What will the new IR35 legislation mean for contractors?

Nick Martindale

The UK Government’s crackdown on what it sees as improper use of contracting shows no sign of abating.

Proposals announced in this year’s Budget aim to take the responsibility for determining whether contractors working in the public sector fall under the remit of IR35 legislation away from the contractor, and put the onus on to recruitment agencies or their clients.

Alongside this, HMRC plans to bring in a new digital tool to help workers determine for themselves whether they fall inside or outside of the regime, with those who do effectively treated as employees for tax purposes.

“The suggested new HMRC test and tool will make it easier to determine whether an individual falls under IR35 and is likely to mean that more contractors will find that IR35 regulations do apply to them,” says Charles Daw, Director of Sales at CXC Global EMEA. “This will lead to more taxes collected for HMRC, who believe they are losing about £400 million a year through non-compliance at the moment.”

Closely linked to this is a second change, which restricts all contractors from claiming travel and subsistence expenses if the person providing the work is under ‘supervision, direction and control’ (SDC) in the manner in which they provide services.

“It appears to put at risk every umbrella contractor because the right of SDC can be by any person in the whole supply chain,” points out David Evans, Director at north-west firm Bishops Chartered Accountants. “The guidance also appears to take away any possibility of having a get-out clause, and suggests that anyone bound by professional standards is particularly likely to be affected by the regulations.” This would include teachers, care workers and medical contractors in particular, he adds.

In the longer term, there is potential for this test to be extended to IR35 more broadly, suggests David Shuttleworth, Commercial Director at BPS World. “While the new SDC guidance has not been rolled into IR35, SDC has always formed part of the IR35 assessment, whether implied or explicitly,” he says. “If SDC is successful in reforming employment intermediaries’ treatment of travel and subsistence, then it is predictably a short hop to having the same SDC test applied explicitly to IR35.”

The new moves have obvious implications for contractors, employers and agencies. “For contractors who discover that they are operating inside IR35 this could lead to reduced tax efficiencies, essentially resulting in lower take-home pay as they are no longer splitting their income into salary and dividends, but instead are required to withdraw all profits through the PAYE system,” says Bivek Sharma, Head of KPMG Small Business Accounting Services.

“This could reduce the incentives to go into contracting and reduce the pool of flexible workers to choose from.” It also creates an imbalance between contractors working in the public and private sectors, he adds, meaning two IT contractors working in different environments could receive different amounts of take-home pay.

This could also see the public sector become less attractive to contractors who can work between that and the private arena, warns Julia Kermode, Chief Executive of the Freelancer and Contractor Services Association. “This marks the latest in a raft of measures that drive up tax, reduce net income and restrict the means of engagement for public sector contractors,” she says.

“We are already seeing contractors cautious about undertaking new public sector assignments, and ultimately we may see a mass exodus from the public sector, which will undoubtedly lead to a skills and talent shortage.” It’s also possible contractors will seek to renegotiate fees to make up for any shortfall, she argues.

The restriction of travel and subsistence expenses will also have an impact on the whole contracting sector, says Louisa Batten, Director of Global Employment Solutions at Airswift. “This will have a significant impact on take-home pay for contractors and may limit the distance they want to travel for work,” she says. “This will obviously have a major impact on margins for agencies.”

For agencies, the possibility that they will have to take responsibility for determining whether individual contractors fall into IR35 or not could create additional risk and workload. “This would create more work for the agencies themselves and they would need to rely on gathering information from the end-client and the contractor about the working environment,” says Daw. “This could be a difficult task, time-consuming and open to challenge from many sides.”

In reality, agencies are unlikely to be able to take on this role, warns Samantha Hurley, Operations Director at APSCo. “Recruitment firms have no control over the relationship between the contractor and the client,” she says. “Clearly they will not be able to take on this kind of unknown liability, so they will have to assume the contractor is inside IR35. Consequently, we are likely to have large numbers of falsely employed contractors.”

Yet there are some who believe a greater degree of clarity over the issue of IR35 would be welcome. “The SDC changes are a further demonstration that the Treasury are serious about recovering tax from disguised employment,” says Shuttleworth. “And, it has to be said, rightly so. The current ‘murkiness’ of interpretation of IR35 and the difficulty in policing this effectively doesn’t really help anyone. By removing the grey areas, employers, end-clients, agencies and of course the contractor will understand their tax liabilities and will be able to plan, procure and employ in their businesses a whole lot more effectively.”

Batten also believes this could help those agencies that are able to undertake such checks, by taking away a hassle from clients and making themselves more attractive. “Businesses are likely to look to employment organisations that have the necessary skills, systems and appetite for managing risk and offsetting the impact of the IR35 changes,” she says.

“Employment organisations with the technology, expertise and processes to ‘employ’ candidates and manage their finances and obligations will help contractors to access a wealth of benefits and operate more efficiently, while also minimising the risk to the end-client.”