IR35: The new challenges and how to handle them – part 3
In this guide from our IR35 expert, Paul Mason, we look at the new challenges self-employed contractors, end clients and fee payers are facing since the April 2021 changes to IR35 in the private sector, and how to navigate them.
In part 3 of this IR35 guide, we will cover:
- How can contractors influence IR35 status decisions?
- Loss of earnings and opportunities
- Where is the ‘off-set’?
- The ‘Demibourne’ approach
Contractors: Influencers but rarely decision-makers
When a contractor is engaged by a small company or an overseas client with no UK presence, then you are the IR35 decision-maker and have the tax liability if an ‘outside’ decision is challenged and found to be incorrect by HMRC. In that scenario, nothing has changed and you fall under the ‘old’ (Chapter 8 Part 2 ITEPA2003) rules.
However, where your company is engaged by a medium or large sized company all you can do is talk to your end client (and agency) to influence the IR35 decision. The best approach would be to get an independent assessment by taking the opportunity to get your engagements reviewed. If you believe that your end client is prepared to listen to reason, then any evidence you can put in front of your end client is well worth the effort.
The reason for doing so is that working on an engagement that is inside IR35 under the new rules (Chapter 10, where the end client is making the IR35 decision), then every single penny of your fees for the work will be accounted for as either taxes or net pay. There is no scope for setting off expenses, other than those you could claim as an employee, against profits, not least because there won’t be any profit.
That means your running expenses - accountancy fees, insurances, travel and subsistence from home to site, stationery etc. - will come out of your take home pay.
Whereas under Chapter 8, someone who is inside IR35 has a 5% general deduction and allowance for expenses, which is deducted from your turnover before PAYE (including Employers NICs) is applied to the 95%.
Are umbrella companies the answer?
Some contractors may be wondering whether they have to go through an umbrella company if faced with an engagement which is deemed inside? In some cases, you might not have the choice. Some contractors prefer it over engaging through their own company because the expenses issue means that it no longer makes economic sense to trade as a limited company on an inside engagement - especially if you’re going to spend the whole tax year doing so.
But be aware, an umbrella company has to earn its income from somewhere and this will come from the fee paid by the agency/end client to the umbrella company for your services. The umbrella company will then deduct Employers NI (National Insurance) and apprenticeship levy, if applicable, before PAYE is then applied to the remainder.
Loss of earnings and opportunities
As noted in the last paragraph, one of the other big factors for contractors is general loss of earnings. If your end client has determined the engagement as inside, then the day rate must include all those taxes as well.
Automatically, the day rate which can be paid to you has been reduced and you can’t claim your expenses. If you’re going through an umbrella company, there is also the deduction for the services they provide.
Yet it’s not just the loss of earnings. Contract opportunities have also disappeared because of other factors of which primarily COVID-19 has loomed large with Brexit perhaps also featuring. Many engagements disappeared as end clients faced an uncertain future and decided to postpone or even cancel projects.
Where is the ‘off-set’?
Under Chapter 8, there was the ability to offset any tax paid on salary and dividends against the sum successfully assessed by HMRC following an IR35 investigation. This is termed the ‘deemed calculation’. Details and how to calculate this for earlier years can be found here on GOV.UK ‘How to calculate the deemed employment payment’ guide.
You could also set off the additional PAYE tax due against your company’s corporation tax bill.
Under chapter 10, there is no offset. If you have been advised that the engagement is ‘outside’ IR35, your company will be paid gross and can then remunerate yourself as you see fit - typically via a low salary and dividends to minimise your tax bill.
If HMRC review the engagement and can successfully argue that it should have been treated as inside, then the fee payer will have the liability for the tax and National Insurance that should have been deducted at source from payments to your company.
The feepayer has to pay all of that over and currently there is no offset. HMRC are then effectively ‘double taxing’ the engagement. This is because the tax issue relates to two separate and unconnected parties - the fee payer and your company - it is causing HMRC some headaches to resolve this issue.
What is frustrating is that as soon as IR35 was changed in the public sector in 2017, this issue arose and so HMRC have had a good five years+ to consider how it should be tackled but, as yet, they haven’t.
The ‘Demibourne’ approach
IPSE (The Association of Independent Professionals and the Self-Employed) are calling for the ‘Demibourne’ principle to be applied which broadly means you can offset.
Take the example of a sole trader engaged by an end client. HMRC successfully argue that the sole trader was an employee for tax purposes and so PAYE should have been applied. HMRC will allow the tax and NI paid by the sole trader to be offset against the PAYE assessed (but be aware if the individual has not paid any tax, HMRC will go to the engager for the full amount).
IPSE would like this approach to be adopted under Chapter 10, as they believe that it is important to ensure that the contractor is not going to get stung by this.
The downside is that we might arrive at a position where no fee payer is ever going to want to pay gross. Even if a client says it’s outside of IR35, they’re not going to take that risk so we believe that we need to have some fair rules in here to give fee payers confidence that their liability will never be the full amount.
Markel Direct offers a range of solutions for freelance contractors including Legal Expenses Insurance and an IR35 Contract Review service.
Please contact 0330 433 2135 for further details or click here for a quick online quote in as little as 90 seconds.
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