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Autumn Budget 2017: IR35 private sector rollout – consultation announced

Category: Personal Tax

Autumn Budget 2017: IR35 private sector rollout – consultation announced

The changes to IR35 currently plaguing the public sector look set to be extended into the private sector, after the Chancellor announced a consultation into off-payroll working in the private sector in the Autumn Budget.

Introduced into the public sector in April 2017, the reforms have caused unprecedented damage. With many contractors preferring to seek opportunities elsewhere rather than risk being incorrectly classed as ‘inside IR35’, public sector bodies have been starved of critical skills.

The fallout has led to delayed and cancelled projects, and the deterioration of public services such as the NHS. With the proposed private sector rollout, the Government threatens to further hamper flexible working in the UK, causing damage to UK plc on a far grander scale.

From the Budget document:

3.7 Off-payroll working in the private sector – The government reformed the off-payroll working rules (known as IR35) for engagements in the public sector in April 2017. Early indications are that public sector compliance is increasing as a result, and therefore a possible next step would be to extend the reforms to the private sector, to ensure individuals who effectively work as employees are taxed as employees even if they choose to structure their work through a company. It is right that the government take account of the needs of businesses and individuals who would implement any change. Therefore the government will carefully consult on how to tackle non-compliance in the private sector, drawing on the experience of the public sector reforms, including through external research already commissioned by the government and due to be published in 2018.

What are the IR35 reforms?

Traditionally it has been the contractor’s responsibility to evaluate their IR35 status for each contract and deduct tax accordingly. However, the reforms – already in effect in the public sector – require end clients to carry out an IR35 assessment for each contractor they engage.

If the contractor is supplied via a recruitment agency, the agency is responsible for deducting tax via Pay As You Earn (PAYE) if the contractor is judged to be caught by IR35. If the client engages the contractor directly, the client is required to make the tax deductions.

The tax liability risk also shifts further up the supply chain. If HMRC investigates and finds that a contractor has been paying tax as ‘outside IR35’ where it believes they are caught, the agency can be targeted for backdated tax, penalties and interest. This is unless it can be proven that the client hasn’t taken ‘reasonable care’ when assessing the contractor’s status, in which case they then become liable.

This creates a huge incentive for clients and agencies to assess contractors as caught by IR35, which contractors are well aware of. Extending these rules could mean many contractors will struggle to ever secure a fair IR35 assessment.

IR35 reforms – what contractors must do now!

The Government may have announced a consultation into the proposed changes, but if the public sector changes are anything to go by, the recommendations already look predetermined. Nonetheless, there is plenty that you can be doing to help protect the livelihood of flexible working in the UK.

IPSE WARNS OF “NIGHTMARE” PRIVATE SECTOR IR35 SCENARIO

The Association of Independent Professionals and the Self Employed (IPSE) has intensified its opposition to a planned government rollout of “disastrous” new public sector IR35 rules to the private sector by detailing major shortcomings in HMRC’s online employment status tool. The flaws, IPSE argues, effectively vitiate the instrument.

IPSE’s Director of Policy and External Affairs Andy Chamberlain explains why the Revenue’s Check Employment Status for Tax (CEST) tool is unfit for purposes. His criticisms are shared by many other organisations including the Association of Professional Staffing Companies (APSCo) and the Freelancer and Contractor Services Association (FCSA) — an umbrella company trade association.

There are many reasons for the pervasive lack of faith in the tool, including:

-The rules are too complex to be captured by a simple online tool. The interpretation of IR35 requires a deep familiarity with case law as well as informed, human interpretation of each contract. As Chamberlain puts it: “Any online tool will lack the nuance required to get it right in every instance”.

-HMRC concedes that the tool fails to make determinations in 15% of cases, which it considers an acceptable hit rate. However, for the 15% affected it is of no use whatsoever. These are almost certainly borderline cases much in need of guidance, Chamberlain observes, meaning that the tool “fails to those who need it most”.

-The tool omits any test for Mutuality of Obligation (MOO), which is a central determinant in case law as to whether IR35 applies to a contract. HMRC recently revealed that it omitted this test as obligations are part of all contracts. But for contracting professionals, the degree of MOO is crucial: employees are far more obliged to perform tasks for employers than contractors are for clients. The omission of this test is a critical flaw.

