IR35 reforms - are they fit for purpose?
Having listened to the on-going debate about the IR35 reforms which are due to be implemented from April 2021, I have asked myself: Why shouldn’t companies be allowed to outsource work to individuals who operate as limited companies? In this article I am considering whether there is an alternative approach to addressing what is a tax issue.
Why are limited companies used in this way?
Let us consider why individuals operate through their own limited companies. The obvious reason for some people, primarily sole-traders, is to conduct their business through a limited liability company so that they separate their personal affairs from their business affairs, thus preventing a loss of any personal assets should the business suffer financial losses. Hence the term limited liability company. If they do this, the creditors of the business cannot (under most circumstances) turn to the assets of the individual for the settlement of the debt.
This all makes good sense. However, some employers were keen not to employ people for a variety of reasons and asked people who might have otherwise been employees, to provide their services as sub-contractors. Some would also stipulate that the sub-contractor must set up a limited company to carry out the transactions between the two parties. People who complied with this term of the contract saw a tax advantage, as did the engager. The tax advantage for the contractor being that they could reduce their tax liability by paying a low salary to themselves through their limited company and distribute a profit to themselves by way of a dividend. The advantage to the engager, that there are no employers’ on-costs that would normally be incurred when employing someone.
Why is this a problem for the government?
Over the years, successive governments have allowed this practice to happen and some would argue have encouraged it to happen. Now the government is seeing that there is an opportunity to collect more tax by ‘outlawing’ these arrangements through what are commonly referred to as the IR35 reforms. In some cases, the response of engagers has been to offer contractors employment contracts at lower levels of remuneration, because they are now incurring the employers’ on-costs that they were previously avoiding. This has been met with resistance by many contractors who are lobbying the government to scrap the reforms and allow them to happily continue as they are, which is understandable.
The essence of the problem in my view is the ability of the contractor to pay themselves a dividend via their own limited company. Finding a solution to the problem is challenging, but I accept the argument that a long-standing method of conducting business should not be radically changed by the government’s desire to collect tax. This method of operating is perfectly acceptable to both engagers and contractors. The IR35 reforms are forcing contractors to either go on to the payroll of engagers or become deemed employees of the engager. When a contractor becomes a deemed employee, they have no employment rights - the engager deducts tax from the fees payable to the contractor, to be paid over to HMRC on behalf of the contractor.
There are many talented contractors who are choosing to go overseas for work, so I think the government should consider an alternative approach. An example of which could be for HMRC to stipulate a percentage of the contractor’s fees to be treated as salary within the contractor’s company, with the remaining profit available for distribution to them as a dividend.
Food for thought.
To understand more about the intended reforms please see our half-day course, IR35 - Preparing for the Changes.
Written by Stephen Smith
http://www.uktraining.eu/news-article/ir35-reforms-are-they-fit-for-purpose/94