The Government have recently announced a consultation on extending the practices introduced last year regarding IR35 in the public sector to the private sector.
Of course, this has left opponents of IR35 disappointed: whilst HMRC claims that the new guidance has been a success and has proven doubters wrong, those doubters have some strong rebuttals to HMRC’s claims. If HMRC go ahead with their apparent plan to extend the public sector IR35 practices into the private sector, this could have a negative effect on the UK’s flexible workforce, so we’ll look at some ways that you can potentially reduce your IR35 risk.
IR35 Reform Works, Apparently…
According to the HMRC factsheet on the IR35 consultation, it’s been a huge success so far, everyone loves it and it benefits us all. The key claim here is that they have recovered an additional £410m in tax and NICs in the last year, and are aiming to make a dent in the predicted £1.2bn cost of non-compliance by 2022/23.
Whilst that’s understandable, it’s worth noting that HMRC have lost as many IR35 tribunals as they’ve won. And with public sector organisations erring on the side of caution in their determinations, it’s likely that at least some of this additional revenue has been collected inappropriately (i.e. the job doesn’t fall within IR35, but has been judged as doing so and taxed accordingly). This is especially worrying as the legislation does not enable contractors to challenge the IR35 determination.
It’s also surprising that, if the problem being solved is underpayment of tax, HMRC are targeting smaller businesses with lower levels of corporation tax, rather than pursuing more lucrative underpayments, like they did last year when they audited Apple and ended up recouping £217m – that’s 53 per cent of the revenue they recouped through IR35 last year in one hit!
It appears as though the thinking behind this is that smaller organisations like personal service companies (PSCs) are less equipped to challenge HMRC investigations or IR35 determinations, with the cost of a tax enquiry defence costing upwards of (an unrecoverable) £5K even if you win. So much for supporting small businesses… and it’s concerning to hear that The Treasury are alleged to have instructed HMRC not to “annoy” the likes of Amazon about trivial matters such as the estimated £1.2bn lost in VAT revenue through services like Amazon Marketplace last year alone (£1.5bn according to the FT, but what’s £300m – or 75% of last year’s IR35 revenue recovery – between friends?).
In fairness, Amazon and eBay are now working on a ‘deal’ with HMRC, hopefully it will be a step up from the IR35 legislation in terms of its quality and clarity.
‘Clarity’ has been an issue with IR35 since its inception – it’s still impossible for contractors or freelancers to get a straight, definitive answer on whether or not a contract falls within the realms of IR35.
Whilst HMRC offer their CEST tool to assist in this, the fact that they have lost half of their cases that went to a tribunal undermines their, and by extension their tool’s, credibility. It also, as Matt Boddington notes, doesn’t consider mutuality of obligation (i.e. the employer being obligated to provide work and the employee or contractor being obliged to accept work) as a factor in its calculation, despite the importance of this aspect in case law so far.
If HMRC are basing their investigations on the outputs of a flawed tool, it’s a little clearer why they lose so often. And if contractors or employing companies are using this tool to do their IR35 determination, it’s likely that contractors who don’t challenge the determination are paying tax when they shouldn’t be.
What If The Employer Decides IR35 Status?
The question of who decides whether a contract falls within IR35 is also messy and fraught with liability concerns: whoever makes the determination is advising the contractor on how much tax they should pay. Technically, this makes the employer (sometimes the recruiter) a tax advisor, which they’re likely not to be! Warr & Co will never tell a client what their IR35 status is, instead we always present contractors with the options and allow them to decide. This is for a very good reason!
Given that the contractor is the one paying tax, the determination should be made by them, but HMRC are instructing the employing company to make the determination and the fee payer to follow it. This means that if the employing company determines that your job falls outside of IR35 and HMRC disagree and win the tribunal, technically the company that is consuming your services is liable for the tax.
As a result of this, and there being no formal right to appeal a determination, it is in the employing company’s interest to err on the side of caution and deem anything even remotely questionable as inside IR35. With CEST being inaccurate and the legislation unclear, pretty much every determination is remotely questionable.
Not a great situation, then for the employing company, the PSC or you, the contractor. In fact, according to the Freelancer and Contractor Service Association (FCSA), 50 per cent of public sector jobs filled using employees sourced via agencies were not assessed for IR35 eligibility, they were “simply deemed to be inside (42 percent [sic]) or outside (8 percent [sic]) IR35”.
Contractors Don’t Mind Working Inside IR35, Apparently…
In the factsheet HMRC claim that vacancies have not been more difficult to fill as a result of the public sector IR35 reform, a claim refuted by groups such as IPSE. HMRC also claim that salaries have not increased to cover the additional tax burden, but it stands to reason that best contractors will demand a higher remuneration and be in a better position to insist on the take-home gap being covered.
IPSE’s Chris Bryce has been quoted as saying, “It is shameful that the Government did not publish the external research into the impacts of the public sector changes prior to announcing this consultation”, and it’s hard to argue with his assessment.
