What a whirlwind of a few weeks this has been! One innocuous statement in the House of Commons and seven short lines of text in the published Growth Plan (23rd September 2022) and suddenly many contractors thought they were returning to 2016. Like a lot of people in the industry I was very surprised by the announcement that IR35 reform would be repealed, coming as it did with no consultation or warning. Whilst I wondered why now and hoped it would come to fruition, I was much less surprised on 17 October 2022 when the repeal was cancelled. Where does this leave contractors now?
What is IR35 and How did we get here?
Back in April 2000, IR35 or the Intermediaries legislation was introduced to combat perceived abuse of the use of Limited Companies, where individuals were in fact acting as “disguised employees”. IR35 required all contractors engaged through their own personal service companies (PSCs) to determine their employment status on each assignment undertaken.
Assessing IR35 is complex. Little guidance existed in 2000 and with no statutory test or status tool to rely on, contractors appeared genuinely concerned by the risk of getting their status wrong, especially following HMRC’s success in Dragonfly Consultancy Ltd v HMRC Commissioners (2008) but over time two things happened. HMRC’s enquiries into IR35 reduced in number and the contractor population grew exponentially. Unfortunately for HMRC they also lost many of the enquiries that they took to tribunal (although more recently HMRC have had far greater success). The result was an ever-decreasing risk of being investigated and a greater appetite to take a chance.
I saw for myself first-hand the complacency that existed in the contractor market in the late 2000’s early 2010’s with many contractors simply not assessing their IR35 status correctly or worse still, assuming they didn’t even need to think about it because they would “never get caught”. The Government recognised a growing problem in the sector, reporting in March 2021 in a House of Commons Research briefing that “in 2011/12 around 10,000 people paid tax under IR35, an estimated 10% of those who should have paid tax on at least part of the income their PSC receives under the legislation.” Whether this estimate of underpaid tax was accurate or not, there was undoubtedly significant abuse of the legislation in certain sectors.
The introduction of Off Payroll Reform in the Public Sector in 2017 and then later in the Private Sector in 2021 meant that end clients now have to determine the IR35 status of any contractor they engage with. This made sense to HMRC and the Government as in their view the end client is best placed to know if an assignment is for a specific project or to cover for an employed position vacancy that can’t be filled. From a practical perspective it also meant HMRC could focus compliance efforts on a reduced number of end clients, rather than hundreds of thousands of individual contractors.
The reforms have clearly led to a reduction in the number of contractors operating Outside of IR35 as HMRC had planned. Whilst in some cases this was the right result, it has been the unintended consequences that have caused much harm to the contracting market. Many end clients lobbied hard against the rules on the grounds that the reform was unnecessary administration and an added expense to their business. Risk adverse organisations took an overly cautious approach to IR35 assessments or simply issued policies banning the use of PSC’s. This led to genuinely self-employed workers being incorrectly taxed and end clients have found it harder to attract the best talent and to remain competitive in their sectors. It is against this background that the repeal appears to have been first announced.
The Growth plan published in September gave us some clues as to why repeal had been considered. The repeal was said to offer the opportunity to “free up time and money for businesses that engage contractors, that could be put towards other priorities. The reform also minimises the risk that genuinely self-employed workers are impacted by the underlying off-payroll rules.”
But did all end clients actually agree with the repeal? For some, there was initial relief especially those who have not undertaken any due diligence in assessing IR35 and have opted to stop using Limited company contractors. However, there are some large end client organisations who have invested a lot of time and money in establishing processes to assess IR35 and wanted to remain involved in the decision-making process, especially to protect themselves from the Criminal Finances Act which requires them to be sure they are not facilitating tax avoidance in any way.
HMRC’s take on things
It’s easy to see why HMRC were likely to be very frustrated with the Chancellor’s proposed repeal. The Off Payroll reform has led to a significant increase in the number of contractors operating through a PAYE model, therefore in HMRC’s eyes reducing noncompliance and abuse.
With a return to the “old rules”, HMRC would have expected a significant increase in the use of PSC’s. which would have applied pressure to their scant compliance resources. I think it was always unlikely that HMRC would have accepted a complete 360-degree U turn, taking us back to a time of obvious abuse. There surely would have needed to be some further guidance or anti avoidance legislation.
We must also remember that HMRC have other tools by which they can attack contractors, irrespective of their IR35 Status. I have recently written about the need to be aware of the Managed Service Company (MSC) legislation as two accountancy service provides are currently under review by HMRC for providing service beyond that of an accountant and akin to influencing, if not controlling the way contractors run their PSC’s.
If HMRC were to win the argument in this case, over 1,000 contractors may find themselves with tax assessments to be paid for the periods in which the MSC legislation is deemed to apply. Other service providers in the contractor accounting sector may also find themselves under review. Orange Genie Accountancy are very careful to ensure we provide and advice and support without influencing or controlling contractors’ business decisions.
Contractors should also remember our friend, TAAR, the targeted anti-avoidance rule. If a contractor is looking to re-start their PSC after a period of employment, then TAAR has to be considered. The legislation looks at “phoenixing”, where a PSC is closed down, profits extracted in a tax efficient manner and then a new PSC opened. To avoid TAAR biting the contractor must be able to demonstrate that the main or only purpose of the liquidation was NOT to avoid or reduce the payment of income tax. There are three other conditions that must also be met, but it is this last one that causes the potential greatest issue on re-starting your company. If the contractor falls foul of the rules, then any tax benefit on profits taken at the time of closure may be lost and taxes will need to be paid to HMRC.
What should contractors do now?
So, for now nothing changes. Chapter 10 ITEPA 2003, Off Payroll reforms remain and end clients are obliged to issues Status Determinations Statements for all contractors they engage through Limited companies. The fee payer in the supply chain remains responsible for ensuring the correct taxes are paid. The ‘old’ Chapter 8 (Part 2 ITEPA 2003) position remains where the contractor is engaged by a small end client or a business based wholly overseas with no UK presence and is therefore responsible for their own IR35 assessment.
On a positive note, even with the rules remaining as they are, the markets have settled since 2021 and Covid. There are more Outside IR35 contracts available as more and more end clients see the benefit of engaging contractors and seek to take the right steps to assess them. Contractors should remain very aware of what makes an assignment “Outside” IR35 so that you can influence the decisions of end clients and agencies at negotiations stages and potentially challenge any assessments not made with reasonable care.
Now is a good time to refresh your memories in the key IR35 status determination factors. We have helped thousands of contractors and end clients assess their status and have plenty of guides that can help.