Old hourglass on the background of clocks - Time is running out to get your IR35 in order

There are changes to the IR35 tax regime coming into force in April 2021 which businesses must be prepared for. IR35 is a tax regime which ensures that an individual who works like an employee, but through an intermediary such as a personal service company (PSC), pays similar levels of tax to other employees.

If your business engages individuals through a contractor’s own PSC – or through an agency – then as a bare minimum you must check if the changes apply to you (see below). If they do then you should review all contractors to try and identify who might be bound by the new rules and carry out assessments. We are on hand to guide you through this process.

Off-payroll working rules (IR35) – background

HMRC’s concern is that some individuals may avoid tax by setting up a PSC as an intermediary between them and the business which they are working for (the client), in order to prevent a contractual employment relationship arising between them and the client. Rather than paying the individual a salary, the client pays a fee to the PSC. The individual then receives payment as dividends from the PSC, on which no PAYE or NICs are payable.

Since 2000, HMRC have required intermediaries to make status determinations as to whether the individual working through them are employed or self-employed for tax purposes, i.e. would they be an employee if the intermediary was not used and are therefore a “disguised” employee. This process is governed by legislation designed to combat tax avoidance referred to as IR35. If a contractor is operating “inside IR35 legislation” this means taxation as an employee.

It has been clear for a long time that this system is ineffective. Often the PSC will only have one director and shareholder, which is the individual in respect of whom the status determination is to be made. Given the choice, individuals are more likely to err on the side of saying they are self-employed to secure tax advantages. Generally speaking, individuals are also less equipped to make an informed judgment about their appropriate employment status for tax purposes. This leads to millions of pounds of lost revenue for HMRC.

Inevitably with the level of independent judgment which must be made in respect of self-determinations, this is a contentious area. There have been some recent high-profile cases on IR35. For example, in March 2019 television presenter Lorraine Kelly successfully appealed against HMRC’s decision that her PSC should account for £1.2 million in PAYE and NICs.  This was on the basis that she did not in fact, due to various factors, meet the definition of a deemed employee for tax purposes.

An assessment of whether an individual is a deemed employee for tax purposes is based on the facts of each situation. It is therefore not possible to give a definitive description of who would and would not be an employee, but HMRC do consider a range of factors to determine status. For example: Does the client provide the equipment needed for the individual to fulfil their role? Who has control over the individual’s work, and who bears the financial risk? Does the individual work for other businesses as well? In the Lorraine Kelly case, the first-tier tax tribunal decided that ITV were not employing someone in the traditional sense, but rather purchasing a product: Lorraine Kelly’s persona and brand.

Changes incoming for April 2021

In a bid to solve the problem, the government decided to shift the burden of who decides an individual’s employment status for tax purposes from the individual and the intermediary to the end-user client, i.e. the company who contracts the individual through the intermediary to undertake services for them. This has already been done in the public sector in 2017.

The changes were previously scheduled to come into force in April 2020. Due to the COVID-19 pandemic, on 17 March 2020 the government announced that the new rules would be postponed and would come into force from 6 April 2021. The government has confirmed that it “remains committed to introducing this policy to ensure that people working like employee, but through their own limited company, pay broadly the same tax as individuals who are employed directly”. 

Will the new IR35 rules apply to all businesses?

In the private sector the new rules will only apply to medium and large businesses. These are businesses which meets at least two of the following criteria for two consecutive financial years:

  • Turnover of more than £10.2 million.
  • A balance sheet total (assets) of more than £5.1 million.
  • An average of more than 50 employees.

See here for more detail on how to determine whether the above criteria are applicable.

Any business which does not meet two of these criteria would be considered a small business, and the responsibility for determining IR35 status would remain with the PSC as per the current regime above.

How to prepare for the changes

It is important that preparations are not left until April 2021. Earlier this year, HMRC confirmed that it will take a softer approach to compliance in the first year following the new changes. In short, HMRC will not “penalise business trying to get it right”. Clearly this does involve business making some degree of effort, because HMRC will penalise organisations where there is evidence of “deliberate non-compliance”.

We therefore recommend that where applicable, affected businesses do the following as soon as possible:

  1. Identify individuals engaged through a PSC (or another intermediary) and review their contract. Talk to the individuals affected about how the changes to the regime might affect them. It might also be useful to review the government guidance on how businesses can prepare for the change.
  2. Use HMRC’s CEST tool as a starting point to assess whether the engaged individual is a deemed employee for tax purposes. HMRC confirmed in its policy paper that it will stand by the results of the CEST tool if it is used in accordance with the CEST guidance. If in doubt, please speak to us or your accountant. The company must take reasonable care in making the assessment and blanket determinations should not be made, i.e. each individual’s position should be evaluated on a case-by-case basis. The CEST tool has its limitations, for example, it does not assess “mutuality of obligation” and in some cases can fail to provide any result at the end of an assessment. We can help by carrying out a more in depth, tailored review.
  3. Once the assessment has been completed, produce a “status determination statement” (SDS) to give to the individuals, agencies and PSCs affected. The results of the CEST tool can be used as part of the SDS. The SDS must include the reasons behind the decision and refer to the appeal process if they disagree with the determination.

There is no formal appeal mechanism: businesses will need to introduce their own process to consider any appeals. Businesses, however, must respond within 45 days if an individual disagrees with the SDS. If the business sticks by its original SDS, it must provide reasons for this, and if it changes its mind it must produce a new SDS.

Businesses will also need to review their PSC contracts to see if they are still fit for purpose, and whether they create the type of employment relationship which is intended. Procedures should be put in place to monitor and reassess the employment of individuals through PSCs using up to date information. Some business may conclude they would prefer to employ individuals as employees rather than continue to engage them as contractors.

Effects on off-payroll working arrangements going forward

The changes to the IR35 regime will likely increase the cost of a business of engaging an individual through a PSC because:

  1. The assessment of each individual’s employment status is likely to be a time-consuming process, increasing the client’s administrative costs.
  2. If IR35 does apply, the client would have increased staffing costs as it may have to make employer NICs for these individuals.
  3. The reduction in the individual’s pay due to PAYE and NICs may result in the individual increasing the cost charged by the PSC in order that their personal income does not drop. The same would apply to the income of an agency supplying contractors, which may likely to lead to increased charges.
  4. There is also an elephant in the room. Individuals working through PSCs may ask: if I am required to be a deemed employee for tax purposes, why am I not a full employee with the full suite of employment rights? Although similar, judging the employment status of individuals for employment law purposes is slightly different and more nuanced to deciding deemed employment status for tax purposes. If ever in doubt, please contact us for advice.

Summary of government clarifications

In February 2020 HMRC published a policy paper in respect of IR35 changes and in September 2020 further clarifications were made in the existing guidance (the Employment Status Manual). We have set out a summary of the key points as follows, and we will continue to keep this updated with any further guidance or changes in the run up to April 2021:

  • HMRC will not be penalised for inaccuracies relating to IR35 for the first 12 months unless there is evidence of deliberate non-compliance.
  • HMRC will not use any new status determinations to make historical enquiries into previous status determinations made by individuals / PSCs.
  • The new rules only apply to payments made for services provided on or after 6 April 2021.
  • Further guidance on calculated the “average 50 employees”, namely “deemed” employees for tax purposes are excluded – example are provided here.
  • Additional details were provided of businesses responsibility in relation to the issue and challenge of SDSs, see here for example. If in doubt advice should be sought on SDSs, particularly where there is a chain of intermediaries between the individual and the end-user client, as this can be complicated.