Around 170,000 people providing work through a limited company might pay more tax from next year, according to a HMRC policy paper published last week.
This is thanks to changes to the off-payroll working rules, known as IR35, which will come into force from 6 April 2020.
The measure will generate £3.1bn additional tax revenue between 2020-2024, but it has been criticised for the adverse effect it could have on both businesses and freelancers.
Here, we explain what the IR35 changes are, who may be affected and how to make sure you’re compliant.
Who is likely to be affected?
Many contractors offer their work to clients by setting up their own personal services company (PSC). The client hires the PSC, which pays the contractor. However, HMRC believes thousands of people working under these arrangements should actually be paying the same tax as employees.
There are three main groups who are likely to be affected by these rules:
- up to 170,000 individuals supplying services through an intermediary, such as a PSC, who would otherwise be fully employed
- up to 60,000 medium and large organisations (50 employees or more) working in the private sector, which hire individual workers via PSCs
- around 20,000 recruitment agencies and other intermediaries that supply staff through PSCs.
Find out more: the taxes you pay as a small business.
What is IR35?
The off-payroll working rules seek to ensure that everyone working for a company pays income tax and National Insurance contributions (NICs), regardless of whether they’re employed directly or via a PSC.
The IR35 rules will apply if you would be considered an employee of the company if the PSC wasn’t in place.
If you’re not sure whether or not you or someone you employ would fall under IR35, there are three main ‘tests’ you can use to check:
- Do you have control over how the work is completed? This refers to being able to decide your working hours, or the location where the work is carried out. If the choice isn’t down to you, it’s likely that you will be inside of IR35.
- Is there a mutuality of obligations? For instance, is the company you’re working for obliged to give you more work once you’ve finished a task? If it is, you may be inside of IR35.
- Do you personally have to complete the work you do? To be outside of IR35, there should be a substitution clause in your contract, and you should be in control of the substitute.
When the IR35 rules apply, companies will have to deduct the relevant employment taxes and NICs from the person’s pay.
Find out more: use our income tax calculator to work out your bill.
What’s changing in April 2020?
The IR35 rules have been in place since 2000. However, as of 6 April 2020, the burden of deciding whether or not you’re compliant will shift to the organisation contracting the work, not the person supplying the service.
This reform was already introduced in the public sector in April 2017. In the Autumn Budget 2018 the Chancellor, Philip Hammond, announced it would be rolled out to private sector business too. It will apply to any work carried out, or payment received, after 6 April 2020.
To avoid fines, companies will need to tighten up their hiring practices, and contractors may increasingly see themselves classified as within IR35.
The rules are only being applied to medium and large businesses, so small businesses are exempt. A small business is categorised as meeting at least two of the following criteria:
- Turnover is £10.2m or less.
- Balance sheet total does not exceed £5.1m.
- It has 50 or fewer employees.
Why are the changes taking place?
Currently, HMRC estimates that only 10% of those who should be applying the IR35 rules actually do so.
The government is seeking to close loopholes to ensure those working under the umbrella of a ‘personal service company’ (PSC) are paying the right level of tax.
In the lead-up to the Budget, a BBC report was released regarding the impending crackdown on ‘synthetic self-employed’ people: those who work under the umbrella of their own PSC with the aim to ‘underpay’ themselves to reduce the amount of NICs they have to pay, and reap more rewards through paying themselves dividends.
For those who are already compliant with the rules, it is unlikely that there will be any change.
Why are IR35 rules being criticised?
The government ran a consultation from 5 March to 28 May, which garnered more than 200 responses from various industry bodies.
One organisation estimated that 90% of the 170,000 affected contractors will lose up to 20% of their income. Other concerns raised included the unknown impact of Brexit on UK business and that many businesses need longer than eight months to alter their their payroll and tax systems.
But the plans are going ahead. In its conclusion to the consultation, the government committed to taking action to improve compliance with IR35 rules, and that anyone who wishes to challenge their employment status can take their case to an employment tribunal.
How much income tax and National Insurance will you pay?
Both employed and self-employed people pay income tax, but while the rates are the same, self-employed people are only taxed on their profits, not their full earnings.
Some people employed through a PSC pay themselves via a mixture of income and dividends. This gives them the advantage of the £2,000 dividend allowance, and dividends are also taxed at a lower rate.
You’ll also need to pay National Insurance, which is paid at a different rate for the self-employed.
To see how much income tax and National Insurance you’ll need to pay, whether you’re employed or self-employed, simply enter your salary into our tax calculator.
The calculator assumes self-employed workers will pay Class 2 contributions.
- Find out more: self-employed National Insurance.