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What are the predicted effects of IR35 on the Contractors market and the private sector in 2020?

by Heat Recruitment

IR35 has been the subject of much speculation since changes to the tax rules for contractors working in the private sector were announced as part of the Autumn budget. According to the amendments to IR35, individuals operating through a limited company within the private sector will now be liable to pay income tax, and National Insurance (NI) at the 12 per cent rate.

From April 2020, the new rules will come into force as part of the biggest revenue-raising measure in the October Budget. Their aim? To crack-down on what HM Revenue & Customs deems ‘disguised employees’ – contractors who work under the banner of a limited company but operate exactly as an employee would for a private sector firm.

While critics have challenged the new rules and accused the chancellor of burdening thousands of self-employed workers and small business owners alike, the Treasury insisted that the changes to IR35 would not apply to individuals who were genuinely self-employed – rather, it would apply solely to contractors working through their own company for another business. Similarly, if a person is deemed to be an employee by HMRC, the firm using the contractor will be liable and must likewise pay national insurance for the first time.

Until now, the tax framework known as IR35 only applied to contractors and organisations employing them in the public sector. However, upon discovering that people working “off-payroll” through personal-service companies in the private sector was set to cost the exchequer £1.3bn a year by 2023-24, proposals were put forward by HMRC and subsequently approved to extend the legislation to private firms. Perhaps unsurprisingly, the rule change has sparked a debate as to the effects on the contractor’s market and the private sector in general.

The introduction of IR35 for public sector organisations meant that employers were suddenly faced with the prospect of determining whether national insurance contributions and income tax applied to the self-employed contractors working for them – previously, it had been up to the contractor to declare this. As a result, many public sector companies became cautious of working with contractors and stopped them from operating in this way. Research by contractor advisory firm Qdos has now revealed that 77% of contractors feel the private sector will be unable to handle this responsibility effectively, 30% of which believe systems will not be ready in time for the 2020 deadline.

For many independent workers, the fear is that employers will make risk-averse IR35 decisions to protect their liability, which would ultimately lead to a drop in the number of available contracts – something that studies have illustrated occurred after the IR35 legislation was rolled out to the public sector in 2017.

Based on what the UK market experienced as a result of the public sector IR35 changes, private sector companies would do well to prepare for their contractors seeking rate rises to compensate for their loss of income due to increased deemed employment costs. This won’t be the route that all contractor’s take – for instance, those with a modest income at present may move away from operating through a personal service company and seek PAYE options or conventional low-risk “umbrella” arrangements.

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According to a survey from ContractorUK, 42% of freelance respondents reported that they had increased their rates as a result of the 2017 Off-Payroll implementation. With this in mind, IR35 could in fact be beneficial to the contractor market. What’s more, changes to the tax framework limits their liability; the responsibility of determining their employment status will soon sit entirely with the employer. This could lead to end users providing their self-employed staff with more clearly defined contracts as opposed to verbal agreements.

Naturally, it’s likely that there will be a certain amount of end users who choose to take the risk of ignoring the change and continue to pay contractor’s working through personal service companies gross with little assessment so as to avoid potential skills shortages or rate rises. Similarly, a number of contractors may arrange alternative methods of payment designed to minimise their tax liability – a strategy which will HMRC would deem aggressive tax avoidance.

In any case, HMRC has been clear in its intention to clamp down on any loopholes that allow for avoidance of IR35 changes. If the company that engages the contractor decides incorrectly that they are self-employed, HMRC can investigate and insist on back payment of all tax owed, as well as fines for late payment.

Ultimately, we can expect to see a move towards private sector firms engaging higher skilled resource on a project-specific basis in which the deliverables are clearly defined. In turn, staffing agencies who work with contractors may begin to act more as an outsourcing partner which could help to increase profits.

While there may still be just over a year until the legislation takes effect, clear communication between contractors and employers is essential in establishing future working arrangements ahead of next April.

If you are looking for more information or would like to speak to one of our Contracting experts, get in touch with Heat Recruitment today.

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by Chris Reid and Mike Taylor