Demystifying IR35

The phrase IR35 has been around for some time now. It is shrouded in mystique and complicated by many years of changes designed to help HMRC collect tax that is rightly owed to them. 

The aim of this article is to demystify IR35 so that companies can navigate through this process and ensure they stay on the right side of the HMRC. 

What is IR35?

IR35 relates to ‘Intermediaries Legislation’ brought in by the then Chancellor of the Exchequer, Gordon Brown as part of his 1999 Budget. IR35 is actually the 35th Inland Revenue news release of that budget ‘Countering Avoidance in the Provision of Personal Services’ which was released on the same day as the Chancellor's Budget. So IR35 is just a reference to the Inland Revenue 35th press release, although it has now been generally used to refer to the ‘Intermediaries Legislation’ it refers to. More recently IR35 has been referred to as ‘off-payroll working rules’. So, if you see the term IR35 or off-payroll they both relate to ‘Countering Avoidance in the Provision of Personal Services’. Throughout this document IR35 will be used for simplicity.

The HMRC were concerned that individuals and companies were avoiding paying their correct tax by utilising limited company status for contractors. The phrase contractor is generally recognised as meaning an individual that is doing work for a company but is not employed by them. If the status is correct, then the contractor can use their limited company to offset costs and benefit from lower PAYE & National Insurance by paying themselves through dividends. At the same time, the company using their services will simply pay an invoice based on an agreed hourly rate and therefore avoid paying PAYE & National Insurance contributions. The benefits to a company of employing a contractor extend to them having less employee rights and an ability to turn this cost off if necessary. 

The HMRC do not have an issue with contractors as such. They have an issue with contractors who are essentially employees of the company benefiting from lower PAYE & National Insurance through invoicing from a limited company.

The line between a contractor and an employee can be noticeably clear but it can also be vague. For example, an individual carrying out a specific task for multiple companies where they bring a specific skillset or service offering (e.g., a skilled trade person) is very clearly a contractor. However, the same trades person working for one company on a full-time basis, receiving the same benefits as a co-worker who is an employee and working to the same rules is clearly an employee. Therefore, not contributing to the HMRC employee or employer PAYE & National Insurance. 

HMRC are not there to police employee rights which may be diminished by this situation. Their interest is that the correct employer and employee PAYE & National Insurance payments are made. If the employer is meeting their employer PAYE & National Insurance commitments and the employee through their limited company are meeting their tax commitments, the HMRC will be satisfied. IR35 legislation is designed to collect underpaid PAYE & National Insurance from both the company and the contractor if HMRC determine that the individual acting as a contractor is actually an employee. This determination will be made by the HMRC irrespective of any cleverly written contracts the company or individual may have.

When will the changes come into effect?

The changes to IR 35 legislation came into place for the public sector on the 6th of April 2017. They were due to come into force on the 6th of April 2020 but due to the COVID-19 outbreak the government felt it prudent to delay its implementation for one year. There was some speculation that this delay may become a cancellation. However, the government is committed to implementing this legislation, and the cost of the COVID-19 pandemic has further increased the need for the government to collect lost taxes. This legislation therefore came into force for projects that started after the April 6^th implementation date.

Who will be affected by these changes?

Any company who is paying workers through an intermediary (i.e., limited company) and any individual who is invoicing a company through an intermediary, will be directly affected by the changes to this legislation. The changes have already taken place in the public sector, giving HMRC a good understanding of how to implement them with case studies already available to illustrate the significant costs that can be incurred by getting this wrong.

The emphasis of this new legislation has shifted from HMRC having to chase every contractor to collect unpaid PAYE and National Insurance over to the ability to collect shortfalls from the companies hiring these individuals. How many contractors they hire and how these contractors pay their PAYE and National Insurance contributions will determine the size of the debt owed.

Inside IR35 and Outside IR35 are commonly used terms to illustrate the difference between a contractor who is acting as an employee and a contractor who is legitimately not an employee. Inside IR35 refers to a contractor who is acting as an employee and therefore both the company and the contractor should be paying HMRC PAYE & National Insurance contributions in line with all other employees. Outside IR35 refers to a contractor who is legitimately not working as an employee and therefore can invoice the company and pay their tax through non-employee (PAYE) rules.

A contract for the purpose of IR35 can be written, verbal or implied between the company and the contractor. The IR35 working rules apply on a contract-by-contract basis. A contractor may have some contracts that fall within IR35 and some that fall outside IR35.

Companies in the bracket of small, are not responsible for taking the employed/self-employed decision. They do not have to pass any information to any other party in the chain.

Therefore, the emphasis of this legislation is aimed at medium to large size private sector companies and all public sector companies.

As a guide to establishing whether a company is small medium or large, the Institute of Chartered Accountants (ICAWE) recommend that if the client’s company is a commercial company and currently needs an audit it will fall into the Medium to Large category. If it does not need an audit, it will be a small company. There is, somewhat surprisingly, no legal requirement for a private sector client to pass on any information specifying its size to any other party involved. While size may be obvious, this cannot be presumed and it would seem sensible in practice for a client or their advisor to ask for a size statement along with the contract, so that everyone in the chain, particularly the worker, knows whether the contract is operating under medium to large company rules, or the small company rules, and so who is responsible for what.  

