From April 2020 the new stricter IR35 rules come in. The idea behind the IR35 rules, which is to prevent consultants, contractors and freelancers being used as “disguised employees” and thus avoiding paying tax and benefits.
Unlike employees on contracts, private sector businesses don’t currently have to use PAYE, pay National Insurance contributions, or offer any benefits, such as holiday or sick pay, to contractors.
However, some businesses have been accused of employing contractors in name only, essentially hiring an employee without paying the additional tax or benefits. Some contractors have also been accused of using their position as a sole trader or limited company to avoid income tax they would otherwise be liable to pay as an employee.
The IR35 rules would make employers directly responsible for their use of contractors as a tax-free way of staffing their business. If HMRC disagrees with their use of contractors, they could be liable for a hefty fine.
How to tell if consultants are IR35 compliant
A big issue for businesses is knowing whether a consultant can be classed as a contractor or whether they would be seen by HMRC as an employee. It can be incredibly useful to hire a consultant on a short-term basis to help with a particular challenge or project, but to hire someone as an employee for a short period is not very cost-effective.
When hiring consultants, it’s worth doing a check and preparing evidence just in case HMRC come knocking. Specifically:
- List ways in which consultants’ work differs from employees’ work. Employees are entitled to minimum hours, workplace pensions, and equipment provided. Note how many employee benefits consultants get and where they differ.
- Highlight working agreements and management arrangements. Consultants provide a service to a client; they aren’t directly managed by the client company. Keep a record of contractual agreements and make sure that correspondence doesn’t imply direct control of the consultant.
- Opt for limited companies with their own business presence. It can be very difficult to prove that a sole trader isn’t a disguised employee. A limited company that isn’t named after the individual consultant is a far safer option. If the limited company also has a website and other marketing material, it’s even easier to show that they are not a disguised employee.
- Check the consultant’s other clients. If a consultant receives work from a number of different companies and, therefore, has a diversified income, it will be far more obvious that they are a consultant and not an employee. Of course, it isn’t always easy for consultants to maintain a diverse client portfolio, with often irregular workloads from occasional clients. But, if a single company provides >90% of a consultant’s work, they are effectively their employer.
Even after completing all of these steps, there is still a risk when engaging a consultant. For larger, more visible companies, this can be a real concern and the stakes are high.
So what can companies do to keep affordable consultants after the IR35 changes?
Three risk-free ways to engage consultants
The obvious risk-free way of engaging a consultant is to take them on as an employee on a fixed-term contract. However, this offers less flexibility for consultants and can be an incredibly expensive option.
Another option is to engage a large consultancy firm. These firms, however, tend to charge exorbitant rates for junior consultants who are managed by more experienced consultants.
If companies want to continue using affordable consultancy without the IR35 risk, there are broadly three avenues to explore:
1. Boutique consultancies
Perhaps in response to the IR35 rules, there has been a marked increase in the number of small, boutique consultancies opening up in the UK. These consultancies tend to focus on one specific area of business, directly employing their own consultants.
The main benefits of these small consultancies are that they are much cheaper than larger consultancies, often supply only experienced consultants, and are easier to hold to account than individual contractors. As such, they can represent good value for money.
Of course, all agencies will add their own fees to cover overheads and grow their profits, so they can never compete with the cost-effectiveness of an individual contractor. Since boutique agencies also tend to specialise, additional consultancies may be required to solve every challenge, which can be both time-consuming and expensive.
Can you change point number 2 to Umbrella/PAYE. Some companies will pay directly the contractor through PAYE. This is even worse than an Umbrella company for a contractor, because it offers even less flexibility for contractors to deduct some of their expenses or to use ‘salary sacrifice’ to contribute ‘pre-taxed’ income to a pension.
2. Umbrella companies/PAYE
The most common way that companies are using to dodge the IR35 risk is to use ‘umbrella companies’. These are separate companies that collect the contractor’s earnings and pay the contractor after deducting National Insurance and tax contributions. While this option is mitigating the IR35 risk for companies, contractors will have to pay more tax and National Insurance, but still keeps the same risks and additional tasks that come with contracting (find their own work, deal with clients, manage their own admin and accept insecure working arrangements).
But things can get even worse for a contractor if a company decides to pay them directly on the PAYE basis. This is an even less appealing option for contractors than an Umbrella company, as it negates any expenses or the use of ‘salary sacrifice’ to contribute ‘pre-taxed’ income to a pension.
As a result, top consultants will move on to other “outside IR35” arrangements as soon as possible, making umbrella companies and PAYE contracts only a short-term stop-gap rather than a long-term solution.
3. Consultant expert networks
An alternative to engaging expensive consultant companies as middlemen is to use expert networks. These networks seek to attract top consultants as needed. Consultants still work on a contractual or freelance basis, thereby attracting top talent, yet the platform itself helps distinguish the consultant as a contractor and not an employee.
Expert network consultants will almost undoubtedly have several clients over the course of a tax year, demonstrating that they are, indeed, a consultant. And since most are paid on an hourly basis, they are even more clearly demarcated as a consultant rather than an employee.
As new technology has matured, expert networks are transforming into platforms, such as Consulthon, where companies can directly review and engage with consultants, improving results while remaining IR35 compliant. Companies can post their challenge on a consultancy platform, review responses from experienced consultants, and choose the expert advice that they feel works best.
If they need more information, they can liaise directly with the consultant over the phone or even in person, for a predictable hourly fee.
The only downside of this approach is that the company must take full responsibility for choosing the approach and implementing the solution. They are essentially paying for advice rather than hands-on work. While this helps demonstrate that the consultant is not, in fact, an employee, companies must have the in-house skills to implement the solution.
Consultants are an important and incredibly useful resource for many companies, especially young businesses with specific growth challenges. Tapping into an expert resource with potentially decades of experience saves time, money and resource in the long-run while helping to overcome specific, short-term challenges.
While IR35 does threaten the affordability and sustainability of using consultants, it by no means spells the death of contractual work. Consultants can still be used on a contractual basis but companies will need to be more considered about which route they take, whether it be using an agency, engaging via an umbrella company, or tapping into skills and expertise through a consultancy platform.
ABOUT THE AUTHOR
Mirel Baila is co-founder of Consulthon, a UK Management Consulting Expert Network.