November 8, 2019 IR35 Changes 2020 – April 2020 private sector IR35 update April 2020 will see some sweeping changes to IR35 for the private sector. The underlying principles of IR35 are not actually changing – what is changing is who is responsible for the decision as to whether or not an engagement is inside or outside of IR35. This means that if your role is genuinely outside of IR35 now, it should continue to be outside of IR35 come April 2020. Please note – in this article when we refer to ‘you’ we are referring to the contractor / freelancer working through their own personal service company. Currently, if you are working in the private sector, it is down to you to make the decision as to whether or not your engagement is inside of IR35 or outside of IR35. However from April 2020 it will be down to the end client to make the decision. They will need to tell you upfront if the engagement being offered is inside or outside of IR35. If you accept a role that is inside of IR35 and you continue to work through your own personal service company (as opposed to through an Umbrella company for example) you will continue to raise invoices to your client in the usual way but the client (or the fee payer such as an agency) will deduct income tax and national insurance before paying your personal service company. If any VAT has been charged this will be paid to you in full. If, however, you accept a role which has been advertised as being outside of IR35 then the client will pay your personal service company in full meaning there are no IR35 issues. Before we get into further detail on the changes lets rewind a bit and go through some of the basics of IR35. What is IR35? HMRC introduced IR35 many years ago as a measure to tackle the situation where an individual would be treated as an employee were it not for the fact they were providing their services through a limited company, known as a ‘Personal Service Company’. IR35 is also known as the ‘intermediaries legislation’. This is an area that particularly affects contractors and freelancers providing their services through a limited company, although all limited companies need to be aware of this. Trading through a limited company can lead to significant tax and national insurance savings but if HMRC investigate a contract and decide that it is caught by IR35 they will seek the lost tax and national insurance and can potentially go back several years. This is because if you are caught by IR35 you aren’t allowed to pay dividends – essentially everything has to be treated as taxable salary and if you have paid dividends when you shouldn’t have then an adjustment will need to be made. The optimum way to save tax for freelancers and contractors, which we cover in our article here, is usually by taking a low level of salary with the rest of your income being taken as dividends. This avoids unnecessary national insurance payments (there is an optimum level of salary which protects your national insurance position). Under the old IR35 rules it is/was down to the freelancer / contractor to make the decision as to whether or not IR35 applies and the responsibility for the decision was theirs. New rules came in during 2017 which meant that if you worked for a client in the public sector the IR35 decision and responsibility flipped to being that of the end client. The IR35 changes coming in April 2020 align the private sector with the 2017 public sector changes (unless your client is classed as a small business, see later in article) and mean from April 2020 it will be down to the end client to make the IR35 decision. As a contractor / freelancer you will be told upfront if the engagement is inside or outside of IR35 and you can choose upfront whether or not you even want to consider an inside of IR35 role. One positive result of these changes is that the responsibility will no longer be with the contractor / freelancer – as long as you are told an engagement is outside of IR35 you don’t need to worry about potential IR35 issues from HMRC. Exception to IR35 2020 changes – small business clients There is one key exception to the IR35 changes in April 2020 – if your client is in the private sector and is classed as a ‘small business’. In these circumstances the IR35 changes will not apply and you will need to continue assessing your own IR35 position. For a client to qualify as a small business it must meet at least two of the below three conditions: • turnover of £10.2m or less; • £5.1m or less on its balance sheet; • 50 employees or less. IR35 decision tree From April 2020 the decision tree will be as follows for private sector clients: Is your client a ‘small business’? YES – this means you have to decide whether IR35 applies or not: IR35 does not apply – you can follow the tax efficient structure of low salary and dividends, normal business expenses can be claimed IR35 does apply – you have to calculate the deemed salary payment and process through your own payroll. No dividends can be paid and no travel, subsistence or accommodation costs can be claimed NO – this means that the end client has to make the IR35 decision and must tell you up front about this IR35 does not apply – if the client tells you that IR35 does not apply then you can follow the tax efficient structure of low salary and dividends, normal business expenses can be claimed IR35 does apply – if the client tells you that IR35 does apply then they will deduct tax and national insurance on your behalf before paying the net amount to your personal service company. If your company is VAT registered you will be paid the VAT in full. No dividends can be paid and no travel, subsistence or accommodation costs can be claimed. Example of being caught inside IR35 with the new rules Let’s consider an example of a limited company contractor and the role has been deemed to be inside IR35 under the new 2020 rules and their client is not a small company. If we assume the contractor is VAT registered on the standard VAT scheme and they raise an invoice to the client of £2,000 +VAT, so £2,400 in total. The client will process the £2,000 as if it were a salary and will deduct income tax and national insurance from this figure – let’s assume for simplicity the tax and employees national insurance come to £600. The client will pay the limited company contractor the full VAT amount of £400 and will pay the £2,000 less the £600 deductions, so in total they will pay £1,800. Of this £1,800 the contractor has to pay the VAT of £400 to HMRC which leaves £1,400 which can then be drawn out of the personal service company by the contractor. As