How will IR35 reforms affect freelancers and contractors?

Words, Pom Chakravarti, QX Finance & Accounts

As expected, Chancellor Philip Hammond confirmed in the Autumn Statement on 23 November that the previously announced changes to the intermediaries legislation (IR35) will come into force from April 2017 onwards.

What do the IR35 reforms change?

Right now, individual contractors working through their own PSC (personal service company) are liable to determine or defend their IR35 or ‘self-employed’ status. As soon as April 2017 onwards, the responsibility of determining this will fall on the public sector employer, rather than the freelancer or contractor. 

This means that the public sector employer will now have to assess each engagement with the contractor and determine whether the contract falls within or outside IR35.

What happens to contractors inside IR35?

If you are caught in the IR35 rules, the fee payer will have to treat you as an employee and deduct NIC and PAYE at the source and submit its report to HMRC.  As a consequence, the PSC will be subject to normal income and national insurance taxes, as opposed to the significantly lower Corporation Tax.  They won’t, however, gain any other of the benefits of being an employee and this is clearly set out in HMRC’s documentation.

If the public sector bodies fail to do so, they may incur a steep fine – a risk no organisation will be willing to take. This has raised fears in some quarters that public sector bodies will err on the side of caution and assume that all the contracts fall within IR35, even when they don’t.

How will IR35 status be determined?

In a bid to make it easier to determine the IR35 status of contractors, HMRC is testing an online tool, the final version of which will be released in February. We reviewed the tool first-hand and there’s a lot that needs to be done before the final version is released to the public.

The tool includes an array of questions, many of which are similar to the ones in the now-scrapped Business Entity Test. Interestingly, the test is not compulsory and it doesn’t offer a clear conclusion on the status at this date. It remains to be seen what approach the various agencies and public sector bodies take to determining the employment status of their contractor workforce. 

How will IR35 reforms impact freelancers and contractors?

HRMC suspects that a majority of freelancers and contractors currently working through a PSC or a limited company do not fall outside IR35. The fact that this is seen as causing a loss of tax is this primary driver behind the introduction of IR35 reforms. By making the closest party of the contractors in the supply chain (who are typically risk averse) liable for the determining the employment status, HMRC is hoping that the industry will self-regulate.

As the implementation of IR35 becomes more stringent, contractors working for public sector bodies and falling within IR35 will see a significant drop in their pay as NICs and PAYE taxes get deducted at the source. In a double whammy, the 5% tax-free allowance has also been removed for such contractors.

Research by IPSE suggests that 54% of the 26,000 PSC contractors may simply terminate their public sector contracts. Other who stay in the sector may bump up their day rates to compensate for the monetary loss. Many contractors may move to the private sector, flooding it with fresh workforce and presumably increasing the competition for private sector contracts. However, it is to be noted that the IR35 reforms may also cover private sector bodies in the future, if they are perceived to succeed with the public sector.

What next?

What can contractors working for the public sector do to avert the impact of the IR35 reforms? HMRC has snatched your right to determine your employment status and the only thing you do is to confer with the public sector body or the recruitment agency and discover what their plans are. If you feel confident that your assignments should fall outside IR35, it may be a smart move to start gathering evidence that establishes your status as self-employed. 

How will you be affected by the latest IR35 changes? Get commenting and join the conversation...

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