Last month we revealed that HMRC had announced an overview of public sector IR35 reforms and there would be several changes that would affect contractors. This month The Accountancy Solutions take a closer look at Public Bodies, IR35 and HMRC tri relation. How tax can be calculated and what impact the IR35 employment tool is having on the status determination and responsibility of taxman.
A brief summary of IR35
IR35 is an item of tax law that was designed to restrict contractors working for organisations under the guise of a contractor to avoid tax benefits. Many contractors, particularly in the public sector, were able to work the same hours, in the same office, with the same staff, and even the same job title but weren’t employed.
Instead, contractors had used their own limited company to process a contract in lieu of a wage by opting to take dividends instead. This in term, allowed them to gain tax benefits on the likes of avoiding National Insurance contributions.
What has changed
Last month HMRC announced changes from April 6th 2017 regarding what classified as a permanent employee for tax arrangements. Essentially, the changes widened the scope of IR35 and now many more contractors are eligible for IR35 and subsequent taxation where they previously were not.
IR35 changes went even further to target contractors by stating that they will in fact lose the right to decide if IR35 applies to them and that the third-party or agency who pays them, should decide their status instead. For the public sector, this means further work and responsibility to classify their contractors.
Many contractors are concerned that with the public sector already under immense pressure, they will not have the skills or resource to make such a thorough decision and instead, classifying all contractors as employed workers under IR35, is a much easier option.
What is “within IR35”
To be deemed “within IR35” means that a worker no longer can enjoy the tax benefits that self-employed status allows. This could see contractors liable for National Insurance as well as Schedule E taxation. Previous tax and financial arrangements would likely need to be changed and a contractor could be looking at a circa 10% reduction in their take-home pay.
What is “outside IR35”
To be deemed “outside IR35” is a positive outcome for a contractor and likely means that they can continue operating under a limited company structure.
I’m a contractor, how do I find out if I’m classed as self-employed under IR35
HMRC have released an employment status service tool that has been developed to help contractors and public bodies to determine if they are within IR35 or not. The ESS tool has five separate components that the user must go through before it can make an assessment.
Firstly, it takes background information about who is using the tool and whether any previous IR35 engagement has yet started. Then it looks at personal services and obligations of the worker to help determine the nature of employed or self-employed. This is further judged based on the next three sections.
- The first measures all aspects of the contractor’s work – what do they do, when do they do it and where do they do it.
- The ESS tool also asks for information regarding finances, in particular, how is the worker paid (hourly, daily, monthly) and whether they are required to purchase/provide their own equipment required to undertake the work.
- Finally, the ESS measures how integral the worker is to the business’ organisation – do they receive any benefits, are any duties similar to that of an employee, how does the contractor interact internally and externally with customers?
- The ESS tool then collates all of the answers to determine the final determinations:
- The worker is inside IR35 legislation and shouldn’t be treated as self-employed
- The worker is outside IR35 legislation and can be viewed as self-employed
- ESS is unable to provide a final judgement and may require further information
- Frustratingly, the final option is not at all helpful and may leave users more confused than they were to start with.
- It is important to note that the ESS is just an aid and there is no obligation for contractors or bodies to use the tool. The data processed by it remains anonymous to HMRC but HMRC have stated that the result is final and binding (unless of course information entered was inaccurate at point of entry).
Is the ESS tool worth using
Whilst the tool provides some clarity around the issue it does come with significant problems that make it hard and frustrating for contractors and public bodies to trust. For example, when trying to determine information about the type of work the contractor like a Locum NHS Consultant undertakes and how “in control” they are of deciding the output, there is very little emphasis on “how” the work is undertaken. The questions are open ended and lack distinction to determine an accurate end result. Even when it’s made clear that the worker decides their own work and how it’s done, the ESS tool can still proclaim a “inside IR35” answer when we have tried our own testing of the tool.
The freedom to decide how work is undertaken is a crucial aspect of self-employment that employees simply rarely enjoy. It is for the attraction of control, that many contractors choose the insecurity of self-employment rather than employment (which offers plenty more perks and benefits as a trade-off).
Are public bodies using IR35 tools
Unfortunately for contractors, this level of inaccuracy and complexity means that many public bodies are taking a much easier option of ignoring the tool entirely and simply classing all contractors to be within IR35.
No public body wants to take the risk of potentially being liable for cost if found to be in breach of IR35 legislation. Instead, many public bodies have completely blacklisted limited companies or have only wanted to work with contractors using umbrella companies.
What can contractors do about IR35
The most obvious and best thing to do is to immediately consult your accountant, if you don’t have one then you can get in touch with us immediately for advice. Secondly, you may be able to rearrange your contract so its terms fall outside IR35 legislation. To do this however you will need to agree with the agency / public body and this can sometimes be a protracted and awkward process.
Another option is to use the ESS tool to see if you’re likely to fall within IR35. If you are, then it may be worthwhile trying to calculate your take home pay under the new IR35 guidelines. This will allow you to see the gap between your original take home pay and the new one. From here you can make an informed judgement about your contract and whether you wish to seek work elsewhere.
How to calculate take home pay with IR35
The HMRC have long been in charge of maintaining an incredibly complex taxation system which uses multiple variables and thresholds. As such, this can cause headaches when it comes to trying to calculate how much take home pay a contractor such as an IT contractor or Sessional NHS GP can take at the end of day.
Below, we’ve tried to outline all the variables that will ultimately affect your take home pay:
- The value of the invoice (net of VAT)
- Ensure that you include any benefit from flat rate schemes
- Calculate a deduction of 5% from your total (with the intention that this is to ensure expenses for running your business – if you fail expense 5% then you could be paying a minor level of corporation tax at 20%)
- Look to deduct any expenses that have been incurred as part of everyday work e.g. travel expenses, lunch expenses, dinner expenses
- Account for deductions to company pension payments
- The remaining amount can then be viewed as a salary minus national insurance
- Finally, add to this figure any other remaining expenses or pension contributions you’ve made and this will provide you with a “take home pay” figure
- What impact will IR35 have
If we use £100,000 as an annual total for a contract, with circa £5,000 expenses and £5,000 pension contributions then we can calculate that your take home pay will be circa £65,00. This takes into account rough estimates for flat rate VAT, National Insurance, income tax and corporation tax. Previously, outside of IR35, this figure would’ve likely been closer to £75,000 take home pay. As when filling self-assessment there may be a tax refund as it is highly likely expenses related to certain business are more than 5% of the fee earned. It is for this reason that so many contractors are concerned they are being unfairly targeted as part of a tax raid, which can see up to 10% of their bottom line lost.
Speak to us today on 01216297768 or 02070784001 if you’d like to know more about IR35 might affect you and your business. We regularly provide business advisory services to locum NHS consultants, session NHS GPs, IT contractors and general contractors across the United Kingdom. We provide friendly, honest and clear taxation advice and should be able to help you understand if you’re within IR35 and if so, what you can do about it.