Today’s companies often rely on a mix of talent – permanent, contractor and freelance – to achieve corporate objectives. Through this approach, businesses can deploy talent as needed, scale up or down their non-permanent workers according to fluctuating demands and, overall, benefit from a more flexible approach to managing their workforces.
For the last two decades, contractors working through their own limited company have had to apply the IR35 rules to their engagements. First introduced by the Inland Revenue (now HM Revenue and Customs, or HMRC) in 1999, the IR35 legislation aims to ensure contractors pay the appropriate tax based on their working arrangements. In effect, if the contractor essentially works as an employee (even though they are working through their own company) they should pay tax as an employee would.
Until 2017, compliance with IR35 was a personal matter for the contractor who was expected to assess their own status and account for tax accordingly. In April 2017, for assignments in the public sector, responsibility for making the assessment, deducting and accounting for tax, transferred to the “fee payer”; that is, the organisation paying the contractor. HMRC consider the implementation in the public sector to be a success, and similar rules will be rolled out to the private sector in April 2020. Understandably, private companies are already considering how IR35 will impact their businesses, hiring strategies and ability to work with independent contractors.
what is the effect of IR35?
The effect of IR35 turns on the employment status of the individual with regards to their relationship to the end-user. The law was brought into force to counteract perceived tax avoidance by individuals providing services to clients via a limited company or limited liability partnership. Even though a significant number worked the same way as regular employees, working through a company or partnership allowed them to benefit from a lower marginal tax rate.
Specifically, by working through a limited company, the workers could take a minimal salary to reduce liability under the Pay As You Earn (PAYE) system, offset genuine business expenses against revenue and take an additional income by way of dividends.
An example case would be an employee leaving their job on a Friday only to return on the following Monday as a contractor through a third party. Since they would do the same job, but pay significantly lower taxes, the Inland Revenue perceives this as avoidance of tax. Of course, not every situation will be so clear cut, and there is usually much grey area around what makes someone an employee or a contractor. In fact, HMRC have themselves struggled with assessments for tax under IR35, winning in around 50% of cases. That is why private sector employers are growing anxious about the potential law.
what is the effect of IR35?
The effect of IR35 turns on the employment status of the individual with regards to their relationship to the end-user. The law was brought into force to counteract perceived tax avoidance by individuals providing their services to clients via a limited company or partnership. Even though a significant number worked the same way as regular employees, working through a company or partnership allowed them to benefit from a lower marginal tax rate.
Specifically, by working through a limited company, they could take a minimal salary to reduce liability under the Pay As You Earn (PAYE) system, offset genuine business expenses against revenue and take an additional income by way of dividends.
HMRC was concerned by the exploitation of this arrangement by people who were in all regards an employee. An example case would be an employee leaving their job on a Friday only to return on the following Monday as a contractor through a third party. Since they would do the same job, but pay significantly lower taxes, HMRC perceives this as avoidance of tax. Of course, not every situation will be so clear cut, and there is usually a grey area around what makes someone an employee or a contractor. In fact, HMRC have themselves struggled with assessments for tax under IR35, winning in around 50% of cases. That is why private sector employers are growing anxious about the law.
making accurate IR35 determinations is difficult?
For instance, in the very first challenge to the law, the case involved an individual who provided services to a bank under a company for which he and his wife were the directors. The lawyer for Inland Revenue successfully argued that he was an employee based on the length of his tenure, the fact that he was supervised by a manager and because he was integrated into the structure of the bank. As a result, the Court determined he should be considered an employee.
Another example from 2010 shows a contractor situation to which IR35 would not apply. In this case, an individual provided IT consultancy services to an organisation through a series of extended contracts, serving in such capacity for four and a half years. Since he wasn’t entitled to the perks an employee is, such as access to the staff car park and the ability to participate in employee training programmes, he was deemed to be a contractor rather than employee and thereby outside the purview of IR35.
dealing with change.
Given how far-reaching IR35 has been, the law has faced significant pushback. Shortly after its introduction, the Association of Independent Professionals and the Self-Employed (IPSE) was established to help support contractors and consultants maintain their contractor status. Many businesses have also lobbied against IR35, citing that there is too much ambiguity to make appropriate decisions around their workforce.
Since much confusion remains, and each case is unique, one of the biggest impacts of IR35 in the public sector has been the increase in businesses created to assist public organisations in navigating the complex law. This includes tax protection insurers, contract review services, employment status experts, and others to help companies remain in compliance with IR35 and related employment laws.
