Prior to the implementation of IR35 into UK law, self-employed contractors of all stripes voiced their concerns with the legislation. It was roundly perceived as a needless obstacle in the way of contractors, with the potential to negatively affect their earnings. The latest reforms have exacerbated this perception, with many contractors’ previous concerns having been vindicated. Due to IR35, and the government’s unwillingness to adjust its position on the controversial legislation, more than a fifth of the UK’s contractors intend to leave the country and take their business abroad. But what is IR35, and why has it inspired such a reaction? More importantly, what can you do about it as a self-employed contractor in the UK?
In this article, Clarke Bell will answer these pressing questions, provide a full overview of the situation, and ensure you have the information you need to make the right calls for your company.
IR35 is a set of rules designed to crack down on certain tax loopholes some contractors would make use of. Namely, IR35 aimed to make it more difficult for employees to “disguise” themselves as contractors. This is typically done through an intermediary, such as a personal service company (PSC), with services being rendered to clients as you would expect from a contractor. However, there is a clear difference between standard contractors and “disguised” employees; the latter has a relationship with a client more akin to an employee than a contractor.
Let’s take a practical example. Say an employee of a company is dissatisfied with the taxes they pay, and would like to become a contractor to reduce their tax burden. This employee establishes a personal service company, quits their position as a salaried employee, then returns to work for the same company providing the same service, with the only difference being their new status as a contractor. Doing so comes with tax benefits, as the tax rules that govern self-employment are somewhat more lenient than those that govern salaried employment.
Such activity would be a breach of IR35, as this contractor would clearly be an employee if not for the PSC, and would place the contractor inside the regulation. This means that the contractor would not benefit from the tax advantages normally provided to contractors. On the other hand, if a contractor would not be an employee if the PSC was not a factor, then they would fall outside of IR35. This would mean that the contractor would be taxed under self-employment rules.
IR35 was implemented to crack down on “disguised” employees. Before its implementation, many companies and employees would take advantage of the benefits self-employment brings. For the employees, the benefits were, as we’ve stated – a lesser tax burden. For employers, the benefit was a smaller overhead, as they wouldn’t have to pay employee benefits or employer’s NIC. This made disguising employment an appealing course of action for well-paid employees and their employers.
While IR35 certainly addressed the tax loophole, it wasn’t eliminated completely. This saw the government implement IR35 reform, which sought to further clamp down on “off-payroll” employment, or employment within the remit of IR35, in the public sector. These reforms were implemented in April 2017, and forced public sector employers to determine whether their employees fell within or without IR35.
These reforms were extended to the private sector in April 2021, after having been postponed due to the Coronavirus pandemic. Quite like their public sector counterparts, private sector employers were now responsible for determining how IR35 related to their employees and hired contractors.
The efficacy of the initial implementation of IR35 can be argued either way; it had some effect on the targeted tax loophole, while not being overly obstructive to employers and contractors. That said, concerns held by contractors when the legislation was in its early stages were founded. The recent reforms have been exceedingly detrimental to UK contractors, with far-reaching effects.
One such effect is incentivising risk-averse companies to mark most, if not all, of their hired contractors as within IR35. This might be good for the company, but it certainly isn’t good for contractors. This push towards risk aversion on the part of companies means needlessly diminishing a contractor’s take-home pay. Naturally, this hasn’t been received well by contractors, many of whom see the legislation’s reforms as punishing the self-employed.
In addition to other organisations, the IPSE (Association of Independent Professionals and the Self-Employed) has conducted extensive research on the effects of IR35 and how contractors have responded. Three figures in particular stand out:
- 53% of contractors have cancelled contracts that placed them inside IR35
- 62% intend to refuse any future contract that places them inside IR35
- 22% of contractors intend to take their business abroad to wash their hands of IR35 completely.
Needless to say, this regulation hasn’t been good for contractors, employers, or the UK economy as a whole.
Despite the negative effects and adverse reactions, IR35 is here to stay, at least for now. This being the case, what can contractors do if they aren’t willing to be governed by IR35?
The answer is unsatisfying – not much. Until the government rethinks its approach to IR35, assuming it ever does, contractors will simply have to bite the bullet while working in the UK. If this isn’t appealing to you, following in the footsteps of other contractors taking their business abroad could be a good solution. But what if these two solutions just don’t cut it?
If IR35 poses a significant threat to your company’s income, but you can’t or won’t move your business abroad, then Members’ Voluntary Liquidation (MVL) could be the ideal solution for you. It is a form of voluntary liquidation designed for solvent companies with retained profits, placing an emphasis on tax efficiency. With this procedure, you can ensure your company is closed cleanly and efficiently, while maximising the profits you can extract from it.
A company’s directors can initiate the MVL procedure with the agreement of at least half of the board. For PSCs, the procedure can begin immediately upon the signing of a Declaration of Solvency. This document states that, to the best of the signatory’s knowledge, the company is solvent, and therefore eligible for an MVL. With the declaration signed, an insolvency practitioner can be appointed as liquidator, and the process can begin in earnest.
Once appointed, the liquidator will identify and dispose of company assets. These assets will be sold at the highest price possible, and distributed amongst the company’s shareholders. These distributions will be made in the form of dividends, rather than income. This means that they will be taxed under Capital Gains Tax (CGT) rates, which are lower than Income Tax rates. This alone would make for significant tax savings, but there is another factor in the MVL procedure’s tax efficiency. Specifically, eligible directors can apply for Business Asset Disposal Relief (BADR), previously known as Entrepreneurs’ Relief. This relief entitles directors and shareholders to a significant tax break on their gains, up to a lifetime limit of £1 million. When combined with the already low CGT rates, this results in directors paying very little tax on their company’s extracted profits.
If you are considering closing your company due to IR35 (or any other reason), Clarke Bell can help you.
You can be assured that you are in safe hands with us. We have more than 29 years of experience in helping directors close their company with the MVL process. In that time, we have liquidated more than 4,000 companies and securely distributed assets of over £500,000,000.
Contact us today for your free, no-obligation advice to find out how we can help you.