26.10.2020

Changes to Contracting & IR35 - Tackling the tax elephant in your room

HMRC has confirmed that the IR35 employment tax changes, which had been postponed due to the coronavirus crisis, are set to take effect from April 2021. The impact will be seismic for those who are affected.

FM companies which engage independent contractors from time to time and have an annual turnover in excess of £10m and a workforce of 50 or more employees need to take note of what follows.

What is IR35 all about?

In law, a contract of employment can only exist if there is a direct contractual relationship between the employer and the employee.

So, if an individual is engaged to supply their services through some other intermediary (such as a private limited company from which they take a small salary plus dividends) and the intermediary (not the individual) has the contract with the end user client, this will not be an employment relationship in the legal sense. Such devices obviously give rise to opportunity to disguise true employment and avoid employment tax and other employment obligations.

IR35 is the common name given to the legislation aimed at reducing large-scale tax avoidance when engaging people to work through a limited company or other intermediary. Pre-April 2021, end user clients of contractors have no responsibility to operate a payroll or to pay income tax or national insurance contributions for the contractors they engage in that way.

What is changing?

By April 2021, end user clients of independent contractors must undertake detailed assessments to determine whether each contractor is caught by IR35 and so, in turn, should be taxed as if they were an employee. This will not be a straightforward exercise.

If, following any particular assessment, the end user considers that IR35 does apply to a particular contractor relationship, the end user will have the obligation to notify the intermediary and, if the engagement continues, operate PAYE; taxing the payments to the intermediary as if it were income from employment.

The new laws will also provide a time limited dispute resolution process for affected parties to follow, on which it is likely that further advice may be needed.

What Are the Risks?

The costs of getting it wrong can be severe with penalties as high as 100% of the income tax and NIC that has been avoided.

The Elephant in The Room?

For many years, contracting has been a comparatively safe, low risk and low-cost method of engaging services from individuals. Providing, at least in theory, greater flexibility for all parties: including greater freedom to end or change the contract, no obligations for holiday pay, sick pay, pension contributions and no risks of redundancy or unfair dismissal rights accruing to the individual doing the work.

With each week that passes the elephant in the room - the risk of deemed employment and of all the associated rights and liabilities that will go hand in hand with employment - gets bigger and bigger.

But what if, as a result of your preparations for April 2021, you reach the inescapable conclusion that your long-term contractor is in fact caught by IR35 and should be taxed as an employee? How will they react?

From an employment law rather than a tax viewpoint, we see a significant risk of retaliatory claims on the horizon. If you tell a contractor they should be taxed as an employee, won’t they eventually ask, “Where’s my holiday pay ?”, “Where’s my pension contributions ?” and “Where’s my sick pay ??”…….Just how big will the elephant become?

Whatever you take from this article, make sure you plan for April 2021 well in advance. Make sure your business develops effective strategies to manage the conjoined employment and tax questions risks before addressing the IR35 elephants in your room.

Alan Lewis and Will Clayton. Partners, Constantine Law

Image CC credit: www.gotcredit.com flickr

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