What is IR35?
The ‘IR35’ reforms have
been the subject of much recent debate, but you may not be clear on what the
changes are, how they will impact you and what you should be doing about it.
IR35 refers to tax
legislation designed to tackle tax avoidance relating to those in ‘disguised
employment’. This refers to individuals who are working ‘off-payroll’, engaged
as a contractor or consultant via a personal service company (PSC) who are performing
services for a third party, but are actually working in a way more akin to that
of an employee.
The reforms will take
effect on 6 April 2020 and will bring the tax treatment of such contractors or
consultants in the private sector into line with those in the public sector.
The changes will also increase business’ income tax and National Insurance
liability for self-employed contractors who fall within the scope of IR35 up to
the same level as if they were an employee.
confirmed a review of the incoming IR35 measures in January 2020. This month the
House of Lords has also launched a concurrent inquiry into the impact of the IR35
rules on the public sector and its extension into the private sector. However,
there is currently no plan to postpone implementation date of 6 April 2020,
despite calls from a number of large businesses and recruitment firms. Businesses
such as IBM, HSBC and Barclays have even announced a complete ban on hiring
independent contractors due to IR35. For the moment, the Government will simply
be looking at ensuring that the implementation of the changes runs as ‘smoothly’
as possible. In particular, the Government will be re-evaluating HMRC’s online ‘check
employment status for tax’ (CEST) tool which has received some criticism (more
on that below). Already, as a result of the review, the Government have
announced that the new rules will only apply to payments made to contractors
for services provided on or after 6
April 2020 and therefore will not
apply to services undertaken by contractors in March, which may then be paid for
review is due to conclude in February which does not leave much time for those
businesses which engage contractors through PSCs to meet their new legislative
obligations. However, there are some
practical steps that can be taken in anticipation.
What to do now
Identify and log current engagements with contractors:
will involve considering:
- How many contractors are being engaged via PSCs?
- On what terms are the PSCs being engaged and are there written agreements setting out express terms? For example: what are the contractor’s responsibilities, who decides what work needs doing by the contractor, who decides when, where, and how the work is done, how is the contractor paid and what (if any) benefits the contractor receives?
- What are the contracting chains between the business receiving the services and the individual contractor? For example, are there contractors who are engaged via agencies, whereby the business receiving the services pays the agency who then pays the individual contractor via their PSC? The party responsible to pay any increased tax liability and operate PAYE (which I will refer to as the “end-user”) will vary depending on the contractual chain.
Engage with the contractor workforce:
- Consider whether a process should be carried out to explain to contractors what the IR35 reforms are, what they mean for the end-user, how it may impact the contractors and how the end-user is going to make the status determinations.
- Identify and request information from contractors that the end-user will need in order to determine status which may not be already known. For example, whether the contractor is undertaking work for other organisations or are they exclusively providing services to one?
- By taking a more collaborative approach and keeping contractors informed, the end-user may be able to minimise any dissatisfaction and maintain the working relationship in the event that IR35 is determined to apply.
Set up processes to undertake status determinations:
- Consider what process will be used to determine whether IR35 applies; for example whether decisions can be made internally or whether external support and advice will be required. This will depend on the size of the organisation, what industry the end-user is in and how many contractors are engaged.
- It might be simpler to start from an assumption that all contractors are either caught or not caught by IR35 if there are a considerable number of contractors engaged in the relevant way who work on similar or standard terms. The end-user can then turn to look at the individual facts where there are distinguishable features.
- HMRC’s CEST tool can assist, but it does not take into account a number of factors, such as mutuality of obligation or its extent, patterns of work or the extent to which an individual is doing other work for other clients, which are all relevant factors to determine status. The CEST tool cannot therefore be relied upon exclusively as it will not accurately analyse all relevant factors and case law. It is currently being reviewed, but can be used as useful starting point.
- Decide who will make the determinations i.e. will HR be determining status, or a perhaps a procurement or commercial team? Will it be useful to consult with contractors or contractor representatives?
- Consider implementing an appeal process in the event that a contractor disputes the status determination so that a more senior decision maker can be involved.
- Gather and retain a paper trail of the evidence used to reach the IR35 decisions on status, especially where the determination is that IR35 does not apply and the contractor will remain engaged with no changes. End-users will need to evidence the decision on the applicability of IR35 and be able to support the conclusion. Organisations should also seek relevant evidence from the contractor themselves to show reasonable care has been taken in reaching the conclusion. For example, where a right of substitution exists which is a factor demonstrating genuine self-employed status (rather than working as a disguised employee), the business should be able to demonstrate what evidence supports the right of substitution and that it can show that the right is genuine and not contrived.
Complete status determination statements and consider any changes to make:
- If the end-user of the contractors’ services determines that IR35 does apply, it may wish to take the individuals on as employees and opt not use intermediaries at all. In altering their status, there is the resulting requirement to give the individuals employment rights including holiday pay and pension contributions. This is likely to increase staffing costs and may reduce net pay for the former individual contractors, however it provides greater certainty for the contractors and potentially a greater level of end-user control over the work.
- Payroll systems should be reviewed to ensure that they can cope with making any deemed employment payments.
- End-users may wish to amend the terms on which PSCs are engaged, such as placing all contractors on standard terms so that determinations become easier. However, there is always the need to consider individual circumstances and the genuine reality which exists, rather than relying on a written contract to cloak the reality and evade the legislation.
- End-users may wish to outsource particular functions so that the contracting chain changes and the tax liability shifts.
- Alternatively, another intermediary could be inserted into the contracting chain such as an agency to move the obligations to operate PAYE to another party.
As there is no one test or clear set of criteria to determine whether IR35 applies, the application of it will continue to develop with case law. Additionally, liability will vary depending on the contractual chain that a contractor is engaged through. The status determinations under IR35 closely mirror the legal tests for determining employee status which already have an established body of case law behind them and can be used to a greater extent as comparable guidance. Taking legal advice will therefore assist in navigating the new rules.
The contents of this article are intended as guidance for readers. It can be no substitute for specific advice. Consequently we cannot accept responsibility for this information, errors or matters affected by subsequent changes in the law, or the content of any website referred to in this article. © Mundays LLP