There is little doubt that IR35 represents one of the most controversial and criticised pieces of tax legislation introduced by any government in recent times.
As insolvency practitioners, we are asked with increasing regularity whether we are dealing with companies affected by IR35. Whilst the answer may vary between practitioners, many are now wondering whether we can expect to become even more acquainted with IR35 when changes are applied in April 2020.
Many of those reading this article, particularly those working in accountancy and related sectors, will know all about IR35 and have a basic knowledge of what it entails. However, it is worth providing some context for those readers who have had no previous exposure to the subject.
Background
IR35 was introduced in 2000 as a means of reducing tax avoidance by those whom HM Revenue & Customs believed to be ‘disguised employees’ – namely individuals who work in the same way as bona fide employees but who invoice their services via a limited company to make their business as tax efficient as possible.
If caught under IR35, individuals previously operating as a limited company would have to pay income tax and National Insurance Contributions (NICs) as if they were employed. The financial impact of this is clearly substantial. It can serve to reduce net income by approximately 25%, costing a limited company contractor thousands of pounds in income tax and NICs.
IR35 was heavily criticised as being badly executed and placing unnecessary burdens on genuine small businesses.
The government responded to this criticism by replacing the original legislation with the new off-payroll tax. However, it appears that it has been impossible to shake off the reputational damage associated with IR35. The subject continues to be known as IR35. The new off-payroll tax was first applied in the public sector in April 2017, and will be extended to the private sector from next April.
Only medium-sized and large businesses will be targeted; small businesses will not need to determine the status of the off-payroll workers they engage. ‘Small’ organisations, defined as having 50 individuals or fewer, will be exempt.
In real terms, for medium-sized and large organisations this means the price of engaging contractors will increase. Subcontractors will need to understand how they are impacted and be ready for April. HMRC’s ‘CEST’ (Check Employment Status for Tax) tool has been designed to help make employment status determinations. However, there has already been much debate about the accuracy of the CEST tool.
Criticisms
Public sector organisations are not known for their risk-taking approach to business, so it has been understandable to see IR35 vigorously over-applied. This approach has seen many contractors paying more in tax than they should. In turn, this has led to contractors exiting the sector, with the unforeseen result of stalling many important government projects.
Legitimate freelancers going about their business using a limited company structure have had to fight off accusations of being in ‘disguised employment’. One-man bands do not generally have the resources of energy to fight HMRC investigations, which can be extremely costly for freelancers, both in terms of time and money.
Will IR35 See an Increase in Company Liquidations?
Time will tell whether the implementation of IR35 into the private sector will serve to increase the workload of insolvency practitioners.
Starting in April 2017, I saw first-hand an increase in Creditors Voluntary Liquidations involving contractors within the public sector, who were faced with an HMRC investigation and subsequent determination on the company.
Such actions by HMRC inevitably led to businesses facing an insolvency situation. If HMRC attacks contractors with the same vigour in the private sector, it is not difficult to imagine more companies struggling with solvency issues in the near future. In such situations, insolvency practitioners will see an increased demand for their services from directors who feel that their company has come to the end of the road. As many of these companies will have little in the form of assets, the benefit to HMRC will actually be negligible.
Casting my mind back to 2017, I also recall receiving enquiries from contractors within the public sector seeking assistance to close down their solvent company through a Members’ Voluntary Liquidation (MVL). Many felt that it was just not worth continuing to work within the public sector, or decided that it was the ideal time to return to employment.
Those who are unfamiliar with an MVL should be aware that this form of liquidation is a tax-efficient process for solvent businesses, with funds in excess of £25,000, to pay the residual creditors and distribute the remaining assets to shareholders of the Company. An MVL may well be an effective exit strategy for those looking to switch operating structures as a result of the changes in April 2020.
The appointed liquidator will ensure that any outstanding liabilities have been settled and clearance has been granted by HMRC to close the company. It may be possible for shareholders to claim entrepreneurs’ relief on extracted funds, which would mean the funds would only be taxed at 10%.
Following the extension of the reform into the private sector, it may well be that many contractors will be minded to liquidate the solvent business and move to a more tax-efficient way of operating.
There is, of course, the small matter of a general election to take place before the introduction of IR35 into the private sector.
However, it doesn’t seem too farfetched to imagine there will be other contractors who will decide that continuing within a limited company structure represents too big a challenge.
Should HMRC seek to increase tax revenues into the Exchequer, there is also the possibility of retrospective tax demands which could actually force solvent businesses into an insolvent position. This then may see a steady rise in Creditors’ Voluntary Liquidations.
I would be interested to hear any of your own experiences of IR35, relating to your own company or that of your client.
If you wish to discuss the impact of IR35, please get in touch at [email protected] or telephone 07968 815 271.