What IR35 means for you

Companies are suspected of hiding employees in plain sight © Getty

(Image credit: Getty Images)

published 18 March 2020

With less than a month to go until the new tax year begins on 6 April, it is clear that the government has no intention of delaying its controversial IR35 reforms. From 6 April most private companies hiring contractors will be legally responsible for judging whether such workers should actually be classed as employees – and taxing them accordingly.

The changes are intended to tackle a system that has undoubtedly been open to abuse. For contractors, operating as a limited company rather than accepting a short-term employment contract has generated tax savings for both them and their clients.

Where contractors are genuinely freelance (working for a number of clients, managing their own time and workloads and deciding how work is delivered) that’s not a problem. But the Treasury thinks many contracting relationships are just “disguised employment”, set up to reduce the tax bills of both parties.

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A rushed job?

However, while a crackdown on what is effectively tax avoidance is reasonable, many contractors’ groups believe the changes are being introduced too quickly and that there is not enough clarity about who does and does not fall within the IR35 system.

Contractors fear they will be targeted by HMRC seeking retrospective tax payments. Companies are worried they will be penalised for getting IR35 determinations wrong. Many have therefore simply introduced blanket bans on hiring freelancers.

It’s also galling for many contractors that while they will pay tax and national insurance in the same way and at the same level as ordinary employees if, in future, they are “deemed employees”, that won’t mean they are entitled to statutory employment rights. They may still miss out on benefits such as sick pay, holiday pay, pension contributions and protection from unfair dismissal.

What to do now

Still, however unfair many perceive the changes to be, they are going ahead, and those affected need to be prepared. If your business hires contractors, you need to get on top of the rules, work out how they apply to you and how you will respond. If you’re a contractor currently supplying your services via a limited company, either directly or through an agency, you need to talk to your clients about how you will work together in future.

It’s not all bad news. Some of the complaints about the IR35 reforms have been addressed, or are based on a misunderstanding of what will change.

For example, small firms worried about the cost and complexity of having to determine contractors’ status need not be concerned since most will be exempt from the reforms. Small companies that do not exceed two of three criteria – an annual turnover above £10.2m, a balance sheet worth more than £5.1m, or having more than 50 employees – can continue leaving it to contractors to decide whether they’re in the IR35 system.

In addition, HMRC has promised a light-touch approach to the rules in the first year, with no penalties for those who don’t get it quite right, unless they’re deliberately failing to comply. It has also pledged not to use information received following the changes for investigations into how contractors organised their tax affairs prior to the reforms. The rules only apply to services carried out after 6 April, not to payments received after this date if they applied to work done before this date.

Nevertheless, it’s crucial to be prepared for next month’s changes. Start with HMRC’s online employment status tool, which both contractors and hiring companies can use to check the probable status of any particular arrangement. The answer it gives should not be considered definitive, particularly as some contractors’ groups complain that the tool gives too many adverse findings, but it will help you to begin preparing.

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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.