IR35 loophole could see contractors escape tax

If you employ contractors, you should be aware of the IR35 rules. Otherwise known as ‘off-payroll’ working rules, 2021 saw a major reform for the private sector. However, according to an article in the Financial Times, these changes also created an IR35 loophole that could see contractors escape tax.

What happened?

In brief, the government wanted to crack down on ‘disguised employees’. These were normally people who were not genuinely self-employed, but individual contractors providing their services via a limited company. These people were to all intents and purposes employees, but the use of a limited company helped lower their tax liability. In addition, employers didn’t have to pay employers’ NI contributions or offer benefits like holidays.

The government has provided a set of criteria to determine whether someone is genuinely self-employed or a disguised employee. These include the following.

• Substitution. Could the worker send someone else to carry out the agreed work (taking into account factors such as qualification and vetting procedures)?
• Working arrangements. How much control does a worker have over the work they do? Does the contracting business have significant direction control over how, when and where someone completes their work?
• Mutual obligation. Does the contracting business have an obligation to offer work? Does the worker have an obligation to accept it?
• Financial risk. Does the worker pay up-front for material costs?

HMRC also offers a useful online tool to help determine a worker’s employment status.

What were the IR35 rule changes?

The most significant change was that the responsibility for determining employment status shifted from the worker to the employer. Furthermore, if an employer now wrongly classifies an employee as a contractor, then the employer becomes liable for any extra tax due.

What is the IR35 loophole?

This is where things get interesting. According to HMRC, miscategorised workers can reclaim any tax they have wrongly paid. This has already occurred in the public sector, which has had to adhere to the new IR35 rules since 2017. In 2020-21, public bodies have had to pay £263m because of not introducing the reforms correctly. Dame Meg Hillier MP, chair of the public accounts committee has said:

Here is the public sector, the taxpayer, paying £263m to you [HMRC]… and then you’ve got private contractors that can be claiming that tax back, so basically having their tax paid by the taxpayer.

HMRC boss Jim Harra confirmed this was the case, though he added there is an “incentive on the engager to get these determinations right”.

Can employers close the IR35 loophole?

This is far from certain. Some people have suggested that hirers may be able to draw up special contracts. These would contain a condition that contractors will reimburse hirers if the latter have to pay a contractors’ full tax. However, there’s no guarantee hirers could legally enforce such contracts.

The best ways to avoid paying unnecessary tax is to correctly assess whether someone is genuinely self-employed or a contractor. If you need help administering IR35, talk to us – we can also make sure that IR35 is properly handled by your payroll.