In September’s ‘mini-budget’ the new Chancellor Kwasi Kwarteng announced that IR35 Reform is to be repealed as of April 2023. This is big news for PSCs and the engaging companies who use their services.
During the nomination race between Truss and Sunak we’d heard the odd whisperings that Truss wasn’t an IR35 Reform fan, but honestly we thought little would come of it – after all it’s been done and dusted for over a year now. But to our surprise, rather than a long drawn out review of IR35, the ‘reform’ part is just being scrapped completely! A bold and decisive move, and probably the most positive thing to come out of the ‘mini budget’ for small to medium sized businesses across the UK.
The History of IR35 Reform
IR35 reform came in in 2017 (public sector) and 2021 (private sector), and it dictated that a contractor was no longer to determine their employment status for tax purposes. IR35 was originally designed to present disguised employment. A contractor working for a PSC must not be treated like an ‘employee’ of the engaging company, they must operate as a separate entity. The line between employed and self employed was blurry and that was unwelcome news for HMRC.
The fact that a contractor could no longer be ‘trusted’ to determine their own employment status for tax purposes led to IR35 ‘reform’ in which the engaging company was to be responsible for making this employment determination. If the engaging company felt that that contractor was caught by IR35, ie: was acting as an employee of the engaging company rather than a self employed individual working for an engaging company.
This caused havoc in the public and private sectors, with companies suddenly responsible for the financial determinations of third party individuals, having very little education around IR35 themselves. What’s more, the engaging companies would be liable for tax if an investigation showed they chose the wrong determination! This difficult situation resulted in one of a few scenarios for engaging companies:
- They either chose to not engage contractors at all
- They engaged their contractors via third party umbrella companies who were responsible for the determination
- They labelled all their contractors as ‘inside IR35’ – just to be safe
- They up-skilled staff members to understand IR35 and make correct determinations
NB: ‘Small Companies’ who engaged a PSC were not subject to the reform rules, and the contractor remained in-control of their determination.
The Government spent a whopping £1.8 million+ on a tool to help engaging companies make correct IR35 determinations, the only issue is that it produced an incorrect determination over 40% of the time… and now that expensive, but somewhat useless tool, is to be scrapped too!
The challenge of IR35 reform saw a mass exodus of contractors from the UK talent pool – some moved to other countries, some closed PSCs and took employed roles, some stuck around but often demanded higher day rates to make up for working ‘inside IR35’.
The reform section of IR35 is to be scrapped completely as of April 2023 – so if we could all just get in our time machines and teleport back to 2016 please, that’s basically the jist of it (wouldn’t that be great!).
IR35 Will Still Exist
It is important to remember that IR35 itself is not being revoked. HMRC can and will open enquiries and challenge an outside of IR35 decision if they see non-compliance. So the following remains important:
(a) Tax advice on employment status or contract reviews;
(b) Tax enquiry insurance; and
(c) Tax planning advice generally.
There are also a couple of other pitfalls to be aware of now:
1. Targetted Anti-Avoidance Rules
These are set out here https://www.gov.uk/hmrc-internal-manuals/company-taxation-manual/ctm36305. Many contractors will have liquidated their old company and realized a capital gain on which they paid 10% tax. This legislation can bite if within two years of receiving a capital distribution a person sets up a new business. Anyone in this position should take tax advice before deciding to set up a new company. If the legislation does bite, the gain will be taxed as if it had been a dividend.
2. Managed Service Company Legislation
This legislation dates back to 2007 and until recently HMRC had been reluctant to use it. They are now taking more of an interest, see https://www.gov.uk/government/publications/spotlight-32-managed-service-company-legislation-tax-avoidance-scheme-involving-unpaid-paye-and-class-1-national-insurance-contributions/spotlight-32-managed-service-company-legislation-tax-avoidance-scheme-involving-unpaid-paye-and-class-1-national-insurance-contributions. You are at risk from this legislation if your accountant controls or strongly influences the way your company is run.
What Choices Do Contractors Have in 2023?
Those working through umbrella companies can start planning now if they’d like to work outside of the umbrella structure. Even for those who would clearly be caught by IR35, a worker can take back some control by switching to a company and tax planning opportunities are likely to become apparent.
A company set up on or after 1 October 2022 can set its first accounting period to end on 31 March 2024. There is then plenty of time to plan by selecting an accountant, considering insurance, opening a bank account and looking at the changes that have occurred since they last used a limited company such as digital filing of VAT returns.
Of course limited companies are not for everyone and many contractors will continue to use umbrella companies for perfectly good reasons.