-The person applying the CEST tool may have a biased or inaccurate view about the nature of the engagement. Believing that certain conditions apply doesn’t make that true — some managers mistakenly think that they have control over how the work is done, but the contract’s details may demonstrate that this is entirely inaccurate. There are no means of challenging how the tool has been completed so, inevitably, determinations are reached based on contentious or simply wrong answers.

Chamberlain writes: “The problem will be multiplied many times over if all private sector clients are forced to make IR35 determinations for each of their engagements. As IPSE has long argued, IR35 is a complete nightmare to wrestle with.”

IPSE is urging all contracting professionals and others concerned about the proposed rollout to write to their MPs. A sample letter is available here.

Autumn Budget: IR35 in private sector more ‘foolhardy’ than ‘fair’

The extension of IR35 regulation has quickly become a topic no business relying on a contract workforce can ignore

Financial secretary to the Treasury Mel Stride was quoted saying that extending IR35 regulation of contract workers from the public to the private sector was “a matter of fairness”, and that there had been “no evidence of significant impact on attrition rates of contractors working in the public sector”.

This has put the market on alert that the government will be applying the controversial changes to private sector businesses far sooner than many had hoped, and seemingly in complete disregard for the serious and ongoing impact it is having in the public sector.

The reaction from organisations close to the situation has been strong and largely uniform. The Association of Professional Staffing Companies (APSCo) predicted the move “will have a devastating impact on the flexible labour market”. The Association of Independent Professionals and the Self Employed (IPSE) has described HMRC as “in denial about the fallout from the public sector reforms”.

As a business that places hundreds of contractors with both public and private companies every year, we’ve been actively advising businesses about what to expect and how to react to the changes.

Expect higher contractor costs…

When the regulation was first applied we saw a widespread movement of contractors from public sector contracts to avoid the burdensome regulation. This ‘boom’ in available contractors may soon turn to ‘bust’, as the increased burden on clients and candidates evens out across markets. Businesses must plan for an increase in contractor rates, particularly from areas where the workers are highly-skilled and business-critical.

…and shorter contract lengths

IR35 puts additional burden on contractors to prove that they are ‘genuinely’ self-employed and not beholden to one employer. This will apply pressure on contractors to seek shorter contract times so they can engage with multiple clients. For major projects this will require businesses to consider alternative resourcing, and will potentially increase the onboarding of permanent staff.

Status questions are coming

One of the most perplexing challenges set by IR35 is making it the hiring business’s responsibility to determine the tax status of its specialist skilled workers. Beyond having to hire or train in the skills to make such an assessment, companies can reasonably expect that their contractors may not always agree with the status they are given – which may cause frustration and delays.

The ambition for an effective consultation on IR35 is to encourage the creation of a more effective and easier to apply set of ‘tax statuses’; placing greater burden for clarity and categorisation on HMRC where it rightly belongs.

Get more consultancy from your recruitment consultants

As these changes come in it’s understandable that businesses will be looking to their recruitment partners for answers, solutions and support. IR35 is bringing significant new challenges to recruitment companies as well, and will fundamentally alter how they can provide candidates and manage their contracts. IR35 adds the need for recruitment companies to administer tax deductions on behalf of HMRC, and provide reports on the earnings and company details of self-employed workers.

The pressures this will add to recruitment companies will have a significant impact on the business and operating models of many. The age of ‘pile them high’ placement is quickly coming to an end, creating the environment for experienced, innovative and consultancy-focused recruitment to return.

Much of the above is based on a ‘worst case’ scenario where the lessons of IR35’s painful implementation in the public sector go unlearned. However, there remains reason to be hopeful. We, along with a number of our peers and leading industry bodies, will remain active in petitioning HMRC and the Treasury to accept consultation and advice from those who are closest to the impacts of this regulation. We are also encouraging our clients to join our calls for a better, more effective set of rules.

A healthy, thriving, flexible workforce is essential to the UK. It’s imperative for all organisations to become aware of IR35, and take an active role in ensuring business is not robbed of the skills, flexibility and power of a thriving contractor environment.

