Liz Loxton 27 Jul 2017 11:00am

Fear, loathing and IR35

Reforms to IR35 that put employment assessment in the hands of public sector bodies have only made this controversial legislation even more of a hot topic. Liz Loxton reports

Caption: Illustration by James Olstein

Legislation designed to counter tax avoidance by bogus contractors via the use of personal service companies, commonly referred to as IR35, has been controversial since it became law in 2000. Over time, the legislation has consistently attracted headlines, as contractors rightly or wrongly contested their tax status and as HMRC pursued breaches, racking up quantities of case law along the way. However, the latest reforms, introduced in last year’s Budget and effective from April this year, have brought stormy debate, uncertainty and – in the assessment of some advisers – absolute chaos.

To counter disguised employment in the public sector, the government announced that the responsibility for determining whether an individual was in fact an employee rather than a genuine contractor would switch from the individual to the public sector body itself – or the recruitment agency used by that body. Grappling with these responsibilities to assess whether or not contractors fall within scope of IR35 turns out to be no easy matter.

Fundamental impact

Many professionals believe that this switch is fundamentally sound. Anita Monteith, technical lead and senior policy adviser at ICAEW’s Tax Faculty, for instance, regards limiting the number of people who have responsibility for interpreting the rules as a start, but she remains concerned that more work is needed. Julia Kermode, CEO of the Freelancer and Contractor Services Organisation, says the HMRC is effectively outsourcing this key task with unintended consequences. Public sector bodies are, she says, reacting by taking a wholesale approach in order to protect themselves.

“End clients have become responsible for determining the IR35 status of the contractor and, as the ‘fee-payer’, recruitment agencies are responsible for processing the tax deductions. Rather than getting it wrong and incurring a huge tax bill, end clients – public sector bodies and recruitment agencies – are deciding that everyone is caught by the IR35 rule. So contractors who work for public sector clients are now in a lot of cases having tax deducted at source,” she says.

And there are other issues. Locum doctors operating via personal service companies have been caught by IR35, with undesirable results. Dave Chaplin, managing director of Contractor Calculator, points out that where locum doctors operate via personal service companies as husband and wife teams with one as a doctor and the other operating the administrative side of the business, those locums have been asking for an increased hourly rate to compensate for the tax differential after being deemed inside IR35. Ugly headlines and accusations around holding the NHS to ransom have ensued.

Defining contractors

Elsewhere, accountants have anecdotal evidence that contractors are walking away from assignments – including, ironically, the deferred Making Tax Digital project. Here, public sector bodies including government departments, the BBC or Channel 4, stand to lose access to suitably qualified individuals.

The issues have come about largely due to the government’s haste in bringing in the changes. Even the definition of public sector has proved problematic, Monteith says. “Organisations like Companies House and nursery schools [are caught] – places where it wouldn’t be obvious to people that they are impacted,” she says.

In a lot of cases, the complexity of assessing employment status is simply defeating organisations, resulting in blanket assessments that everyone is caught by IR35. Kate Cottrell, managing director and founder of Bauer & Cottrell, a specialist IR35 advisory firm, says when it comes to assessing the status of contracts and contractors there is a huge amount of confusion. “The problem we have is that people who haven’t had anything to do with evaluating employment status have to get up to speed very quickly on what their responsibilities are,” she says.

So what happens if an engager decides its contractor is caught by IR35? If the contractor agrees to stay with the engager, they will go on the payroll via RTI, but while they will be treated as employees in this respect, they won’t attract employment benefits such as holiday and sick pay. And the burden of appealing their status lies with them.

HMRC’s online assessment tool, designed to help individuals and employers work out the employment status of contractors, has not so far inspired much confidence. “Mountains of case law have been reduced to a flow chart,” says Tim Stovold, head of tax at Kingston Smith. “There is not a great deal of faith in it.”

There is real concern that individuals are in a position of having to rely on an assessment tool that is still a work in progress and is therefore capable of giving different results from one day to the next. Added to which, commentators believe it fails to go into issues in sufficient detail to give a reliable outcome.

Chaplin, whose own online assessment tool for contractors asks 101 questions around the nature of contracts and engagements, regards it as symptomatic of the problems with IR35 itself. “Your employment status is on a spectrum. It’s not as simple as asking 10 questions.”

The situation is all the more ironic when you consider that employing freelance specialist contractors has been pursued over the years as an important cost saving measure. That’s a principle widely used both inside and outside the public sector.

“Many take this route to take advantage of the flexibility and choice that it brings them and not for tax reasons. And there are benefits to business in terms of getting access to very skilled contractors at a fraction of the cost they would pay large consultancies. They are a really valuable part of the economy and are being penalised by these rule changes,” says Kermode.

Widespread confusion

But far from being a money saver, it looks like it will increase costs. Grant Speed, managing director at Odgers Interim, says that along with the widespread confusion within the public sector, irregular communication from HMRC and the “problem-filled” online tool, contractors are in limbo and public sector organisations are themselves starting to feel the pinch.

“They now have to pay the 13.8% employer’s National Insurance rate as well as the 0.5% apprenticeship levy on these hires,” he says. “As well as this, they’re under pressure to increase pay to try to keep hold of critical interim staff or bid to make them permanent employees.

“What we’ll see is more individual contractors questioning whether the public sector is worth their while or turning permanent as the benefits of holiday and sick pay become more attractive. In turn, it is public sector organisations that will be picking up the hefty bill for these work perks.”

So how should accountants advise people? The appeals process is likely to be key.

“Accountants will be getting set up to help contractors reclaim tax overpaid at the end of the year as tax returns are prepared, but I would advise contractors to ask their accountants well in advance to prepare to reclaim tax paid at source and, if necessary, change their accountants to ensure they work with someone well placed to pursue HMRC,” says Kermode.

And at Kingston Smith, Stovold emphasises caution around the outputs of the revenue’s assessment tool. “We strongly recommend to any of our clients that when they use it they print it out, so that if the reasoning behind the tool changes, they have a marker.”

The future

It seems unlikely that the issue of IR35 is set to go away. The reforms around off-payroll working or disguised employment appear very likely to be extended to all personal service companies and not just the ones working for public sector entities because the system works far better when you go to many fewer organisations, Stovold argues.

“Alongside these personal service companies, there is a whole body of other entities and associated rules that need looking at including managed service company rules and agency rules. Just looking at IR35 will only add complexity.”