What is the financial impact of being inside IR35?
If the global COVID-19 pandemic hadn’t happened, the IR35 reform would have been three-months old by now, and and getting to grips with them would probably be most contractors’ biggest worry. As it happens, one of the earliest COVID-19 economic protection measures put in place by the government in March was to delay the IR35 private sector reform until April 2021 in order to ease pressure on businesses and the self-employed.
We appreciate that, due to the aforementioned pandemic, IR35 might not be the most important issue for anyone right now. That being said, contractors really do need to keep it in the back of their minds. After all, the April 2021 launch date has now been set in stone after MPs voted against further delays earlier this month, giving you a little under nine months to make sure you’re prepared.
What is IR35?
In the simplest of definitions, IR35 is the legislation designed to clamp down on the use of PSCs by individuals whose working practices would normally see them classed as employees. If you are found by HMRC to be ‘inside’ IR35, then it means you do not meet their definition of a self-employed person and therefore are liable to be taxed at source using PAYE, just like an employee.
However, as you are not an employee, you are not entitled to benefits such as sick pay or annual leave, meaning you have increased tax and National Insurance obligations, but without any of the perks.
IR35 legislation has existed for a long time, but the reforms rolling out next year make some important changes.
- Your end client, rather than your PSC, will now be responsible for determining your IR35 status by creating a Status Determination Statement (SDS).
- Your fee-payer, not you, will be liable for ensuring the correct tax is paid once they have received your SDS.
How could I be found inside IR35?
When determining IR35 status, three main factors are taken into account:
- Personal service/right of substitution – Can you send a substitute to carry out work in your place without requiring permission from your client? If you do, then you can argue that IR35 doesn’t apply to you.
- Mutuality of Obligation (MOO) – Are there obligations on you and your client to accept work and provide work respectively? This would need to be the case for IR35 to apply.
- Control – As a contractor your client should not have control over your output in the same way they would have over that of an employee. While they would set the project brief, it should be up to you to carry it out how you see fit.
Another test that can be applied is the business-on-own-account test, made famous by journalist Kaye Adams when she won the IR35 case HMRC brought against her. This looks at a variety of working practices to see if you are indeed self-employed or a disguised employee.
If an examination of your contracts and working practices suggests you could be classed as a disguised employee then you would be placed inside IR35 by your SDS.
How much could being found inside IR35 cost me?
Exactly how much IR35 could cost you will depend entirely on your personal circumstances, your day rate, and how you manage your PSC. But, making certain assumptions, we can give an illustration.
Assuming you pay yourself a minimal salary and leave the rest of your earnings in your limited company, drawing down dividends, then moving from outside IR35 to inside IR35 could cost you a 30% loss on your income (give or take for slight changes in tax thresholds year to year) on a day rate of around £650. On a day rate of £1,000, this goes up to as much as 33%.
This is based on the move to IR35 meaning you pay basic and higher rate income tax through PAYE, as well as NICs.
What are the other effects of being found inside IR35?
As well as the obvious financial implications, the main secondary effect of being found inside IR35 is that, despite paying the same contributions as permanent employees, you would not have the same benefits as them. So, you would be working alongside people who pay in the same as you, but have access to annual leave, sick pay, and other workers’ rights, that you do not get to enjoy.
Of course, one of the main ‘gripes’ with PSC contractors was that they enjoy more take-home pay than their permanently employed colleagues.
However, this was generally regarded as compensation for the lack of in-work benefits. The reforms, then, do not level the playing field, but rather dig a deeper hole for the self-employed.
What are my options if I’m unfairly found inside IR35?
A big difference between the public sector IR35 reforms and those for the private sector is that the April 2021 reforms include a client-led status disagreement process so that you can challenge your SDS if you have reason to believe it’s incorrect. Your end client has 45 days to respond from when you push back, however, they are not obliged to change their decision if they wish to stand by it.
Of course, prevention is always better than cure, so we would recommend reviewing your contracts and working practices now to ensure there is no reason to find you inside IR35 for any future engagement.
We’d also suggest taking a look at Kingsbridge’s IR35 Protect cover. As well as cover for taxes, interest and penalties from HMRC, the Standard and Premium packages include IR35 Status Reviews by an expert panel so that you can be confident in your status and communicate this to end clients.
Uniquely, the policy flexes to cover whoever holds the tax liability. While that is currently you, come April 2021 it will be your fee-payer so IR35 Protect could also make you a more attractive hire as it minimises financial risk.
Find out more here or call our team on 01242 808740.