What’s Happening with IR35 in 2021?
The Government’s delayed IR35 rule changes are almost upon us. The regulations which were postponed due to Coronavirus are due to come into force in April. However, none of the controversy has gone away. So, what impact will IR35 have and how can you get ready?
A noble intention
Even critics of IR35 agree its intentions were noble. The regulation aims to create a level playing field in the workplace by removing situations when two people could be doing the same job but be taxed very differently.
Under these new rules, responsibility for deciding who should be included in IR35 from the contractors to large and medium sized companies. The same rules already apply to the public sector, but from April the private sector will move onto the same playing field.
It’s an attempt to remove the practice of disguised employment in which people work full time as employees but are paid as contractors. By doing so companies could avoid PAYE obligations and contractors could benefit from a more favourable taxation situation.
The changes could impact 170,000 contractors and about 60,000 engaging companies, and they are not happy. They argue the rules could have unintended consequences such as seeing legitimate freelancers forced into IR35 or discouraging engaging companies from using freelancers.
Already freelancers have seen a 30% reduction in pay. IR35 could exacerbate this problem at a time when the economy is struggling to cope with the biggest downturn for 300 years.
For the government, on the other hand, this is a chance to close a loophole which costs the exchequer billions. According to HMRC just 10% of contractors were treating engagements as being inside IR35. By the 2023/24, they estimated this could cost the Treasury £1.3bn per year. They hoped changes to regulations would increase that 10% to a third.
The government sold this move to contractors as a chance to reduce administration. This, presumably, would be because they would close down their personal service companies. These would become redundant as they would no longer be able to offset their expenses against tax.
For all the protests, therefore, IR35 looks set to become law. Both contractors and engaging companies will have to make sure they are ready.
Considerations for engaging companies
For many companies, this is a second chance. The delay of IR35 came as a lucky break for many companies and contractors. Many were ill prepared for the change and were struggling to get up to speed.
Those who did act either chose to accept the changes and retain their best talent. They worked to ensure their contractors could continue to work with them through limited companies.
Others, however, chose to either move everyone into employed solutions or stopped using the contractors altogether. A fear of falling afoul of the regulations, coupled with a lack of preparation meant many erred on the side of caution.
Contractors suffered as a result. Many have had to accept a reduction in their take home pay because they have been unable to negotiate an increase in their rates to compensate.
Confusion also exists over the definition of the end client. This arose thanks to issues of outsourcing. Where a company is genuinely outsourcing these services to a third party, responsibility for making the determination will lie with the third party.
However, if the client is using a consultancy to fill a vacancy, the consultancy is not the end client of the contractor. Responsibility would rest with engaging firms because they would be the ones paying the freelancer’s company.
The legislation only applies to large and medium size businesses. Smaller companies are excluded, but even here there are complications.
Generally speaking, a small company refers to a firm which has fewer than 50 employees, a balance sheet of £5.1 million or less and turnover of no more than £10.2 million. However, where a small company is part of a group, the group’s financial situation will be considered.
Some contractors have come together to form small consultancies through which they can undertake projects. It is possible that HMRC may decide to look more closely at the contractual groups to ensure they are not being used to get around the rules. When they are genuinely being used to outsource work there should be no problem.
Others have used Statements of Work (SoW). This would define a project by specific deliverables and is seen by some as a solution to IR35. This in itself may not be enough to ensure an engagement falls outside IR35 if the contractor can be moved from one deliverable to another.
Opportunity for umbrella companies
These changes will represent a considerable upheaval. Whatever approach firms decide to take, they will have to take on more paperwork, and get their heads around new rules. This creates an opportunity for umbrella companies.
Many companies have responded to the changes by not working directly with limited companies. This avoids any possibility that they may find themselves running into problems with the regulations. Umbrella companies offer a way for them to become instantly IR35 compliant. All contractors who work through umbrella companies will be already classed as employees and should not be impacted by the rules. Already, umbrella companies are directly marketing themselves to both end clients and engaging companies as offering a solution.
So too are recruitment agencies. They can also add value by taking care of additional paperwork and providing due diligence for IR35. They can also offer advice and guidance on setting up agreements.
What the future holds
The changes to IR35 represent an enormous upheaval. In many cases they have made life difficult for contractors. Critics say that doing this at a time when work is fragile is counterproductive. Many will hope that the ongoing pandemic crisis will trigger a further delay to IR35.
Others warn that, coupled with the impacts of Brexit and the rise of digital technology, many companies may replace UK contractors by outsourcing services overseas.
Contractors may baulk at the prospect of their taxation position worsening, being forced to take less favourable terms or into employment. Many will find themselves moving either by choice or at the request of their end clients into umbrella companies.
However, this needn’t be the case. The biggest problem with IR35 is uncertainty. The prospect of financial penalties from the authorities and a lack of confidence about making determinations themselves, lead many companies to take what seems to be the easiest approach.
Those which prepare early, and embrace these changes, though, will be able to continue working with their favoured contractors. They can adjust their contracts to ensure they are abiding by the new rules.
By doing so they will be in pole position to retain the best talent and work with people of their choice. In turn, this will open up a difference between successful adopters and those who are struggling to keep up.