The government is facing renewed calls to scrap the IR35 legislation it has relied on for 20-plus years to curtail tax avoidance by limited company contractors, as concerns about the after-effects of its introduction continue to grow.
More than two decades have passed since the government pushed through the original version of the IR35 legislation in April 2000 to clamp down on disguised employment by limited company contractors seeking to minimize their income tax and national insurance contribution (NIC) liabilities.
The legislation aimed to curb the number of limited company and personal service company contractors who essentially work as permanent employees but use their off-payroll working status to avoid making pay-as-you-earn (PAYE) NI contributions.
Under the original legislation, contractors needed to decide and declare for themselves whether the work they did and how it was performed meant they should be taxed in the same way as a salaried employee (inside IR35) or as an off-payroll worker (outside IR35).
An inside-IR35 designation, therefore, means the contractor should be considered an employee of the company for tax purposes and should pay broadly the same income tax and NICs as a permanent employee performing the same duties would do.
The IR35 working rules have been subject to repeated criticism since their introduction, with a House of Lords inquiry concluding in April of last year that the legislation had never worked satisfactorily since it was introduced more than 20 years ago.
The inquiry described the IR35 legislation as flawed and said a fundamental revamp of it was long overdue. That is a many view share, including Dave Chaplin, CEO of contracting authority ContractorCalculator.
“It has always been sold to Parliament and the Treasury as a tax-avoidance measure and a threat to the Treasury, but this has always discounted the fact that contractors earn more money than their permanent counterparts,” Chaplin told Computer Weekly.
“Comparing the tax take from a contractor and an employee earning the same amount is misleading because contractors typically charge more than the employees are paid.
“This is due to free-market forces, which dictate rates of pay. Firms are willing to pay more for short-term access to essential skills, and contractors are entitled to accept nothing less, especially given that they are already surrendering employment rights and stability.
“Contractors who earn significantly more than their permanent counterparts inevitably generate a considerable amount more in tax, which is, of course, more beneficial for the Treasury. Meanwhile, flexible working continues to stimulate and benefit the economy.”
On a related point, another criticism leveled at the legislation is that it commands that contractors be taxed in the same way as permanent employees. Still, workplace benefits – such as holiday pay, paid sick leave and pension contributions – remain off-limits to them.
One IT contractor, who spoke to Computer Weekly on condition of anonymity, said: “I work for myself for the flexibility to save for a rainy day, and I can’t do that anymore because I’m working inside IR35 and I’m a zero-rights employee as a result of this legislation.
“I pay all the tax, all the national insurance, the apprenticeship levy, the employer contributions to my pension. I pay my own sick pay, my holiday pay, and when the contract ends – that’s it. I could easily have no work next year and no income.”
IR35 and the rise of umbrella companies
The legislation is also credited with accelerating the proliferation of umbrella companies at the turn of the millennium, which claimed they could offer contractors and their end clients a way of neatly side-stepping the legislation.
To take advantage of this, all contractors had to do to cease trading as a limited company contractor and start providing their services to clients through the umbrella company instead.
Doing so means the contractor becomes the umbrella company’s employee and moves onto its payroll, which means IR35 no longer applies to the assignments they do for their end clients.