resulted in a backlash from contractors and private companies.

Recruitment industry impacts

Many contractors are now starting to look for permanent jobs due to the IR35 crackdown. Once the legislation comes fully into effect, companies may find it challenging to recruit contractors and will need to pay the additional fees associated with hiring a new employee.

Previously, contractors opted for a higher salary in exchange for their employment rights. However, the IR35 significantly diminishes their earning potential, which will cause this type of employment to lose its appeal. Companies will either need to increase contractors fees to accommodate the new legislation or take them onboard as short-term employees.

Some industries, like media and IT, will particularly notice a difference as these industries have a greater need for long-term contractors. As such, a diminished pool of suitable applicants may easily lead to a skills shortage and companies will need to find new ways to attract contractors.

History has shown that this was certainly the case following the public sector crackdown with 80% of public sector hiring managers reporting a rise in workload for engaging and paying contractors.

However, on the other hand, we must remember that the government still hasn’t finalised their plans for the IR35 crackdown and many factors remain unknown. Meaning that for many private contractors business will continue as usual.