Update 7 February 2020: The government has clarified that the changes made to IR35 will only be applied to payments made for services carried out after 6 April 2020. Previously the rule rules suggested the changes would be applied to payments made before or after the deadline, regardless of when the work was carried out.
Changes to IR35, the tax legislation that looks over off-payroll working, are coming in April 2020.
Named after the press release that announced it back in 1999, IR35 was originally adopted to stem the growing number of “one-man” limited companies providing services to businesses as freelancers – thereby avoiding a considerable amount of tax – while still maintaining a traditional employee-employer relationship.
In its 20 years in operation, the legislation has been criticised, ridiculed and debated. In 2016, the government announced changes to the legislation would be made to the public sector, which at the time had been affected by a number of freelancer-employee scandals (including “around 100 cases” of BBC presenters supposedly avoiding tax).
Being determined as outside IR35 legislation means freelancers can continue to pay themselves through their own limited companies. But being inside IR35 means the freelancer has been deemed as essentially an employee, and should therefore be paid – and taxed – as such.
In 2018 it was announced the changes would be rolled out to the private sector.
What are the changes?
Before 6 April 2020, freelancers and contractors working in the private sector are able to decide their own workers’ status. In short, they are able to identify as freelancers and contractors and pay their own tax accordingly at the end of the financial year.
However after this date, the onus shifts from the workers, to the clients they are servicing. If clients evaluate their relationships with contractors and find that they in fact fall inside IR35, then it is their responsibility to start paying them as an employee, thus incurring all the associated tax and National Insurance expenses.
What are the (expected) implications?
Though the public sector got the ball rolling with this back in 2016, there are likely to still be some unpredicted effects of April’s deadline on the private sector.
“When tax legislation changes, there are always going to be teething problems,” says Mike Hayes, partner at accountancy firm Moore Kingston Smith.
These teething problems will likely include a number of workers who have been deemed inside IR35 by their client, against their own judgement.
“A lot of companies that use the services of personal service companies (freelancers or contractors) will be looking into things now,” says Hayes. “And if it’s decided their contracts are within IR35 legislation, companies will really have three options: to tax payments to those workers in the future, to put them on the payroll, or to end the contract altogether.”
While it might seem daunting to have another party deciding yours or your service company’s worker status, Hayes does point out that clients have a responsibility to notify their freelancers and contractors of their IR35 status ahead of the change date on 6 April.
“This is to give personal service company workers the opportunity to challenge the decision – no company is allowed to just impose the changes on you without giving to time to dispute their decision.”
What’s the problem?
The view of some design bodies and freelancer associations is that in the wake of the changes, a lot of businesses will make a blanket decision to switch all of their previous freelancers and contractors onto the PAYE system.
One of the key issues here, however, is where the money paid as tax through this system will actually come from.
“Many freelancers who have been deemed inside IR35 will believe it’s up to the company employing them to pay their tax contributions,” says Julia Kermode, chief executive of the Freelancer and Contractor Services Association (FCSA). “But many businesses will likely want to take those contributions out of the already-arranged fee for the service being provided.”
If businesses pay employee taxes out of the prearranged fees, some estimates suggest a freelancer or contractor could lose up to 25% of their earnings. In that situation, Kermode says workers should be prepared to renegotiate their rates. “If you have a written contract that says your rate is £500 a day, clients should be mindful of this.
“We’re actually seeing a lot of our members report their contracts are being terminated now and renegotiated for the start of March or even February, in mind of the upcoming changes.”
On the other side of the problem, design businesses (see small business exemption below) that regularly procure the work of contractors and freelancers are also likely to be affected, according to Adam Fennelow, head of services at the Design Business Association (DBA).
“In an increasingly digital and specialised industry, a lot of design businesses turn to freelancers with dedicated skills to help with certain projects,” he says. “Smaller businesses might not necessarily have the talent in-house to complete a project, which is why freelancers are valuable.
“What we are warning our members however, is that the rate of freelancers will likely go up in line with companies who are paying taxes out of their fees – whether or not design businesses have that extra money could be a problem.”
