IR35 has become an even more frightening Kafkaesque nightmare for medium- and large-sized businesses and charities because of changes to the regulations in April 2021. IR35 has been around for over two decades and it’s hard to think of a more unpopular tax.
So why did IR35 come to be a thing?
The history of off-payroll working
In 1973, “advanced corporation tax” (ACT) was introduced. Companies withheld tax on dividends prior to shareholder distribution. When companies paid ACT, the Inland Revenue (as it was then) offset the amount paid against the company’s overall tax bill. Dividend-receiving shareholders also received generous relief against their personal tax bills as the taxman was keen to avoid taxing shareholders effectively twice.
This relief made off-payroll working pay a lot better than being an employee and the number of self-employed grew by 29%. The UK saw a spike in the number of independent contractors doing business through limited companies, especially in ICT, sales, and construction.
In 1993, ACT was cut to 22.5% and dividend tax to 20%, meaning there was now a notional tax credit of 20% to the shareholder. Contractor numbers remained steady throughout the rest of the decade despite this incentive. Primarily the economy was weak during much of the nineties.
It’s time to stop the party – part 1
In 1999, then Chancellor Gordon Brown introduced IR35 as a way of stopping people from using personal service companies as a way of disguising what, to all intents and purposes, was actually an employee-employer relationship.
In the same year, ACT was abolished and a much less generous 10% tax relief took its place on income from dividends.
Although that did reduce the financial advantage to employer and contactor to having an arm’s length relationship, it was not effective in encouraging high-paid, specialist professionals back into full-time, salaried jobs.
The problem, for Gordon Brown and subsequent Chancellors, was the loss of tax. For the contractor, his/her new limited company shell means no deductions for income tax and National Insurance. The cheaper option of salary versus dividend is now the way they’re paid. For the company, no 13.8% National Insurance Employers’ Contributions, pensions contributions, and employment law.
Everyone wins. Except for HMRC which is potentially £10,000s down in revenue.
If you employ someone, you have to pay National Insurance Employers’ Contributions, give them 28 days’ holiday a year, sickness pay, handle student loan repayment and attachment of earnings orders, offer maternity/paternity/adoption leave, plus much more – and don’t forget auto-enrolment pensions were added to that list a few years ago.
If you hire the services of a contractor, there are no National Insurance Employers’ Contributions to worry about. You don’t even have to collect and hold a contractor’s income tax or National Insurance Employees’ Contributions. You have no pensions or employment laws to worry about, no holidays to schedule, and no leave you legally have to permit.
With suspected cases of IR35 non-compliance, HMRC inspectors established three ‘tests of employment’ in order to establish whether a worker is operating as an employee of a company or as a genuine self-employed individual within the gig economy. These tests considered:
This test establishes whether the worker has autonomy like a self-employed worker should or if the client company decides what, when, where, and how work is completed. If HMRC believes the client to have control over the worker then they will class them as an employer and an employee.
Self-employed workers should not be required to personally carry out the work themselves. Where IR35 does not apply, someone in the gig economy should be able to send a substitute in their place if they are unable or unwilling to carry out the work themselves.
If a company is obliged to offer paid work to the individual and the worker is obliged to then accept and complete the work, this is considered mutuality of obligation. In this case, the worker would be deemed to be an employee of the company.
Over time, these tests have become more complicated as HMRC attempts to expand the definition of what it means to be a “hidden employee”.
It’s time to stop the party – parts 2, 3, 4 and beyond
Did all of the above produce the desired result for HMRC? No.
Between 1999 and 2016, Britain’s army of self-employed grew from 3.5m to around 4.7m. The number of limited companies, many of which will have been used by the newly self-employed went up from 3.47m in 2000 to 5.5m in 2016.
In the intervening period, contractors and holders of offices have been forbidden from being paid as shareholders. 100s of First Tier Tribunal cases have been won and lost by HMC. Business entity trust tests have come and gone.
In 2016, the dividend tax relief was abolished with a much less generous £5,000 annual allowance, later reduced to £2,000.
In 2017, fee-payers in the public sector became responsible for determining IR35 status among their off-payroll workforce with this being extended to medium- and large-sized companies in 2021. In the eyes of many people, the loan charge debacle was a shameful period in the history of the country.
The government has not succeeded in stopping the growth in the ranks of self-employed nor the number of limited companies since 2016. Where they have succeeded in is making the gap between what contractors and employees earn much smaller.
Gains to employers have barely been touched in recent years but the jeopardy of IR35 determination has been transferred to them with the changes in the 2017 and 2021 rules
The good news is that it’s still completely legal to use contractors. You just have to manage it much better and it’s for this reason that Colnort’s IR35 compliance-as-a-service was created.
To get your arrangements right for IR35 compliance, call Colnort now on 0203 971 5667, email [email protected] or fill out the form below.