IR35 changes from April 2020

There are significant changes looming for medium and large employers who engage contractors via service companies.  This is a fairly common practice in some industries, and is especially prevalent in technology and engineering.

How does the set up work?

In essence it is simple: John Smith, an individual, forms a company, John Smith Limited.  John Smith Limited then enters into a contract with another business, X Limited, to provide the services of John Smith.  X Limited pay John Smith Limited in accordance with the contract, and John Smith Limited then pays John Smith.  John Smith is a shareholder in John Smith Limited (often the only one), is a director of it and is also employed by it.  John Smith Limited can therefore choose how much to pay John Smith, and how much of that should be paid in dividends and how much as salary.  Until a few years ago, there were considerable tax advantages in being paid in dividends rather than as salary, but those advantages have been significantly reduced in recent years.  However, dividends do not attract National Insurance, so there is, on the face of it, still a sound financial reason to utilise this type of structure.

What is IR35?

IR35, or to give it its correct title, the off-payroll working rules, was introduced in 2000 to try to prevent this form of tax avoidance.  In simple terms, what IR35 said is that, were it not for the service company, if (in our example), John Smith would have been deemed to be an employee of X Limited, then all payments made to John Smith by John Smith Limited will be treated as earnings and taxed accordingly.

The changes

The big change coming up in April 2020, is to who needs to decide whether IR35 applies (i.e. who is liable).  When the rules first came in, it was for the contractor through their service company to make the initial assessment, and then for HMRC to challenge it if they wished.  In 2017, the rules changed so that in the public sector it was the end user, not the contractor, who had to determine whether it applied.  That obligation is now being extended to medium and large businesses from 6 April 2020.  A medium or large business is (not surprisingly), one which is not defined as a small business.  A small business is defined as one which satisfies at least 2 of the following criteria

• less than 50 employees
• a turnover of less that £10.2 million
• a balance sheet of no more than £5.1 million.

The effect of the changes

So, what does this mean for medium and large businesses, and for the John Smiths of this world?  In short, from April, the end user (X Ltd in the above example) will need to assess and declare the IR35 status of the service companies with which they contract.  In order to help in that process, HMRC have launched an online assessment tool to help people determine whether or not IR35 applies.  However, it is worth remembering that the tool has been prepared by HMRC, and they have a vested interest in determining that IR35 will apply, so where there are grey areas, it might not be entirely impartial!  Certainly, there have been cases which have decided that IR35 did not apply, notwithstanding the online assessment tool saying it did.  In addition, the Government have just launched a review into the implementation of the forthcoming changes, so the detail may change at the eleventh hour.