How do you know if the contractor is Inside or Outside IR35?

There have been several ways to determine if a contractor is Inside or Outside IR35, with the emphasis on how much control the company has over them. Over the years third-party companies have established businesses based on writing contracts to avoid the payment of PAYE & National Insurance through various clauses to meet HMRC requirements. This new legislation is designed to overcome these loopholes irrespective of what the contract says. HMRC will make their determination by what is happening not by what someone says is happening.

This still leaves a massive amount of uncertainty around who is Inside or Outside IR35. 

Medium to large sized organisations need to decide whether a specific contract implies employment or self-employment tax status. Having decided this, they should issue a status determination statement (SDS) accordingly. The SDS is a new and important document informing all those involved whether payments for the work will need to be made with the deduction of PAYE and National Insurance. HMRC have created a check employment status for tax (CEST) tool to make the determination. However, there is some concern that the HMRC tool will find the majority of contracts as employed status meaning that PAYE & National Insurance should be deducted. 

HMRC have put an emphasis on the ‘Fee Payer’ being responsible for ensuring that the PAYE and National Insurance Deductions are taken. The ‘Fee Payer’ is usually the party paying the contractor. However, there are rules stipulating certain conditions a fee payer must meet so it is important that you understand if the person paying the contractor meets these conditions. If no other party in the supply chain meets the conditions, the client becomes responsible. As the client you are obliged to pass on the details of the statement of determination to the fee payer so that they can take the appropriate action. The fee payer will report the National Insurance and PAYE contributions deducted directly to HMRC. The fee payer or the contractor can challenge a status determination if they think it is wrong. The company who made the determination will need to have a process in place for dealing with disagreements about determinations they make. 

Fear of getting this wrong with the financial costs from fines and the repetitional costs from high profile court cases involved, have meant that some organisations (banks etc) have taken the decision that all contractors are to be treated as Inside IR35. Proving that they are paying their PAYE & National Insurance correctly. Whilst on the face of it this may seem a logical and safe reaction, the implications here are that these companies will be paying unnecessary PAYE & National Insurance, but also that the best contractors will choose to work for another company who will correctly define them as working Outside IR35.  Therefore, it is in every company’s best interest to make a clear and honest judgement of each assignment to ensure they are doing right by their company and attracting the best talent on the market.

The payment of PAYE & National Insurance will usually fall to the third-party agency, however, if you employ the contractor directly then it will also be your responsibility to deduct and remit these to HMRC. It is currently proposed that if any other party in the contractual chain fails to account for PAYE & National Insurance the liability will be the clients as end-user. Therefore, it is within everybody’s interest that these decisions are made carefully and honestly.

What has been the impact of IR35 in the Public Sector?

There have been some very high-profile cases illustrating the cost of getting this wrong. Here are two examples, one where the contractor has been fined and the other the employing company: 

BBC

TV journalist, Christa Ackroyd, the BBC offered Ms Ackroyd a contract in 2001 to present the BBC’s equivalent programme, Look North. The IR35 enquiry into Christa Ackroyd Media (CAM) Ltd. regarding its engagements with the BBC began in 2011 and resulted in a Tribunal Hearing, which was heard in September 2017. CAM Ltd. appealed HMRC’s decision that the company was caught by the IR35 legislation, more specifically that Ms Ackroyd was a disguised employee. Whilst it is known that the total liability for tax and NIC purposes in relation to CAM Ltd.’s engagement with the BBC is more than £400k, the actual amount that CAM Ltd. will have to repay is unknown and may have to be addressed at a future tribunal hearing.

It was the BBC who sought that Ms Ackroyd set up her own limited company and when questioned by HMRC regarding Ms Ackroyd’s employment status, the BBC terminated her contract and consequently avoided any employment obligations concerning Ms Ackroyd, coming away completely unscathed.

NHS

The NHS has been hit with a £4.3million tax bill after HMRC decided it had set its contractors’ IR35 status incorrectly, even though the organisation used the taxman’s very own IR35 tool, CEST, when doing so. NHS Digital announced in its Annual Report and Accounts that despite having used “the toolkit supplied by HMRC” to determine IR35, the tax office is under the impression contractors engaged between 1st April 2017 and 31st December 2018 had their tax status assessed inaccurately. As a result, HMRC is demanding millions in unpaid tax, interest, and penalties from the National Healthcare Service. NHS Digital explained in its published accounts that it “undertook a considered assessment of the status for each individual contractor which we believed met the HMRC requirements.” Despite conducting case-by-case IR35 determinations, the numerous flaws, and inaccuracies of CEST - which NHS Digital used to assess status - meant that these contractors, in the eyes of HMRC, were wrongly placed Outside IR35. 

Above all else, this should serve as a reminder to businesses that to rely on CEST poses a considerable risk, even if they are assessing the status of each contractor individually.

What do I need to do to comply with IR35 changes?