Why the axe keeps hovering over Entrepreneurs’ Relief

“The thing that’s wrong with the French is that they don’t have a word for entrepreneur.”  Well, whether or not it’s true that George W Bush actually said it, it’s too good a line not to quote.

But the more important point for our purposes is that UK tax legislation doesn’t have a word for it either, in the sense that it isn’t a defined term.

Yes, you get Entrepreneurs’ Relief — not because you pass some objective test of being “an entrepreneur,” but because you meet a set of pretty arbitrary conditions laid out in the statute.

And that might be why government has, over the years, seemed to have been uncertain at quite what it was aiming to achieve with Entrepreneurs’ Relief and why, despite regular tinkering over the years, it might be in line for further changes.

Entrepreneurs’ Relief (‘ER’) is essentially a special low (10%) rate of Capital Gains Tax which applies to gains on the disposal of trading businesses (including shares in trading companies).

If it applied only on the sale of a business (or a company) as a going concern to a third party, it probably wouldn’t be of great relevance to most contractors. Sure, you do occasionally see the sale of a contractor business which has developed specially valuable intellectual property or a saleable niche business, but most contractor businesses are never sold.

Yet ER also potentially applies to a capital gain on shares on a winding-up of a company following “retirement,” including packing up as a contractor and going to regular, 9-to-5 employment. In that circumstance, the main (often the only) asset coming out in the winding-up is cash. And given a choice between taking surplus cash out as a dividend during the company’s active trading lifetime and paying Income Tax at up to 38.1% or leaving the cash in until winding-up and paying CGT at 10%, guess which most people choose?

HMRC are on record as saying that they have two related problems with that. The first is “phoenixism” — periodically winding-up a company, taking the cash out at a 10% tax rate and then starting over again. “Phoenixism” is what is intended to be countered by the new(ish) Targeted Anti-Avoidance Rule (though the scope of the rule is a whole lot wider than that; another article for another time).

Less well-known is HMRC’s second issue — “money-boxing,” the deliberate leaving of cash in a company until the business is finally closed down on “retirement”. So far, there’s no specific legislation countering that. If the amounts are large, and especially if the retained profits are invested rather than simply being held on short-term deposit, HMRC might try to deny ER on the basis that the company is no longer a “trading company” — though, depending on the facts, HMRC may struggle to get that over the line.

Back in the day, there was targeted legislation which effectively discouraged money-boxing by deeming you to have divided out any cash which was surplus to business requirements, and requiring you to pay Income Tax on the deemed dividend accordingly. But the legislation was horribly subjective and hugely labour-intensive for HMRC to police: we can’t really see that being dusted off and brought back.

However what is worth noting is that the tax law of many countries doesn’t differentiate at all between dividends during the lifetime of a company and dividends in a winding-up: all distributions are charged to Income Tax. Could it happen here?

No reason to suppose not. It would certainly penalise money-boxing — especially if you were unlucky enough to be winding-up your company just as a left-wing government had introduced new higher rates of tax on dividend income! Less drastically, though, it would be relatively simple to amend the ER legislation so that it applied only to sales of shares and not to proceeds in a winding-up, thereby doubling at a stroke to 20% the rate of tax payable on a winding-up. Will it happen in this Autumn Budget 2017?  Nothing’s been leaked. But in the longer-term, who knows?

Taylor Review suggests protection for ‘Dependent Contractors’

The independent Taylor review into modern employment practices has highlighted seven principles to achieve ‘good quality work for all’.

Matthew Taylor, who was commissioned last year by the Prime Minister to carry out this review called for a fresh look to be taken at employment laws to make it easier for workers to understand and access their rights.

Among its key recommendations is that there should be protection for those working through the ‘platform based model, such as Uber. It renames these ‘workers’ as ‘Dependent Contractors’, and flags up that it should be clear how they are distinguished from ‘legitimately self-employed’.

The seven principles are:

1. A national strategy for work should be explicitly directed toward the goal of ‘good work for all’. It is something for which Government needs to be held accountable, but for which everyone needs to take responsibility. It says: “The same basic principles should apply to all forms of employment in the British economy – there should be a fair balance of rights and responsibilities, everyone should have a baseline of protection and there should be routes to enable progression at work. Over the long term, in the interests of innovation,fair competition and sound public finances we need to make the taxation of labour more consistent across employment forms while at the same time improving the rights and entitlements of self-employed people.”

