Reversing IR35 reform
The Chancellor may have done a huge U-turn in relation to his much-criticised decision to abolish the 45p tax rate for the highest earners, and there still remains a degree of uncertainty with regards to how the mini-budget is going to pan out, but businesses who engage a consultant workforce will be hoping that he doesn’t backtrack on his proposed changes to the IR35 tax regime.
Since 6 April 2020, large and medium sized businesses who engage consultants via intermediaries have been caught by unpopular changes to the IR35 tax rules. These 2020 changes made the use of consultants more challenging from a tax perspective and more costly and onerous from an administrative point of view.
*(A large or medium sized business is defined as a business which exceeds two of the three following limits: an annual turnover of £10.2 million, a balance sheet total of £5.1million and/or 50 employees).
However, in his recent mini-budget, the Chancellor announced that these unpopular and unhelpful tax reforms are set to be repealed in April 2023 as the government seeks to stimulate economic growth.
What was the impact of the 2020 changes?
The IR35 regime was originally introduced back in April 2000. When it was first introduced, it was the contractor’s responsibility to assess their own employment status (for tax purposes). If the nature of the relationship between the consultant and the end user was essentially akin to an employer / employee relationship in all but name, it was down to the consultant to account for any necessary PAYE deductions via their own PSC (personal service company). Factors which influence employment status include control, mutuality of obligation and the right of substitution – but this is a notoriously ‘grey area’ in law.
Fast forward two decades, and the unpopular IR35 changes introduced in April 2020 switched the responsibility of determining the employment status of contractors (for tax purposes) from the contractors to the end users of those contractor’s services. This accordingly added an unhelpful layer of administrative process that end users had to go through before engaging a contractor via an intermediary. The 2020 changes also shifted the tax liability to the end user, so that if the consultant were deemed to be an employee for tax purposes, the end-user would be responsible for accounting to HMRC for the relevant PAYE deductions. This, in turn, added a new layer of financial challenge for businesses who hired contractors. In short, the changes added additional cost and administrative complexity for businesses and it had a direct impact on businesses’ willingness to engage a contractor workforce.
The reasoning behind these changes was primarily based on the fact that tax compliance is far easier for HMRC to monitor and enforce against large end-user companies engaging multiple contractors, rather than again numerous ‘one-man-band’ PSCs. However, it is easy to see why these changes were hugely unpopular with businesses who were reliant on the use of contractors and, indeed, with contractors who found their potential work streams reduced.
Why is it being reversed?
As the government seeks to help both companies and citizens deal with the ongoing challenges of inflation, reversing the 2020 changes was described as a measure to “free up time and money for businesses who engage contractors that could be put towards other priorities”. In addition to this it is believed these reforms will also minimise the risk of genuinely self-employed workers not being offered work, or being subject to PAYE unnecessarily (particularly where end-users have simply adopted a blanket approach to IR35 by treating all contractors as employees for tax purposes, even when they are not).
Accordingly, from 6 April 2023, regardless of whether a contractor is operating in the public or private sector, they will once again be responsible for determining their own employment status and paying tax appropriately.
So what next?
It is worth remembering that the IR35 regime isn’t being withdrawn completely and the issue as to whether a contractor is employed or self-employed for tax purposes will still be of relevance to the contractors themselves.
Businesses who engage contractors need to remain mindful of the ongoing risk of establishing an employment relationship more broadly – particularly if they do treat them as if they were employees, rather than operating the relationship at ‘arm’s length’. In such circumstances, the contractor could argue that they should benefit from various employment rights (such as the right not to be unfairly dismissed and the right to holiday and sick pay, redundancy payments etc).
Remember too, that contractors will continue to enjoy the protections enshrined in the Equality Act 2010, so businesses must be careful not to treat contractors less favourably or otherwise disadvantage them because of any protected characteristic or they could well face a damaging and costly discrimination claim.
These changes come into force in April next year. Between now and then, however, it is ‘business as usual’ and end users will continue to have to determine the employment status of their contractors (for tax purposes) before hiring them and to make an assessment as to whether or not to apply PAYE to their fees.
In anticipation of the forthcoming changes next spring, we would recommend that businesses who use contractors consider negotiating more favourable rates with new contractors, given that the changes will remove a layer of expense and administration for the end user. This may also enable businesses to attract a wider cohort of contractors, who want to maintain the flexibility in their working practices. Reviewing working practices to minimise the risk of contractors being employees for tax purposes will also help attract contractors (and facilitate better rates) as this gives the contractors greater reassurance that, after April, they can legitimately pay themselves without having to make PAYE deductions from monies paid to them via their PSC.
So, even with the reversal of the 2020 changes, the correct assessment of an individual’s employment status, both from a tax and an employment perspective, still remains important. But, from April 2023, life for businesses who use contractors will certainly become a little easier again.
Please contact the Bevan Brittan Employment team if you would like to discuss these changes, the potential impact on your business or the issues of employment status generally and we would be happy to advise you.