The belief that IR35 only brings in direct tax takings of about £1.5millon a year is not the full story with the estimation that just eight out of the more than 120 umbrella companies between them paying over income tax and National Insurance contributions of about a quarter of a billion pounds per year.
As the true impact of IR35 and its tax take for the Treasury is debated, Parasol Groups Rob Crossland urges the industry to look harder at segmenting contractors as the only way to gain meaningful insights into how IR35 has affected them.
“In the contracting sector we have a workforce with widely different skills, rates, types and terms of contracts, plus, of course, many sectors,” explains Crossland. “We need to segment and understand these different kinds of contractors before we can assess how IR35 has impacted on them.”
According to an information request under the Freedom of Information Act by the Professional Contractors Group (PCG), between the tax years 2002/3 and 2007/8 IR35 has directly raised just £9.2m – the equivalent of just £1.5m per year. But, as ContractorCalculator has pointed out, there is the indirect impact of IR35 to consider.
Would umbrella companies exist without IR35?
Crossland agrees, but corrects the commonly-held impression that umbrella companies developed entirely as a response to IR35’s introduction in 2000. “They did exist before then, offering a wide range of non-IR35 services,” he says. “You have to remember that umbrellas provide a lot more than simply a payroll facility for contractors who are really disguised employees inside of IR35.
“However,” Crossland continues, “it is likely that there would not be so many umbrella companies, nor so many contractors choosing them as their trading vehicles, if IR35 had not been introduced, and then followed by the Managed Services Companies, or MSC, legislation.”
So the umbrella sector has grown considerably as a direct result, and this has had a dramatic impact on HM Treasury’s tax take from the contracting sector. For example, Parasol represents over 10,000 contractors and collects and pays over £100m each year to HMRC in income tax and National Insurance Contributions (NICs).
So it is a reasonable extrapolation that the top eight umbrella companies representing 50,000+ contractors are likely to result in annual tax and NICs contributions in excess of a quarter of a billion pounds.
It is clear that, with an estimated 1.4m contractors and freelancers in the UK and over 120 umbrella companies, the indirect contribution to the Treasury as a result of IR35 is considerable, and certainly more than £1.5m per year.
Contractor segments and types
Not all contractors who use umbrella companies are inside IR35, and this is one of the reasons why Crossland feels it is important to recognise different contractor segments and types. As he explains: “A first-time contractor on a three-month contract and earning £15 an hour clearly does not need to set up a limited company, and an umbrella company is a good short-term solution.
“Equally”, he continues, “skilled and experienced contractors on high day rates who have worked to develop their careers for many years clearly deserve the legitimate tax allowance benefits that accrue from running their business through a limited company.”
But, warns Crossland, many contractors still inhabit a dangerous no-man's-land: “When the MSC legislation was introduced, service providers typically polarised into umbrella companies or ‘accountancy factories’ for limited company contractors.
“As a result, there are contractors who have found themselves in a limited company structure not knowing their IR35 status. Some consider this a calculated risk, others simply know no better, and the advice from service providers can be highly variable.”
There are contractors who have found themselves in a limited company structure not knowing their IR35 status. Some consider this a calculated risk, others simply know no better, and the advice from service providers can be highly variable
Rob Crossland, Parasol Group
IR35 – benefit for whom?
Crossland’s view is that IR35 is not the most sophisticated or clever piece of legislation, and quite clearly does not fit all contractor scenarios. But, as he points out, it is solidly in place and in general terms does address the issue of fair payment of tax. Clearly, for now, everyone just has to work with it.
“IR35 is a successful piece of legislation from HMRC’s perspective, because there are many contractors paying tax at source that would otherwise be paying less tax,” continues Crossland. “Conversely, because the regulatory burden is now so high on small business owners, you could argue it has not been successful for limited company contractors.”
There is a strong argument to say that all but six of the 1,468 tax cases identified by PCG have been won because the contractors investigated were actually genuine contractor micro-businesses and not disguised employees.
Contracting sector yet to bottom-out
The contracting sector may still have a way to go before it starts to recover, and this is still influencing how contractors are choosing to trade.
“We are seeing a lot more initially shorter contracts of three months, where before they would have been for six or nine months,” explains Crossland. “This is clearly clients choosing to manage their risk more effectively. And the good news is that we have also been seeing a corresponding increase in renewals.”
The public sector and telecoms are still strong performers, with oil and gas holding up following a contraction earlier in the year, as major infrastructure projects continue to receive funding. Energy, and specifically the nuclear sector, have responded well.
“Our market analysis suggests that the contractor market has yet to bottom-out,” concludes Crossland, “but the number of big corporate projects, traditionally the source of contractor contracts, will start to increase as firms invest to maintain competitiveness.”