How can designers prepare?
As a freelancer, contractor or business, you are encouraged by HMRC to take the Check Employment Status for Tax (CEST) test, which can be found on the gov.uk website. While some organisations believe the CEST test is “not fit for purpose”, it is at present the recommended way for freelancers and employers alike to assess their status.
The CEST test uses 16 questions to determine whether your role in a company truly is as a freelancer (outside IR35) or if you actually perform the role of an employee (inside IR35). It makes a decision based on some of the following considerations:
- Mutuality of obligation – is your client obliged to offer you work, and are you obliged to accept it? Do you need to work on certain days (for example, like in 9-5, Monday to Friday employment) in order to get paid?
- Personal service – are you required to carry out the work your limited company has been contracted for, or can you send someone in your place?
- Control – following on from personal service, how else are you in control of the job at hand? Does the client control your output, or can you conduct the work in the way you see fit (for example, working late nights, working from home, or not wearing a company uniform)?
- Financial risk – would you be at financial risk for sub-standard work? Would you get paid, even if you didn’t perform the job given to you?
- Day-to-day functioning – is your personal service company actually independent, or are you an integral art of the day-to-day operations and organisational structure of the business you work for?
“Slipping into looking like an employee”, according to Kermode, is an easy move to make when freelancers and contractors stick with “business as usual”. To avoid being deemed inside IR35 wrongly, she advises workers to have full and open dialogues with their clients.
“Tax can be boring, but it’s much better to know where you stand beforehand,” she says. “Rather than have ill feeling between yourselves and a client, we’re advising members to speak about it now.”
Are there any exemptions?
There is one principle exemption from the IR35 tax legislation, and it involves what HMRC call “small companies”.
In short, freelancers contracted by a small company will still be able to identify as freelancers, because the onus will fall on them rather than the small company client. HMRC defines a small company as meeting two or more of the following:
- Its annual turnover is not more than £10.2 million
- Its annual balance sheet total doesn’t exceed £5.1 million
- It doesn’t employ more than 50 people
At the moment, many freelance designers’ contracts will likely fall into this category, and similarly most design businesses procuring freelance work will too.
This said, Fennelow says small businesses should prepare to be affected in the future. “We [the DBA] are warning our smaller business members to be aware of what might be coming in the next few years,” he says.
“While they aren’t affected now, we are expecting IR35 to be rolled out more extensively soon.”
Importantly, however, Kermode is urging designers not to be taken in by tax avoidance schemes.
“There are so many tax avoidance schemes out there, and if any freelancers are duped into these schemes, it’s them who will be saddled with a massive tax bill when HMRC looks into them,” she says.
“Any business claiming to freelancers that they can be paid through a scheme rather than PAYE should be ignored.”
How does the industry feel? Should designers be worried?
According to Fennelow, the DBA position on the IR35 changes is that it isn’t “helpful” for the industry.
“We can understand why HMRC are doing it, since they are losing a lot of tax revenue,” he says. “But it puts a lot of onus and responsibility on design businesses, and ultimately we feel the responsibility should lie with the person or company selling the service.
“We hope that HMRC will clear up the parameters of the changes in the run up to the 6 April deadline, so that businesses will not feel confused by red tape.”
The FCSA echoes this position. Kermode says: “We feel the changes are incredibly unfair – essentially HMRC are delegating their role to clients.
“It’s an incredibly complicated piece of legislation that a lot of experts don’t agree on, a lot of judges don’t agree on, so how clients are supposed to make the decision – without just making all their freelancers fall inside IR35 – is beyond me.”
But in terms of whether designers should be worried about work after 6 April, Kermode says there is reason not to be. As the deadline passes, she hopes businesses will become more comfortable with making IR35 determinations, which will ultimately benefit freelancers and contractors.
“There is likely to be issues in the immediate aftermath, but in the fullness of time we hope it will calm down, as it did when the changes were implemented in the public sector four years ago.”