Contracting and freelancing is inherently more risky than taking permanent employment; and benefits such as sick pay, pensions and health insurance come out of the contractor’s pocket; and creditors are more wary of you due to the risks inherent in self-employment.
Clumsy, heavy-handed IR35 only serves to decrease the ‘reward’ aspect of the risk:reward ratio, so the Government only stand to lose out on contractors who choose to walk away from the public sector, either abroad (so HMRC lose revenue and companies in the UK lose skilled workers and workforce flexibility) or into the private sector (so UK companies still lose workforce flexibility).
So What Can You Do To Ensure You Won’t Be Caught By IR35?
As going abroad is foolhardy when our weather is so sublime, and going permanent is not terribly appealing, what can you do to try and shift your next contracts IR35 determination in your favour in light of the possible private sector reform? Well, here are some things that may help, but none of these are guaranteed in any way, shape or form…
1) Change Your Payment Model
Being paid on a day rate for your time implies that it’s your time being paid for, not your services. If you can change this so that it’s clearer that you’re charging for services rendered rather than time, then that makes it clearer that you are a service provider rather than a disguised employee. There are a couple of ways you can do this:
- Think like a freelancer, not an employee. Charge for outcomes or outputs rather than time, for example if you write documentation you could charge on a per document basis, or if you provide management consultancy you could charge based on achievement of KPIs subsequent to your consultancy. Yes, this requires you develop your accuracy to estimate, and incurs risk if you get it wrong (so get good at being explicit and clear in your contracts), but it can be mutually beneficial: you (hopefully) get a bit of cover IR35-wise and your clients get better quality service.
- Charge A Subscription. If charging for outcomes or outputs is too risky or inappropriate, you could charge on a subscription basis, like when you sign up to use Spotify or Netflix. Your client pays a monthly fee for your services, which you could describe in the form of a service level agreement (SLA). In the SLA you specify exactly what services you will provide and to what level of quality, when your services will be available, how much they cost, what warranty you provide etc.. As with the first option, this approach makes what you’re actually providing explicit, meaning that you can ensure that you’re providing your clients with the right services to the right quality at the right times. Win/win!
2) Use Your Own Stuff
This one might be blocked by your clients’ security policies, but if you provide your own equipment at your own (or, rather, your PSC’s) expense, then this differentiates you from generic employees.
3) Write Up Your Own Contracts
Quite often the contracts that one signs as a self-employed worker are just edited permanent employee contracts, which makes it more difficult to prove that you’re truly self-employed and therefore outside of IR35. By writing your own contract, you can ensure that conditions within that contract that make you appear more employee-like – such as dictating work hours, where the work must take place, your right to refuse work, notice periods, disciplinary policies etc. – don’t appear, or are at least worded in a manner that is more accurate in describing the nature of your employment.
4) Challenge Contracts and Client Company’s Determinations
This needn’t be adversarial – after all, we’re all trying to work together – but some clients may insist upon drawing up contracts and making IR35 determinations. You can still challenge these as part of your negotiation, for example removing or amending undesirable language in the contract, or challenging a determination altogether. Your client has already decided they want to work with you, but it’s got to be mutually beneficial, so negotiating in order to get a suitable determination and contract will be increasingly important when HMRC extend their IR35 reforms to the private sector, which they look poised to do.
5) Educate Your Customer
You may have dealt with IR35 for years, but they haven’t. As with the public sector, the private sector may soon be lumbered with this scary acronym that they equally fear and don’t have time for. And while the legalities of the employing company deciding IR35 status for a contractor are dodgy at best, if it becomes their responsibility to do so, help them.
So since you, the contractor, are likely to be somewhat of an expert, provide them with the tools they need to make a real IR35 determination instead of the blanket ‘Inside IR35’ determination that has descended on much of the public sector. And by tool, we don’t mean CEST which has been found to return an incorrect determination in 37% of cases. Instead, point them in the direction of ISPE who even have free inside/outside IR35 contract templates available.
Bonus Client Tip: Create Templates for Contracts Inside and Outside of IR35
If you’re looking to use contractors, or already do, it’s worth creating different templates for each of the IR35 determinations. Inside IR35 contracts can include stuff like provision of equipment and working hours and so on, and outside IR35 contracts can talk about the services to be provided and so forth. Contracts for jobs outside of IR35 should be closer to commercial contracts you sign with other suppliers than they are to contracts your employees sign.
Those who take on the risk and embrace the freedom of being self-employed by-and-large don’t mind paying their share, although (understandably) no-one wants to overpay! What contractors want is a clear, equitable and consistent system to determine how much they should pay. The IR35 legislation falls well short of that, and expanding it in its current state into the private sector could prove very damaging to the UK’s flexible workforce. With all the risk and uncertainty being incurred as a result of Brexit, the last thing the UK needs right now is more risk and uncertainty.