Contractors in the UK have historically been able to determine their tax status, based on whether they consider the terms and conditions under which they work for the business, to constitute employment or whether they are a genuine contractor; in principal they are delivering a service rather than working as a disguised employee masquerading as a contractor for tax purposes.

If deemed employment, the contractor is subject to the same taxes that an employee pays.  Unsurprisingly, the majority of contractors currently deem their engagement services based, referred to as ‘outside IR35’ or ‘off-payroll’ engagement.

The tax reforms in April 2021 will move the engagement status determination from the contractor to the end-user company that engages them.  That means that effectively nearly every contractor (aside from those defined as a small business) working through a Limited company in the UK will have to have their working engagement and conditions assessed so their appointing company can determine their employment status for taxation purposes.

Should a contractor be deemed ‘inside IR35’ (i.e. the working conditions of the contractor are broadly the same as an employee), the contractor will be subject to the same taxes as an employee, without any of the benefits afforded to employees, but with the added risk that is associated through working as a contractor, such as the lack of security.

If the HMRC investigates and determines that an incorrect status has been made by the business, namely, if they conclude that the contractor was declared ‘outside IR35’ but should have been considered an employee for tax purposes, the end client is responsible for picking up the tax bill.  Therefore, payment for the contractor is for all intents and purposes considered a net payment, and the company is responsible for the ‘grossing up’ and paying the outstanding funds to the HMRC.  Ouch.

And to top it off, assessing the role is far from black and white, it is complex and therefore fraught with risk.  The HMRCs own CEST tool is terrible, and rarely gives an accurate determination, and the HMRC themselves do not trust it to use it in their own investigations.

The contractor workforce in the UK contributes an estimated £140-£145 billion to the UK economy each year (CRSE, June 2019) and the HMRC expect to collect £1.6bn in additional tax revenue per year after the reforms pass.

Despite significant protests and a last-minute push to delay the reforms in the house of commons, the reforms passed through in the Finance Bill in parliament on 1st July.  This was after a reported direct intervention from Rishi Sunak and Boris Johnson personally 24 hours prior to the vote to influence ministers into voting to push the bill through without any delay or amendments.  They are taking these reforms very seriously.

So we have a conundrum – contractors do not wish to engage in contracts where the business will deem them ‘inside IR35’ due to the significant impact on earnings, however, businesses want to take a risk averse approach and tend to lean the status determination towards ‘inside IR35’ if they have any inkling that the HMRC may judge them as working within the realms of deemed employment.

Whilst the implications of the IR35 reforms are significant, there are particular sectors that engage contractors more widely and where the reforms are going to be harshly felt.  When it comes to recruiting talent, innovative industries where agility is key to retaining competitive edge, and highly skilled contractors, whether developing code, supporting on a security implementation or strategically leading a project itself, offer companies the opportunity to get quality skills without the commitment of a permanent long term engagement.  And getting those skills on a services basis offers the business delivery and quality of work assurances not often associated with permanent employees.

Post COVID-19 companies will need to engage more contractors whilst the dust settles and businesses realign, in order to move forward.  The flexibility contractors offer allows them to do so, but with one eye on April 2021 and the reforms, businesses will need to be engaging contractors on a compliant service-based agreement now rather than have to manage any complex upheaval next year.  Starting to work properly now is much easier than back tracking and unpicking.

Engaging the flexible workforce will migrate to a service based model, and those that have the right strategy, partners and have planned ahead will have a distinct advantage over those UK businesses that have taken their eye off the ball come next April.

By Michael Cleavely, Director – New Client Engagement, Colnort