As we await the first Budget of the new Conservative majority government, it is in fact an announcement made in the previous Budget at the end of 2018 which is going to have a significant impact on some businesses in the coming months.
The changes to ‘off-payroll working’ (more commonly known as the IR35 rules) are being extended to private sector businesses from April 2020. This means that if your business engages with sub-contractors who operate through companies, it will now be your responsibility, and not theirs, to determine whether tax and National Insurance should be deducted.
The IR35 rules have been in place for nearly 20 years and are an attempt to tackle sham self employments where the sub-contractor has formed a company to avoid being classed as an employee of a customer. The benefits to both the sub-contractor and the customer have been significant tax and especially National Insurance savings. The long standing IR35 rules seek to remove this tax advantage by levying additional tax charges for the sub-contractor. The table below shows an example of the tax consequences:
|Income Tax/ Corporation Tax
|Total Tax and NIC
As you can see from the table above, the total Tax and National Insurance for an IR35 company is similar to the figure if the individual was employed. However, because they are also responsible for the employer’s National Insurance, the individual sub-contractor is left with a much reduced net earnings figure.
Under the current IR35 rules, it is the individual’s responsibility to determine whether or not the IR35 rules apply. However, HMRC believe that as many as 90% of the people who should be applying the rules are not doing so. The rules have therefore been amended to push the responsibility of establishing if the IR35 rules apply to the client, ie the end user business. If the client believes that the rules are applicable, they need to deduct Income Tax and National Insurance before paying the sub-contractor. If the client fails to do so, they will be liable for interest and penalties on any underpaid amounts.
End user clients who are small businesses have been excluded from these changes. A business will qualify as a small business if it has either less than 50 employees, turnover below £10.2m or a balance sheet of less than £5.1m. There will therefore be a large number of large and medium-sized businesses who will be affected by the new regulations from April 2020.
This new process is a significant change and is likely to increase the administrative burden of engaging sub-contractors who operate through companies. HMRC have updated their own online tool for helping businesses determine whether deductions are necessary. However, there is a lot of scepticism as to whether this tool will be helpful in a large number of cases where contracts between businesses and sub-contractors are not necessarily straightforward.
When this change was enacted for public sector bodies in April 2017, many of them decided to apply a blanket rule and treat any contractor with a company as being within the IR35 rules. This led to an additional £550million in tax for HMRC in the first year of operation, but also resulted in a lot of contractors leaving the public sector creating a shortage of workers and an increase in contractor rates.
A recent survey in the Financial Times showed that over 60% of large and medium sized businesses were concerned about missing out on skilled contractors when the changes come into force. Although small businesses are exempt from the rule changes, they could be impacted by a shortage of workers and an increase in prices.
My advice for any business that uses sub-contractors is:
- Don’t leave it too late, there are only 3 months until these rules come into force, so now is the time to act and review whether you have any exposure to the changes.
- Don’t just apply a blanket rule to all subcontractors who use companies. This is going to significantly reduce the take home pay of many and could lead to a shortage of workers or higher rates.
- Review your contracts with sub-contractors. If possible, consider whether they should be amended so that they do not fall within the IR35 rules. The tax savings for the sub-contractor are significant.
- Take professional tax and legal advice. The penalties for not applying the rules correct can be substantial and could pose a large risk to your business.
HMRC are looking to raise an additional £1.3billion in tax per year by changing the rules in this way. They are going to use significant resources to ensure that businesses are applying them in the right way. Act now so you won’t be caught out.