this income has already been taxed at source there is no corporation tax for the company to pay on this income. The client will give the contractor payslips so that the contractor can include the earnings on their personal tax return, like they would with any other employment. What are the key factors which affect whether an engagement is inside or outside of IR35? When HMRC perform an IR35 investigation they will look at both the actual contract in place between the contractor and engager as well as what the real day to day working practices are. HMRC will speak to the engager and the contractor during their investigation. Ensuring you have an ‘outside IR35’ contract in place is an important step, but it’s just as important to make sure that the working arrangements actually do reflect the contractual terms. There are a number of key areas to consider when determining IR35 status, but three of them are particularly important – Personal Service / Substitution, Mutuality of Obligation and Control. Personal service / substitution It is important to understand that a self-employed contractor / freelancer should be providing a service rather than their own personal skills and if required they should be allowed to provide someone else to do their work. This is known as ‘substitution’. If you were an employee of a client then you would be providing your services personally with no ability for you to bring in someone else to do the work. The tricky thing is that for many contractors and freelancers, in reality, they will never bring anyone else in to do their work, so substitution is often a theoretical situation, however as long as their contract with the client provides a right to substitute someone else to undertake the work (and this is genuine) then this is a very important step towards not being caught by IR35. It is often the case that the client / engager retains a right to say no to a substitution on reasonable grounds but this should be limited to factors such as the experience or qualifications of the potential substitute. It is very important that the client can only reject a substitution on reasonable grounds. Mutuality of obligation This means that there is no obligation on either the client or the contractor to offer or be offered continuing work. A self-employed contractor will work on the specific project that they are being contracted to do and once finished there should be no expectation of any further work by either side. An issue can arise in a situation where work is continued to be performed over a longer period of time – purely on the basis of this ‘habit’ HMRC could try and argue that the contractor has become an employee. Your contract should let you leave a contract early if you wish, and equally the client should be able to terminate early. It is also good habit for a notice period to not be longer than one month. Control The more direction and control that a contractor has over the services they are providing, the better. A true subcontractor is being engaged to provide their expert services, not to come into a business and be told what to do. The more specialist skills and expertise that a contractor has, the more control they are likely to have over their services. For example, if a manager tells a contractor to move from one job to another, it tends to be an indicator of employment. Other important IR35 factors Although the above three areas are very important, there are many other factors to consider, including: Financial risk – if a contractor does something wrong they should have to correct the mistake at their own cost and should not be paid for the additional work. Own equipment – the more of their own equipment that a contractor uses to perform their services, the better. Ideally they should provide their own computers and phones. Other work – it is important that a contractor has the right to take on other work / work for other clients – if a contract states that they are not allowed to work for anyone else this is an indicator of employment rather than self-employment. Part and parcel – HMRC will look at whether a contractor is in effect a ‘part and parcel’ of the organisation they are working for – examples of this would include having a client email address, being on internal employee contact lists or receiving any employment benefits. Being in business – general proof that a contractor is a real business is good, for example do they have a website, business insurances and other typical things that businesses would have but employees would not. As you can see there are many factors to consider with IR35 and employment status – it is important to ensure that the contract covers these factors and also that the day to day working practices are in line with the contract. Three key reasons why being inside of IR35 is not tax efficient The are three key reasons why being inside of IR35 under these new rules could be costly for you: National insurance – you will pay national insurance which you would typically not be paying under the traditional outside of IR35 tax planning strategy of low salary and dividends Income splitting with spouse – if you used to pay your spouse a salary and/or dividends you will no longer be able to do this if you are inside of IR35 as all the income will be taxed on just you – if you’re a higher rate tax payer this could be costly Expenses – you will no longer be able to claim key expenses such as travel & subsistence if you are inside of IR35 IR35 changes 2020 – the reality The key thing to remember with the IR35 2020 changes is that if your engagement is genuinely outside of IR35 now, it should continue to be the same come April 2020. However this depends on two key things: Firstly, it assumes that you are correctly assessing your IR35 position now! Secondly, it assumes that come April 2020 the clients will be correctly assessing IR35 positions and are happy to continue working with personal service companies. They are not meant to be making blanket decisions – each engagement should be assessed on it’s own merit – however in reality this may not happen. There are also concerns that some clients may decide to stop hiring contractors working through personal service companies to protect themselves from any associated tax risks. These may be genuine concerns, however the clients that decide to approach the rule changes properly and can structure engagements to be outside of IR35 will end up attracting the best talent, so the hope is that, even if there is a period of uncertainty, things will calm down once clients fully understand how to manage the IR35 changes.