2. Platform-based working (a business model which provides exchanges between two or more groups, usually consumers and producers), offers opportunities for genuine two way flexibility and can be beneficial for those who may not be able to work in more conventional ways (companies Uber operate like this). It says: “These should be protected while ensuring fairness for those who work through these platforms and those who compete with them. Worker (or ‘Dependent Contractor’ as the Taylor review suggests renaming it) status should be maintained but we should be clearer about how to distinguish workers from those who are legitimately self-employed.

3. The law, and the way it is promoted and enforced, should help firms make the right choices and individuals to know and exercise their rights. The ’employment wedge’ (the additional, largely non-wage costs associated with taking on an employee) is already high and increasing it further should be avoided. It says: “Dependent contractors are the group most likely to suffer from unfair, one sided flexibility and therefore there should be additional protections for this group and stronger incentives for firms to treat them fairly.”

4. The best way to achieve better work is not national regulation but responsible corporate governance, good management and strong employment relations within an organisation, which is why it is important that companies are seen to take good work seriously and are open about their practices and that all workers are able to be engaged and heard.

5. It is vital to individuals and the health of our economy that everyone feels they have realistically attainable ways to strengthen their future work prospects and that they can record and enhance the capabilities developed in formal and informal learning and in on-the-job and off-the-job activities.

6. The shape and content of work and individual health and well-being are strongly related. For the benefit of firms, workers and the public interest ‘we need to develop a more proactive approach to workplace health’.

7. The National Living Wage needs to be accompanied by sectoral strategies engaging employers, employees and stakeholders to ensure that people – particularly in low-paid sectors – are not stuck at the living wage minimum or facing insecurity but can progress in their current and future work.

The Government will now be engaging with stakeholders across the country, including those who represent employers and employees, to understand their views ahead of publishing a full Government response later in the year.

IR35 Reforms Blamed for Public Sector Decline

Two large IT recruiters have blamed IR35 reform in the public sector for taking the shine off their performances in the last six months.

Parity Group, an AIM-listed agency hiring for state bodies, and Hays, a FTSE-listed firm with public clients like TfL, each cite the off-payroll rules in trading updates up to June 30th.

Hays, which reported first, said its temp business was “negatively impacted” by factors including “uncertainties created by the recent implementations of the IR35 regulations.”

‘Uncertainties’

These IR35-induced uncertainties, the firm explained, served to drag its public sector gross profits down 17%, on top of a nine per cent drop in temp recruitment fees as a whole.

A few days later in its update, Parity said its staffing unit had turned over “slightly lower” revenues in 2017’s first half than a year ago, due to “lower public sector contractor volumes.”

The dip in the number of contractors was not specified by the group, but it was blamed — at least in part — on the “transition required to deal with the IR35 taxation reforms.”

‘Familiar story’

With two recruiters in about as many days each pointing an accusing finger at the April framework, “a familiar story” is unfolding, say IT analysts TechMarketView.

Yet Parity hinted that an end is in sight, as its affected unit (‘Professionals) “appears to have weathered the [IR35 reform] process more favourably than some other staffing businesses”.

Alan Rommel, group chief executive said: “Hays [is] a recent example but others [too] have declared unfortunate drops.”

The Parity CEO also said that, despite the IR35 reform’s initially downward impact on contractor volumes, “client demand has been restored post-implementation.”

“Client demand is high both public and private, and both contract and perm — we are working hard to replace churn on contract,” he said. “Demand is there.”

‘Tight ships’

No restoration in demand was noted by Hays, which told Bloomberg in a video interview that all its UK clients were exercising “very tight cost control.”

This financial restraint seems to add to the growing list of pressures that a growing list of contract IT staffing agencies seem to be facing.

“Hays, this month cited a tough public sector market and also pointed to IR35 issues,” TechMarketView said. “And [another recruiter] PageGroup pointed to Brexit, political uncertainty and a late Easter for its poor UK performance.”