While the burden of determining one’s work status typically relied on the contractors themselves, a change to IR35 in April 2017 made it the responsibility of the user of the contractor’s services. In addition to making these determinations, employers must ensure their contractors are taxed at the correct rate and make the appropriate national insurance deductions.
Although many believed this recent change would lead to a massive drop off in contractors willing to work in the public sector, and individual agencies report various outcomes, HMRC reports no evidence of drastic changes in the attrition rates of public sector contractors or significant increases in contractors’ payment demands.
lessons for the private sector.
For private sector employers, the roll out of IR35 for their businesses has led to a great deal of confusion and uncertainty. Will they still be able to hire contractors? Will such talent still want to work for them on a contingent basis, or will they seek permanent positions instead? And how can they devote the necessary resources to vetting contractors while ensuring they and their contractors are compliant with tax requirements?
Despite the reports from HMRC, it’s not just employers that are concerned about the legislation. According to research by Qdos Contractor, more than 60% of contractors surveyed fear that the changes introduced by IR35 would be unmanageable, driving concerns of a talent shortage in the U.K. as more contractors seek employment in other locations.
For an idea of how they can respond to the introduction of IR35, businesses need only to look at the public organisations that have already had to comply with its requirements. One example is Transport for London (TfL), the public-sector organisation - responsible for public transport in and around Greater London.
In preparation for the April 2017 changes to IR35, TfL sought to assess its entire contractor workforce to ensure compliance, with minimal disruption to its critical ongoing projects. TfL performed a rigorous assessment of each part of the organisation, categorising which operations are most business critical. The categorisation classified certain roles, such as call centre advisors, as inside of IR35 to be paid via PAYE or Umbrella companies. It decided that it would only allow limited company workers, PSCs, to continue if they passed an independent tax test, with the manager signing off, as a valid way of working. Many of the organisation’s PSC workers in IT and engineering were able to continue as a result. TfL partnered with its suppliers under the guidance of the Head of Tax to deliver tax testing to ensure IR35 compliance.
how you can prepare now.
Perhaps the most important thing TfL did to get ready for the newest changes to IR35 was to start preparing before it even became official. This gave the organisation a head start to begin the transition. As IR35 will soon be extended to the private sector, employers can take a similar approach and prepare for its launch right now.
Here are five ways you can prepare your organisation for IR35 to achieve compliance and maintain a successful contingent workforce strategy.
- Understand the impact.
IWhen IR35 goes into effect, the impact on your company’s contingent workforce strategy can be significant. Many contractors may raise their rates to compensate for the greater tax burden, leave to find new opportunities or dispute any judgments about their work status. Acknowledging these risks and developing a workforce planning strategy to compensate for sudden talent scarcity or greater costs can help minimise disruption.
- Evaluate contractors now.
When the April 2017 changes to IR35 were rolled out, the public sector only had two months to comply. Begin assessing your current contingent workforce now to see how many would go against the requirements of IR35 and what you can do to convert them to either employees or true contractors.
- Communicate with your talent.
To ensure the appropriate determinations are made, talk with each contractor to better understand their unique work arrangements. As many public sector organisations have learned, it can be a mistake to make assumptions and apply a blanket strategy for multiple workers, even if two contractors do very similar work. This can reassure your company and your contractors that you’re investing in due diligence to make the right decisions.
- Work with a contingent workforce management and recruiting partner.
The regulations of IR35 are complex and can pose challenges for anyone tasked with interpreting them to determine whether contractors may be in violation. Collaborating with an experienced third party that understands how IR35 has impacted the public sector can help you assess your risk, guide you through the changes and help ensure you maintain a compliant approach.
- Consider an employed consultant model (ECM).
The ECM model can be a cost-effective way to acquire the consultant skills your company needs. As the employer of record, Randstad Sourceright can recruit, hire, train and deploy a variety of skilled workers available to you as statement of work (SOW) consultants. That means your only costs are for the contracted services. Additionally, this highly scalable solution delivers resources as needed, so it can grow with your needs. Typical savings range between 8 to 25%.
As IR35 will be mandated for private businesses in April, 2020, it is well worth it to begin preparing now. This will not only help you streamline processing to ensure compliance, but it can also help you build trust and maintain relationships with the contingent talent that is critical to your business.
want to learn more?
Contact a contingent workforce management expert for a personal consultation or more information on ECM talent models today.
*The content included here is for educational purposes only and is not intended to serve as legal or tax advice.