Next Tuesday, long-delayed changes to a controversial tax rule will come into force and pile on an additional burden on companies already reeling from the effects of the pandemic.
The rule, known as IR35, was originally designed to limit tax avoidance but it has caused dismay for employers and contractors alike. Before now, it has been for contractors to declare their tax status. Now the onus will be on companies themselves to determine this for off-payroll workers – and they may be liable if they get it wrong. The changes to the rules threaten to overhaul the relationship between companies and contractors.
In the UK, there are around 60,000 organisations who use around 2 million off-payroll workers – freelancers, contractors or consultants. This was growing, but recent studies suggest over 40 per cent of companies are reviewing their strategy. The reason is simple: they will now have to assess every single worker on a case-by-case basis.
It is not merely assessing the status of every worker that will be expensive – although it will. There are other consequences. HR departments need to adjust current procedures and be trained on new ones. Finance teams need to wholly review payroll and tax accounting processes. Each IR35 employee will now cost 13.8 per cent more in National Insurance Contributions. And those are the fixed charges.
There are other, unquantifiable, ones.
It is tempting to think companies could simply shift all off-payroll workers onto the payroll. Those workers would lose 25 per cent of earnings immediately and many will take their labor elsewhere – to different clients with more enlightened views of the new rules.
Traditionally, higher contractor incomes were compensation for having no holiday or sick pay, pension contributions, or job security. Contracts will have to be renegotiated – or companies face losing often-vital staff. Contracting is not primarily a tax mitigation vehicle – it is a way for companies to employ workers who often have specific skill sets which are not needed full-time.
Last February, Deutsche Bank almost lost 94 per cent of their compliance team – all contractors – before delays to the changes were announced.
Companies will be left with difficult decisions. The definitions of what falls under IR35 have been left deliberately broad.
If cautious employers opt to capture all contractors within their interpretation, they will find it difficult to attract workers – now deterred by lower pay. Go the other way and they risk the wrath of HMRC, who have powers to investigate under tax compliance rules. HMRC has already announced they will be liaising with businesses after implementation of the new rules to determine if they are being applied successfully – officially under the guise of “supporting businesses”, but it feels like a way of HMRC giving teeth to the new regulations.
If the authorities decide assessments are incorrect they can both demand unpaid tax and NIC’s – with interest – and issue additional penalties of up to double the money owed. Companies that get a reputation for making the wrong calls either way will find it harder still to recruit – since either they offer lower remuneration or contractors fear finding themselves liable for back taxes.
Whilst HMRC’s Check Employment Status for Tax Tool (CEST) is a huge improvement on previous incarnations, it is only binding if correctly and accurately completed. There remains the nagging feeling that CEST can be played to receive the ‘right answer’ and some questions are far from intuitive. Although it can lighten the administrative burden, it is not a panacea and we will only see in the fullness of time how rigorously HMRC might test its outcomes
Businesses have an uphill task to ready themselves for the changes. This will include identifying contractor-related risk, establishing proper processes – whether for assessing status, communicating with those affected, or necessary training – and making sure they understand the rules and their obligations. They may need to plan for potential disputes.
The fact the rules have been delayed twice means companies should have had ample time to prepare, but a recent Grant Thornton survey suggested almost 40 per cent aren’t. But better late than never; the alternatives could be very expensive indeed.