Reduced Dividend Allowance Makes a Return

One of the main discussion points from Budget 2017, the proposed cut contractors’ tax-free dividend allowance by £3,000 has been officially re-tabled by the government.

But unlike last week’s re-tabling of Making Tax Digital, where a delay has been put in place, the cut in the allowance will go ahead from April 2018, as planned.

The absence of a delay not only means — in officials’ words — that “those affected” by the cut “should continue to assume” that their dividend tax-mitigation strategies will still be needed.

It also means that there will be limited scope to debate or revise the proposal (due to raise £1billion extra by 2020), because the bill to pass it will come at a busy time, partly due to Brexit.

This will result in tax hits of £225, £975 or £1,143 for basic, higher and top rate tax payers.

Overall tax strategies will remain virtually the same but as with recent changes to the way dividends are taxed, increase the tax burden on small businesses.

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Entrepreneurs’ Relief – shares in trading companies

Capital Gains Tax (CGT) has a main rate of 20% (reduced from 28% in April 2016) other than for basic rate taxpayers who now have a rate of 10%. However, a higher rate of 28% continues for the disposal of residential properties.  Importantly, Entrepreneurs’ Relief (ER) can allow a tax rate of 10% to apply for ‘qualifying business disposals’ on the first £10 million of capital gains in an individual’s lifetime.  ER is an important relief; so how does it work for shares?

What is a ‘qualifying business disposal’?
In order to qualify for ER there must be a qualifying business disposal. The following are qualifying business disposals:

  • A material disposal of business assets
  • A disposal of trust business assets
  • A disposal associated with a relevant material disposal

What is a material disposal of business assets?

  • A disposal of the whole or part of a business – where the individual has owned the business for the year leading up to the date of disposal
  • A disposal of assets in use for the purposes of the business where the business ceases to be carried on – if the disposal is made within three years and the individual owned the business for the year preceding the cessation
  • A disposal of shares or securities of a company – if one of the following conditions is met:

Condition A – throughout the year preceding the disposal (ie 12 months):

  • The company is the individual’s ‘personal company’
  • The company is a trading company or holding company of a trading group, and
  • The individual is an officer or employee of the company or trading group.

Condition B – where the company has, within the three years preceding the disposal, ceased to be either a trading company or a member of a trading group, the terms of Condition A above must be satisfied throughout the year preceding the cessation.

For the purposes of ER, an individual’s personal company is one in which they hold at least 5% of the ordinary share capital of the company and have at least 5% of the voting rights in the company. These conditions are relaxed for members of qualifying share option schemes.

A trading company or trading group is defined as one which carries on trading activities and does not carry on other activities to a substantial extent. This is the same as the definition that applied for holdover relief and substantial shareholding exemption purposes.

What is a trading company?
HM Revenue & Customs’ (HMRC) must be satisfied that the strict “trading company” definitions are met. In the case of a single company, it must be “a company carrying on trading activities, whose activities do not include, to a substantial extent, activities other than trading activities”. In practice, HMRC applies a 20% benchmark to determine a substantial level of non-trading activities. HMRC will look at the factors affecting each case but, as an example, it may review contribution to profits, assets employed, expenses and management time (see HMRC manuals at CG64090). As this is a subjective area, it is necessary to consider each case on its own merits.

In terms of a trading group, the definition is much the same as a sole trading company. A trading group is a 51% group of companies where the activities of the group do not include any non-substantial, non-trading activities. Any intra-group transactions are ignored.

Can I get guidance as to the company’s trading status?
A non-statutory clearance can be requested from HMRC and guidance can be found in the HMRC manuals at CG64100 which states:

“The company itself may have genuine doubt or difficulty as to its trading status. There is no statutory clearance procedure under which companies can have their status confirmed. However, in such circumstances a company can seek from HMRC an opinion under the terms of the Other Non-Statutory Clearance service as to its trading status for the purpose of a shareholders Entrepreneurs’ Relief claim.”

Advisers may wish to consider obtaining a tax clearance if there is doubt about the trading status of the company to underpin a subsequent for ER on the disposal of shares.

As with all such tax situations, advice should also be sought before proceeding.  For further details contact us on 0113 2461007 or enquiries@dynamoaccounts.co.uk

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