The off payroll working rules, known as IR35, were rolled out into the private sector on April 6th, 2021. The changes forced many contractors working through Personal Service Companies (PSCs) to rethink their position – and if you’re one of them, you may be wondering ‘how will IR35 affect my limited company?’ So let’s start with how inside IR35 works.
How does inside IR35 work?
A contractor who undertakes an engagement deemed caught by or inside IR35 through their PSC now has tax and NICs deducted at source from their fees. This means that when their invoice is paid, they receive a net amount – the employment taxes have been deducted by the fee payer (the entity which pays the PSC) and paid to HMRC as part of the fee payer’s payroll.
After a full tax year on this basis, the whole of the PSC’s fee income from the last financial year has been accounted for as either taxation or net pay. There is no profit or loss, so how does the contractor account for the running expenses of their business?
The answer is that the contractor pays for their accountancy fees, insurances and other expenditure out of their own pocket. It simply isn’t worth working inside IR35 through a limited company.
We saw this impact in the public sector when the changes were introduced in April 2017, with many contractors closing their companies and returning to employment and/or some form of pay as you earn (PAYE) arrangement. The private sector is no different.
However, contractors were also impacted by the reaction of some public sector bodies, which has also become a feature in the private sector – particularly in banking and financial services – and that was an effective ban on engaging contractors operating through PSCs. What this has meant for contractors is that they are left with four PAYE options:
- Take a staff job
- Take up a Fixed Term Contract
- Become an agency employee
- Become engaged through an umbrella company (and some end clients don’t want to engage contractors that way, either)
If end clients are limiting their PSC engagements, and being engaged on inside IR35 contracts through a PSC isn’t worth it anyway, how can operating through a PSC be a viable option now that the new rules have come into effect?
Where there is a realistic proposition of an ‘outside’ engagement
So, we know that if you’re working inside IR35, limited companies aren’t profitable anymore. However, there is a way forward. While many end clients may feel that side-stepping IR35 by refusing to engage PSCs has the benefit of reduced administration and mitigates the risk of making incorrect IR35 determinations, others are engaging with the new legislation and offering outside IR35 engagements.
Even if your engagements in the 2021/22 tax year were deemed inside IR35, a limited company can still be worthwhile, so you might not want to close it. Even if you chose not to be engaged through your PSC for inside IR35 assignments, the future may well hold engagements that are outside IR35 – and you can use your PSC for those.
The knee jerk reaction of some end clients to avoid PSCs may come back to haunt them if they start losing the best talent. There was a similar response in the self-employment arena a few years ago following the introduction of the onshore intermediaries (s44) legislation.
However, slowly but surely, there was recognition that if you engaged with the legislation, it was possible for agencies to legitimately provide self-employed workers to clients and a sense of normality resumed. We believe the same will happen for IR35 in the private sector. The use of PSCs won’t be as widespread as it has been, but it’s not the end for PSC contracting either.
Being engaged by a small company
HMRC has determined that small companies, as defined by s382(2) of the Companies Act 2006, are exempt from making IR35 status decisions. This effectively removes 1.5 million companies from the requirements of the Off Payroll Working legislation.
Small companies must meet at least two of the following criteria:
- Turnover of no more than £10.2 million
- Balance sheet total of no more than £5.1 million
- No more than 50 employees
While these small companies engage a very small proportion of the contractor population, their exemption from decision-making means that the contractor retains the responsibility for determining IR35 (and the liability for getting it wrong) from April 5th 2021.
If you are engaged by a small company, your PSC will be paid gross, and you must determine how you will be remunerated. But it will be your responsibility to demonstrate due diligence and show that your outside IR35 decision is based on a proper assessment of the contractual terms and working practices, so it would be appropriate to have the engagement and even consider tax losses insurance.
Even if the independent assessment returns an inside IR35 decision, you will still have the benefit of the 5% notional relief for expenses, which is not available to those contractors whose IR35 status is determined by their medium and large-sized end client engagers.
Being engaged by a wholly overseas company
If your end client is overseas with no UK presence, HMRC cannot compel a non-UK based entity to consider IR35 – irrespective of the organisation’s size – and your PSC as the first onshore intermediary is obliged to consider the IR35 status of the engagement.
We would offer the same advice as a small company engagement: have your contract and working practices independently reviewed to be sure whether you are outside or inside IR35.
Managing mixed assignments
IR35 status is based on each individual assignment, not based on the PSC. Therefore, if you are going to work on contracts that are both inside IR35 and outside IR35, it is advisable to make sure you have a robust process in place to manage them. Engagements where PAYE is deducted will leave you with a much lower take home pay – sometimes 30% less – and so you need to be able to cope with fluctuations in income.
There is nothing wrong with being engaged via a compliant umbrella company. Yes, the day rate will be reduced by the umbrella’s margin for providing its services and it must include the statutory PAYE deductions, meaning that you will pay considerably more tax than on an outside engagement via a PSC. However, ‘compliant’ is the key descriptor.
The moment you read statements like “Take home 85% of your pay”, then it’s time to ask yourself how this can work and whether the taxman will view it as compliant. This also applies to offers to divert your funds offshore to reduce tax, or requests for you to pay to enter a scheme.
And if it says that it is “HMRC approved”, then it really is time to look elsewhere – unsurprisingly, HMRC don’t approve arrangements which claim to avoid the payment of tax or boost take home pay. For more on this subject, see the government website.
What does the future look like after private sector IR35 is introduced?
Find out more about IR35 in the private sector in our IR35 Hub. The Hub is packed with information to help contractors and fee-payers navigate their way through the IR35 maze so you can continue to thrive, regardless of the rule changes.
Click here to download the Essential Guide to IR35 in April 2021