IR35 consultants and contractors
IR35 self employed contractors or consultants do look like a win win. The end user finds a cost effective staffing solution. The IR35 contractor or consultant pays less tax. But, IR35 can create tax problems for both end users and the contractors or consultants. The risks are compounded by the HMRC clamp down with legislation designed to bring more contractors and consultants within PAYE and make the end user responsible for collection and payment of income tax and national insurance under PAYE.
We highlight the key risks for both end users and IR35 contractors or consultants. The good news is it is possible to avoid the risks if your eyes are open.
We work with both consultants and contractors and their clients or end users.
The tax risk
The law is currently a mess. This is why self employed contractors or consultants create tax problems.
There are three categories of staff in this country and the changing working pattern is blurring the distinction.
On the one hand we have employees – not a problem in terms of tax exposure for the employer as PAYE applies.
2. Self employed consultants and contractors
At the other extreme we have the genuine self employed contractor. Someone who finds his own business opportunities and manages his business. Many trades people such as plumbers for example fall into this category. Not a problem for the person using the services.
- Under current tax rules the end user, i.e. the person using the services, has no exposure as the self employed contractor is responsible for his or her own tax.
3. IR35 contractors
It is staff who in practice fall in the middle of employees and self employed where we find the problems. Typically the individuals will be providing intellectual capital such as IT, consultancy, technology where they do not manage the business as this is a large corporate managed by someone else.
The tax problem with contractors and consultants
- HMRC has the power to assess the end user to income tax and national insurance under PAYE. But if the business using the contractor cannot collect the tax as they either cannot trace the contractor, the sums make litigation too expensive or there is no right to reclaim the tax – it is fair to say there is not much hope of the end user recovering the tax HMRC assess.
- There is a nasty regime of interest and penalties for those who do not operate PAYE correctly.
- The PAYE legislation is complex.
The middle also includes contractors operating via personal service companies (“PSC“). If HMRC cannot assess the personal service company the risk is HMRC assess the end user under the disguised remuneration rules.
Many contractors are also “workers” for employment law purposes. This means that they are entitled to certain statutory rights such as holiday pay. This is a particular problem for the gig economy. There has been a spate of cases in the Employment Tribunal with wins and losses.
Public sector and larger businesses
HMRC is extending the scope of the IR35 legislation to bring more contractors within PAYE. Changes have been made for contractors in the public sector and this now mirrored for larger businesses in the private sector. There will be less use of IR35 consultants.
Who gets to decide if tax if PAYE applies?
There is a swing away from leaving it to the contractor to decide if IR35 applies. Now, if the end user is a larger business or a public sector body – it is the end user who decides. Previously the end user did not make the determination on whether to operate PAYE as the decision was left to the IR35 contractor’s personal services company (“PSC“). If the end user is not classified as large or is not a public sector body the position remains that the IR35 contractor determines whether to operate PAYE on income drawn out of the PSC.
HMRC does operate on online service called CEST that can confirm whether IR35 will apply. Providing the information submitted is accurate and there are no tax planning arrangements, HMRC will stand by the test result produced by CEST.
However, there are problems. CEST, being designed by HMRC, will fall on the side of caution, i.e. the contractor is caught by IR35. Despite improvements, the test continues to lack sophistication and does not take into account key employment concepts such as mutuality of obligation. There is no substitute for professional advice.
In addition to this, if the result cannot be backed up with decent documentation, a HMRC investigation may nevertheless determine an exposure to PAYE. We can help with the documentation.
The IR35 ending
We are seeing a trend in IR35 contractors shutting down their personal service companies and taking up employment as that is what the market is demanding. This is in response to a growing number of end users who are not prepared to take the tax risks associated with IR35 contractors.
Closing down the IR35 personal service company
If the IR35 contractor is retiring or going to re-invent himself as something entirely new there can be tax benefits on closing down the personal service company (PSC) the IR35 contractor traded through. But if as in many cases the contractor will continue providing similar services but now under an employment agreement there are no particular tax benefits applying when the contractor takes out the cash retained on winding up the PSC.
- The position can be different if the trade ceases or changes after winding up the PSC. We do offer specialist advice on how to extract cash retained efficiently and can put you in touch with liquidators.
Commercial risks in using contractors
In addition to the tax risks there are commercial risks associated with any type of contractor as we explain. Lack of documentation causes some of problems. Whilst written documentation will not finally determine a tax or commercial problem, an agreement setting out what you thought the position was will assist.
How the commercial risk arises
The usual rule in an employment relationship is that the employer owns what the employee creates. However, this is not the case in consultancy/contractor relationships. Therefore the only way the end user can protect its business is by putting in place assignments between the consultant/contractor and the engager. A well drafted consultancy/contractor agreement will include an assignment of all property created by the consultant/contractor. This is an area where we can help you.
Protecting the assets
The following types of assets can be protected by assignment. If not protected the assets can be easily taken and used in competition to your business:
- Customers lists;
- Employee contacts;
- Software coding;
- Inventions or works created during the course of the engagement;
- Know-how; or
- Source code.