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May 2021 | Market

A new type of mortgage prisoner

Tim Hague is managing partner at Sagis

You might think that IR35 sounds like a dull detail that affects only a small number of self-employed contractors, but it’s actually a really big deal for everyone in the mortgage market.

HMRC wants the self-employed to pay similar employment taxes to those paid by company employees. The rules around limited companies have been, in some cases, used to avoid this. Contractors who receive payment into a limited company of which they are a director tend to pay corporation tax at 19% – rising to 25% in 2023 – plus capital gains tax on dividends taken in lieu of a salary, at 10% or 20% depending on annual income.

While this is legal, where a contractor has just one client for whom they work regularly they are technically able to pay less tax than a colleague doing exactly the same job who’s on the payroll.

The latter will pay income tax up to a rate of 45% plus national insurance, typically at 12%. The Treasury also banks a further 13.8% of that worker’s earnings in employers’ national insurance contributions.   

HMRC estimates that just one in 10 people in the private sector who ought to have been paying employment taxes under the rules that existed before April were actually doing it right. 

  The changes that came into effect mean that contractors’ clients now have a legal responsibility to take ‘reasonable care’ to check whether contractors they use now need to be treated the same as PAYE employees.   

It’s no longer up to the contractor to make sure they’re paying the full whack of tax; now it’s the company employing them. Companies that are regulated, and often listed, have big compliance and finance departments with which to get this right.

The impact of this recent change is going to be seismic in some cases for individuals. As a mortgage broker, you’ll already be seeing how this might play out.

Many people will now earn less and have liabilities that will create concerns about future affordability. Some homeowners may well be unable to even refinance them for the original loan amount.

For contractors, moving to on-payroll equates to an overnight circa 30% reduction in income, and they are the ones who would be hit by back tax if proven that they should have assessed a role as on-payroll previously.

Many contractors’ limited companies could now be regarded as insolvent as they receive no income but still incur accountancy, professional indemnity insurance (PII) and other costs like bank charges.

Many contractors still working as such will also have seen income levels reduce, and assessing two years’ accounts may not reflect realistic affordability going forward. Add the increasing difficulty of assessing income post-pandemic, and matters are becoming more complex, not less!

Existing mortgage repayments will feel onerous with a significant hit on income, and those unable to secure permanent jobs may incur substantial blips on their credit file, which could affect their ability to find permanent work in the financial services industry – especially if they have to voluntarily liquidate their business.

Though HMRC has said – most recently in February – that it won’t be too aggressive with billing contractors and companies for taxes unpaid under IR35 before 6 April 2021, there is a risk that the rules will be applied retrospectively.

The worst case scenario is that employers unaware that their contractors ought to have been paid under IR35 before April could be on the hook for unpaid taxes going back years. It’s blank cheque territory.

Contractors are also looking at this prospect with no way of knowing if HMRC will dig into past accounts.

So, how do you lend to those who could be affected by this?

Effectively, some of these borrowers will have a debt hanging over them which could be called in at any time by HMRC, but there’s no telling who or when this might be.

That is a risk no lender is going to want to take. And yet, there are still five million self-employed people in the UK, some of whom are going to be in this position. Many of them will already have mortgages.

There are answers and opportunities for lenders that are imaginative enough, and good advice will be crucial if these people are to avoid some very unpleasant outcomes. We should brace ourselves, as all this will undoubtedly impact turnaround times and packaging for new lending.