How will IR35 affect contractors?
Off payroll legislation IR35 has been making the news as new changes come into effect in April 2020. They are set to change the way many self-employed workers pay tax, but how does the IR35 change affect contractors?
What is IR35?
IR35 is designed to ensure that taxation is the same, regardless of how a worker is engaged or employed, in particular, employer National Insurance contributions. Previously it has been up to the individual contractor to determine their tax status, but from April 2017, public sector organisations gained the authority to decide. From April 2020, more changes to IR35 mean this responsibility rolls out to the private sector too.
What IR35 changes are coming in 2020?
2020’s IR35 changes aim to close some loopholes in the status of current off-payroll legislation and crack down on tax avoidance – businesses must pay Employer NI contributions for contractors who fall under the rules as contractors will become employees in all but name. HMRC also wants to limit contractors using dividends from their personal service companies to reduce their tax burden.
As it will be up to employers to decide the taxation of contracts, if you work on multiple contracts at the same time, some may fall under IR35 rules and others, outside of it depending on the circumstances. Some estimates suggest contractors in IR35 could lose as much as 25% of their gross income as a result of the changes.
Do the IR35 changes affect me?
IR35 regulations apply to people operating as Limited Companies or so-called Personal Service Companies: those working as sole traders, through umbrella companies or paid PAYE through an employment agency are not affected. If you are deemed as being a legitimate business, then you can also carry on as normal.
Small businesses also have an exemption to the rules (defined as a business having an annual turnover of £10.2 million, fewer than 50 employees and a balance sheet of less than £5.1 million in the previous financial year), so if your contracting work is largely with this size business, you will also be unaffected by the changes to IR35.
If most of your contracting is with public sector organisations, then there will not be any further changes. However, as part of a general crackdown on tax avoidance, if you have been contracting long-term and HMRC find you have wrongly declared your IR35 status, then you can find yourself facing a hefty tax bill, including interest and penalties: a number of contractors previously working for HMRC itself have even found themselves falling foul of this.
How will changes to IR35 affect contractors?
As you are deemed an employee for tax purposes, businesses will deduct employer NI contributions from your income at source, just as they would do for a PAYE employee, rather than receiving the gross pay. While the difference in income might be minimal in the long-term, depending on your arrangements, expect to see a short-fall in your bank balance in the short-term. Other affects coming into play from 2020 include:
- You still won’t get access to the same benefits as normal employee would, such as sick pay, holiday pay and employer pension contributions
- You will no longer have access to the 5% allowance for business costs (accountancy, administration) for earnings insider IR35
- Your administration costs could increase if you work on contracts both inside and outside IR35
Many large companies also report that the changes will force a rethink of how they are using contractors to keep their tax burden down, and there may be a downturn in the contracting market come April 2020.
Latest Update on IR35 Government Review
In January 2020, the government announced it would be conducting a review into how it implements the changes to IR35, and to assess whether any additional support for contractors affected is required. The review is coming to address concerns from both contractors and businesses so that the IR35 reforms can take place smoothly.
Major contractors have been auditing freelancers employed via personal service companies as thousands of professionals are braced for a move back to PAYE. The government is now calling for evidence from affected individuals and businesses to ensure “smooth implementation of the reforms.”
Results of the review will be announced in February, but don’t expect any last minute amendments to off payroll legislation. The announcement was clear it would only examine how April’s IR35 changes are being implemented, not the changes themselves.
A separate review will also follow that will explore possible support to the self-employed, including making the tax system easier to navigate. One key area to be analysed is the Check Employment Status for Tax (CEST) tool – a tool for contractors to test their IR35 status.
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