Getting good quality tailored tax advice is more important than ever. Three examples involving companies are set out below:
1. Miss A
Miss A is aged 38 and has been a contractor for many years using a limited company until April 2020 when her client made a blanket decision that they would no longer engage limited companies. This was despite the fact that Miss A had commissioned an independent IR35 review which concluded she was outside IR35. Since April 2020 Miss A has provided her services via an umbrella company. She has £100,000 in savings and has been paying £2,000 per month into a personal pension. She sees a return to a limited company in six month’s time as an opportunity to increase pension contributions at that time, but takes tax advice now.
The advice is that she should maintain existing contributions, but enter into a salary sacrifice scheme with the umbrella company under which she sacrifices £5,000 per month of salary and relies on her savings to meet her living expenses. On the salary sacrifice she saves 40% tax and 2% National Insurance. The umbrella company enhances her contributions with their 14.3% employers National Insurance savings. When she gets to April 2023, she starts to use her limited company and reduces contributions as her company only benefits from 19% tax relief.
2. Mr B
Mr. B is widowed and aged 62. He retired two years ago and received a pension of £30,000 per annum which is just about adequate although he would like more. He would be happy to take on work for two or three years.
In March 2023 he is offered work through an agency to commence in April and with a rate of £1,000 per week. The agent explains that the work is almost certainly caught by IR35 and the he would be better off using an umbrella company rather than his own limited company. In his discussion with the umbrella company he states that he intends to work 45 weeks and can therefore expect to be paid £45,000 per annum. The umbrella company explains that this is wrong as there are their fees and they have to pay employer’s National Insurance. Instead, Mr. B will get a gross salary of £40,000. Half will be taxed at 19%, half at 40% and employees National Insurance will be due at 12% on £27,500. His net will be £24,900.
Mr. B decides to take tax advice from an accountant familiar with IR35. The accountant agrees the contract will be caught by IR35 but nevertheless recommends a limited company. In this scenario £45,000 comes into the company, £2,400 is put aside for expenses, £9,100 is paid as salary to Mr. B incurring £1,729 in tax, and the remaining £33,500 is contributed to a pension scheme for Mr. B.
The company pays no corporation tax and because of the salary and pension contribution it complies with IR35. In due course, Mr. B can take 25% of his pension fund tax free and the rest over a number of years subject to 19% tax. From £33,500 contributed, he gets £28,726. Add in his net salary and his return is £36,097, a very favourable outcome when compared to £24,900 on offer from the umbrella company.
3. Mr & Mrs C
Mr. C is employed as a solicitor and has a salary of £50,000 per annum. Mrs. C has been a contractor for many years, using a limited company until April 2021 when her client made a blanket decision that all of their contractors were caught by IR35. This, despite the fact that she had used the HMRC CEST tool which clearly indicated she was outside of IR35. In December 2021, Mrs. C recognized that she was unlikely to use a company again and she put her own company into liquidation realizing a capital distribution of £500,000 in February 2002 on which she needs to pay £50,000 capital gains tax on 31 January 2023.
In light of the mini budget Mrs. C explores the idea of setting up a new company. She approaches her old accountant, and he draws her attention to the Targetted Anti-Avoidance Rules. He says he doesn’t feel they are relevant but that nevertheless there is a risk. Mr. C is concerned. If HMRC open an enquiry they may win. If they do win the gain will be taxed at up to 38.1% rather than 10%. Mr. C is worried, the net proceeds of the liquidation have largely been used to discharge their mortgage. Mr. C works in conveyancing and knows that it will be difficult to raise a re-mortgage to pay tax.
Mrs. C is mindful to stay with the umbrella company but decides to get a second opinion.
A second accountant concurs with the first accountant that it is unlikely that HMRC can use the Targeted Anti-Avoidance Regulations but understanding the concerns that Mr. & Mrs. C have, comes up with a solution. The anti- avoidance rules only apply if a person making a disposal starts a new business within 24 months. The accountant suggest that Mr. C should incorporate a company and employ Mrs. C. Mr. C should be the sole shareholder and director of the new company. Mrs. C would be paid a salary of £4,000 per month. Employer’s National Insurance would be covered by the employment allowance and employees National Insurance would only be about as much as dividend tax would have been. In April 2024, Mr. C would gift his shares to Mrs. C and Mrs. C would become a director.
All of these examples are fictitious, the point being made is that contractors, just like other tax payers, need individual tailored tax advice.
Contact our Team
We would encourage those looking to make a change to contact our accountants for professional advice, as every scenario is different and you must be careful to remain compliant.