Written by Ray Coman
At the time of writing IR35 has been the subject of concern in the contracting market. However, IR35 has been around for a long time. The main change occurring on 6 April 2021 is that the person hiring, or paymaster, will be responsible for deciding whether an individual is inside IR35 or outside IR35.
Contractors are greater in number than their paymasters and therefore, HMRC monitoring is facilitated by the change in regulation. There is also an argument that the human resource function is inclined to risk aversion as opposed to the contractor. For instance, insolvency is more accessible to the lone contractor as compared to the corporate giant. It is the shifting in burden of responsibility which is likely to result in more workers being brought in as employees or inside IR35.
In some of the commentary, there is a kind of misconception that IR35 law is changing in a significant way. The regulation that seeks to tax a person as an employee who is in substance an employee is decades old.
Where an individual is in fact in an employment relationship but provides services through a company, that company contract is inside IR35. A number of case laws decide whether a person is employed or self employed. However, in the HMRC guidance, working status determinants are boiled down to the three aspects of: supervision, control and direction. The diverse nature of the modern market renders it impossible to give a definition of self-employment that is both concise and satisfactory. However, if a working arrangement seems like an employment, it probably is. Coman&Co do not offer an opinion on whether a working arrangement is inside IR35. It is the responsibility of the person hiring to make this judgment. HMRC provide a “Check employment status for tax” tool.
Where the company is small, accountability for determining working status remains with the contractor. In this context a business is small if less than two if the following apply:
- Yearly turnover is more than £10.2 million
- Net assets in the balance sheet are greater than £5.1 million
- There are more than 50 employees.
IR35 opportunity is to improve the marketability of contractors. The hiring company enjoys more favourable terms as it is no longer liable for redundancy, holiday leave and other statutory entitlements such as sick pay. Both parties to the arrangement enjoy the comfort of a pay scheme which is HMRC compliant.
Through IR35 the contractor can effectively exchange the perks of employment for more favourable compensation elsewhere.
A contract is inside IR35 if the contractor would be an employee ‘but for’ a company that is contracted. Usually, the contractor will be told that the company is inside IR35. From 6 April 2021 it is the responsibility of the person hiring to determine whether a contract is inside or outside IR35.
Tax regulation requires that a pay received through an inside IR35 contract is taxed in the same way as employment earnings. This means that the pay is subject to tax, employee’s national insurance and employer’s national insurance. In an employment contract, it is the employer who is liable for employer’s national insurance and employer’s pension contributions. At the time of writing employer’s NI is 13.8% and employer’s occupational pension is 3%. The rate applies to income over the lower NI limit. Therefore, a contractor should adjust pay package prior to a comparison with that of an employment package.
Company accounts show fee income as turnover and deemed payment as costs. Certain costs associated with running the company be additional expenditure. The result is no corporation tax payable on income generated from deemed employment.
A contractor who is providing services inside IR35 will not benefit from redundancy, notice, or holiday leave. It possible that statutory pay could be engineered through the IR35 company. The contractor is not working for the end user, he or she is director of the intermediary company. Therefore, if the contract is ended, this does not automatically result in termination of the director. The company owner would have to call their own redundancy, but since it is not arm’s length, the tax free element of a redundancy pay is unlikely to stand up to HMRC scrutiny. The contractor has a bias for overstating the tax free redundancy. There is also the legal hurdle of re-defining and processing the final pay as redundancy rather than taxable earnings.
Employment contracts often include private medical, gym membership or other perks. These benefits would need to be arranged by the company. Taxable benefits such as private healthcare can create additional annual p11d compliance. Where pay is being processed at regular, say monthly, intervals taxable benefit can be treated as settled out of take-home pay to avoid the paperwork. A negotiating factor would therefore be the additional cost of arranging perks which are commonplace for comparable employment roles.
Salary sacrifice such as the cycle to work scheme and workplace nursery could be arranged via the company. Besides the arrangement cost, the IR35 contractor is no worse of than an equivalent employee in that regard.
From 6 April 2021, it will no longer be possible to deduct administrative expenses which are a flat 5%. However, the following expenditure is tax deductible:
Professional subscription or union fees related to the work activity;
Professional indemnity insurance;
Work from home costs, usually at the statutory rate;
Uniform or safety wear;
Broadly, expenses that are necessary for the role can be deducted (such as office equipment.)
The rules for what can be deducted from a deemed payment are stricter than those related to what can be deducted from the profits of a sole trader or of a contractor outside of IR35. In particular, accountancy fee cannot be deducted from earnings. A Tax Return preparation fee is not tax deductible for an IR35 contractor, just as it is not tax deductible for an employee.
If the contractor subsequently uses the same company for a contract outside IR35, accumulated losses for corporation tax purposes can be set against future income. Therefore, accountancy fee could be deducted from future profits of the company, which in practice would only arise if there were some activity that was not caught by the ‘off payroll’ regulation.
A contract vis the company will potentially give rise to a VAT requirement. Many services provided to business outside the UK will be outside the scope of VAT. Certain services will also be VAT exempt, such as in the medical field. The deemed payment would be calculated on VAT exclusive pay. VAT registration would allow for recovery of VAT on costs incurred for the purpose of the company’s activity. This would include accountancy fee, telephone and other business inputs. The VAT position can be contrasted with that of an employee or director who cannot register for VAT.
A contract inside IR35 will require a company. This means filing of company accounts with both the registrar and HMRC, Company Tax Return with HMRC and confirmation statement. Given deemed payments will usually be paid to the contractor in that person’s capacity as director a personal Tax Return compliance requirement arises. As explained above, VAT compliance, including quarterly VAT Return filing could be a necessity. Payroll, usually monthly will be required to calculate the deemed payment. Payroll is likely the most onerous especially where invoiced amount and any expenses are variable. Effectively the contractor has assumed responsibility for payroll function of the kind typically carried out by an employer.
Coman & Co offer a service to accommodate all the accounting requirements of a contractor, both inside and outside IR35. For those inside IR35, this would include monthly reporting. The task can seem dauting, however we are well experienced and provided the communications are dealt with promptly, there can be a high expectation that the running of the scheme will go smooth. We continue to provide an outside IR35 limited company service for contractors following a path of self-employment.