A survey by ContractorCalculator has revealed that many private sector companies may be at risk of legal action through misinterpreting the new IR35 tax reforms.

What Is IR35?

The IR35 tax reform legislation, set to be introduced this April, is designed to stop tax avoidance from ‘disguised employment’, which occurs when self-employed contractors set up their own limited company to pay themselves through dividends (which are not subject to National Insurance). IR35 will essentially mean that, from April 2020, medium-to-larger private sector organisations become responsible for determining whether the non-permanent contractors and freelancers should be taxed in the same way as permanent employees (inside IR35) or as off-payroll workers (outside IR35), based upon the work they do and how it is performed.

Also, the tax liability will transfer from the contractor to the fee-paying party i.e. the recruiter or the company that directly engages the contractor. HMRC hopes that the IR35 reforms will stop contractors from deliberately misclassifying themselves in order to reduce their employment tax liabilities.

The idea for the introduction of the legislation dates back to 1999 with Chancellor Gordon Brown and Chancellor Philip Hammond introduced IR35 for public bodies using contractors from April 2017.

National Insurance

One of the potential problem areas for private sector companies revealed by the ContractorCalculator questionnaire, answered by some 12,000 contractors, is that some may be unlawfully deducting employers’ national insurance contributions (NICs) from their contractors’ pay. This means that they are effectively imposing double taxation on these contractors.

Given that 42% of contractors said they weren’t aware that such deductions were unlawful, the survey appears to show that although these companies have been acting unlawfully, it is likely to be because they have simply misinterpreted the new tax reforms given the complicated nature of the IR35.

Tribunal Threat

The survey also showed that 58% of survey participants are classified as ‘inside’ IR35 (taxed in the same way as permanent employees) said that they would consider taking their client to an employment tribunal because, if they have to pay the same amount of tax as a permanent employee, they feel that they should receive the same benefits as permanent employees e.g. sick pay and a pension.

Contractor Loses Case

On this subject, there was news this week that an IT contractor who had worked through his limited company Northern Light Solutions for Nationwide for several years and been treated as outside IR35 has lost an appeal to HMRC against a £70,000 tax demand whereby HMRC had argued, successfully, that he should have been categorised as inside IR35.

What Does This Mean For Your Business?

When the IR35 tax reforms were first announced, many business owners thought that the reforms appeared to be very complex and that not enough had been done by the government to raise awareness of the changes and to educate businesses and contractors about the implications and responsibilities. This survey appears to support this and shows that this lack of knowledge and awareness of IR35 by businesses could be leaving them open to the risk of legal action. Contactors and the companies that use their services need to learn quickly about the dangers of hiring freelance workers long-term and companies that use freelancers need to conduct correct due diligence in order to ensure that the business relationship they have with them complies with IR35.