How contractors can prepare for the IR35 Off-Payroll tax changes

28 January 2021 6 min. read
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New tax legislation will come into effect on April 6th 2021 that is set to have a huge impact on contractors working in the private sector as the Government takes steps to raise more taxes from so called ‘deemed employment’.

The new legislation means medium and large private sector companies will be responsible for determining a freelancer or contractor's employment status for tax purposes, or ‘IR35 status’, and then tax the contractor’s earnings as employment income if applicable.

Dave Chaplin is CEO and founder of contracting authority ContractorCalculator and IR35 compliance solution IR35 Shield. He is also the author of ‘IR35 & Off-Payroll Explained’. He outlines what contractors should do before April 2021, and why.

How contractors can prepare for the IR35 Off-Payroll tax changes

Educate your client

If clients ignore or delay addressing the legislation, projects will suffer as we saw happen in the public sector when hirers were inclined to issue blanket bans on limited company contractors. A recent survey carried out by IR35 Shield amongst some 3,000 contractors found that 52% of contractors currently in work are yet to be assessed with 23% saying that their client has imposed a blanket ban on PSC workers.

So, it is vital that, as a contractor, you explain the impact of such actions to your client and warn them of the consequences. These may include:

  • IR35 status disputes resulting in contractor walkouts
  • Contractors abandoning projects, resulting in delays and cancellations
  • Greater cost of retaining contractors ‘inside IR35’ due to increased rate demands
  • Difficulty in attracting talent to work ‘inside IR35’, thereby losing competitiveness.

Clients need to recognise that the accumulative cost of refusing to engage contractors who are genuinely ‘outside IR35’, via their limited companies, could be potentially very damaging. But the impact can be effectively mitigated, providing hirers adopt the correct compliance solution.

Secure an outside IR35 contract

Opportunities outside of IR35 will be available, and some positions will even be advertised as such. But they won’t be vacant for long, which is why it pays to find an ‘outside IR35’ contract as early as possible. Once you have secured work on an ‘outside IR35’ basis, the key is to sustain your IR35 status and engage in working practices which continue to reaffirm this. Brush up on your understanding of IR35 and the key status factors.

Control, personal service, and mutuality of obligation (MOO) are the three fundamental factors which generally determine IR35 status, and contractors should have a solid grasp of them.

There will now be two versions of IR35 in play – the original intermediaries legislation (Chapter 8 of ITEPA 2003), which will still be applicable where the client meets the small company’s exemption, and the new and updated Off-Payroll legislation (Chapter 10 of ITEPA 2003) from April 6th 2021. Whilst both are based on the concept of ‘deemed employment’, the tax treatment is different, and you’ll need to understand why.

Dispute assessments where there are material errors

If you’ve been told the position is inside IR35, then first ask for a copy of a Status Determination Statement (‘SDS’) and a copy of the contract on which it is also based, then you can evaluate it to see if there are flaws in the assessment. If you are going to dispute an assessment, then you need to make representations to the client, who is then legally obliged to consider them and then either change the status or provide reasons why they are standing by their original determination.

This essentially means the hiring client is the judge and jury, so will simply dismiss any frivolous representations. You’ll need to provide representations with content similar to how a barrister might prepare the pleadings for a case and point out errors in facts and misapplications of the law. You may decide to get help with this. Or you may decide that whatever you do, the client isn’t going to change their mind.

Either way, it won’t change unless you try, in which case a rate hike might be your next move. 72% of contractors told us that they will increase their rate for on-payroll engagements.

Calculate rate renegotiations for ‘inside IR35’ contracts

If you’re considering an ‘inside IR35’ engagement under the new legislation, understand the financial impact that the Off-Payroll rules have on your income. Working ‘inside IR35’ under the new regime will impose an employment tax liability on the end client and/or agency, as well as a tax hike, so knowing how much you would need to increase your rate by for an ‘inside IR35’ engagement to be net income-neutral is important. But, bear in mind that they will be wishing to renegotiate too and want to pass their new tax bill onto you.

If the ‘inside IR35’ status determination has come about because of a risk-averse client refusing to conduct a considered assessment, you could attempt to renegotiate your rate to counter your tax hit if you feel your bargaining position is strong.

The challenge some clients and contractors will face is the impact of the withdrawal of tax relief on expenses previously claimable. For a contractor who travels and lives in accommodation close to the client site during the week, if they are ‘inside IR35’ then they may need to increase their rate by up to 40% to maintain the same level of take-home pay. This increase may make the hire completely untenable.

Avoid historical tax risk

If you are offered an ‘inside IR35’ contract by an existing client, having previously operated outside of IR35, beware that you could be exposing yourself to historical tax risk.

Though HMRC has stated that the Off-Payroll rules will not trigger a retrospective investigation, be aware that the taxman could use the overturning of a contractor’s IR35 status as a solid reason to open a tax enquiry.

Beware of non-compliant ‘umbrella companies’

Contractors are also advised to avoid non-compliant umbrella tax avoidance schemes. Despite setting out to tackle tax avoidance, the Off-Payroll rules have seen a rise in non-compliant schemes with many contractors unwittingly duped into these arrangements. Be wary of the indicators of a non-compliant scheme, such as dubious or unclear payment terms, or a lack of professional accreditation. The safest route is being on the client or agency payroll.

Talk to clients and establish their approach to the Off-Payroll rules and their plans around their contracting workforce. Take the initiative. You don’t want April 2021 to be fast approaching when your client demands that all contingent workers be put on-payroll, as some large firms have done.