By working closely with your contractors and supply chain you will be able to transcend from old to new requirements less painfully. Part of this process will be to look internally at your organisation, how you engage with contractors, who handles this process and their understanding (if any) of the implications of the change. You will also need to look at your contractors and supply chain to establish their understanding and compliance with the new legislation. It may be necessary to make changes to your current supply chain to ensure that you have faith in its compliance. There will be companies and fee payers who either fly close to or disregard the rules. Irrespective of the fact that the fee payer is liable, it is likely that the end client will be heavily implicated in any failures to meet the legislation.

Internally it will be important in large organisations that some level of control is implemented to ensure that the legislation is met. The employment of contractors can be an amazingly fast process and can be for very short periods of time. This urgency in the front line of the company could encourage rules to be bent, which of course could lead to disastrous consequences. If the company can create a policy for hiring managers to follow that is simple clear and does not slow the process down, then compliance should be relatively simple. Also, companies need to audit their supply chain so that they can create a preferred supplier listing that they trust to maintain compliance and assist them in helping their hiring managers to do so.

In addition to this companies need to:

1. Look at the current workforce (including those engaging through agencies and other intermediaries) to identify those individuals who are supplying their services through personal service companies (contractors).
2. Determine if the IR35 off-payroll rules apply for any contracts that will extend beyond April 2021. You can use HMRC‘s check employment status for tax service to do this although there are other systems available that could be more advantageous and guarantee compliance.
3. Start talking to your contractors about whether the IR35 off-payroll rules apply to their role.
4. Put processes in place to determine if the IR35 off-payroll rules apply to future engagements. These might include who in your organisation should make a determination and how payments will be made to contractors within the IR35 rules. 
5. It is also important to put regular checks into place as an assignment may change status as it matures. Without this check in place, you could be caught with a contractor who started their contract Inside IR35 and ended it Outside IR35 as they became more integrated with the team.
6. Ensure that contractors are re-checked for each time they take on a new assignment, even if it appears a seamless change.
7. Implement a robust, manageable process to ensure that Hiring Managers go through the correct process.
8. Determine whether you want a separate cost centre for these workers and set one up ifrequired.
9. Update your new starter checklist to include completion of the IR35 questionnaire.
10. You will need to keep a record of the IR35 questionnaire results for everyone.
11. You may also need to complete the IR35 questionnaire again for the same individual if the terms under which they are engaged change.
12. You will need to ensure that individuals have access to all necessary employee documents.
13. Ensure record keeping is robust in case you are subject to an HMRC audit.
14. Upskill and train HR professionals on the legislative changes, so they can accurately assess the status of contractors.
15. Line managers may also require training.
16. Determine and process appropriate NI and tax deductions for each worker that has been deemed to be an employee.
17. Produce payslips for each worker that is deemed to be an employee.
18. Issue P45’s and P60’s for workers deemed to be an employee, as appropriate.
19. You may need to increase your subscription for HR and payroll software, licences, and services if you will be processing a higher volume of individuals as employees.
20. Holiday, sickness absence, parental leave and employer taxes for workers deemed to be employees will be due.

ACS insurance backed IR35 compliance system gives an average of 91% Outside IR35 determinations

In partnership with IR35 specialists, Qdos, ACS can help ensure your compliance with the IR35 rules.

The Status Review service provides expert assessment of your contractors’ IR35 status, backed by comprehensive insurance cover – providing you with expert defence in the event of compliance activity from HMRC.

Qdos specialise in insurance and compliance services for UK-based contractors, freelancers, and consultants, as well as the companies which engage their services.

Qdos are the UK’s leading independent IR35 experts, working with over 2,000 businesses to manage the off-payroll rules. With over two decades of experience defending contractors against IR35 enquiries and determining the IR35 status of over 150,000 contract engagements – Qdos provide the most trusted opinion on IR35 status.

Working hand in hand with your organisation ACS can pass each engagement through the Qdos system where an experienced consultant will establish the contractor’s status as either Inside or Outside IR35, and following your approval, issue the status determination statement as required by the off-payroll rules.

Qdos includes the whole supply chain in its process, reducing the administrative burden on your business at the same time as improving communication with contractors, whilst ensuring you comply with your obligations under the new rules.

In addition to all this Qdos provide a determination in 100% of assessments vs 80% provided by the government Check Employment Status (CEST) tool, with 91% of status determinations resulting in an Outside IR35 result (based on assessments completed between Feb 2017 and Apr 2020).

In partnership with Qdos we will carry out six monthly assessments to make sure you are maintaining your compliance throughout the engagement.The other benefit of this is that it builds an audit trail – If questions are asked, HMRC may investigate companies that do not have an audit trail or rigorous process first. By ensuring a rigorous process with evidence of your due diligence, you will dramatically reduce your risk of an investigation escalating.

Each Outside IR35 determination is backed by comprehensive insurance provided as a benefit of the assessments.

This process ensures that your contractors receive a fair and compliant assessment of their status and you can easily manage your obligations under the off-payroll rules whilst mitigating your liability risk and reducing the inherent burdens on your business.

Note:

All of the information in this document is for guidance only and is not designed to represent facts or be your only point of reference. ACS are very happy to discuss this further with you and introduce you to Qdos who after all are the experts in this field.