IR35 — what should the private sector do to prepare?

This article, now updated since it first appeared in late 2019, explains what the issue is all about and what businesses should do (if they haven't already) to prepare.

Background

If it looks like a duck, and quacks like a duck, we have at least to consider the possibility that we have a small aquatic bird of the family Anatidae on our hands.

Chances are though, when Hitch-hiker’s Guide to the Galaxy author Douglas Adams wrote that line in his 1987 novel Dirk Gently's Holistic Detective Agency, he wasn’t thinking about changes to IR35.

But his words seem oddly fitting for employers now working out if a particular contracting relationship will likely fall foul of soon-to-be extended legislation.

We were originally expecting the changes to come into force in April 2020. Then along came coronavirus.

They'll instead come in next month.

IR35 explained: current position

What exactly is IR35 and what should businesses be doing, or have done, to get ready?

IR35 is designed to assess whether someone is genuinely a contractor rather than a so-called disguised employee, for the purposes of paying tax.

Contractors supplying services to a client — the end user — working through an intermediary such as a limited company (the personal service company, or PSC) enjoy a level of tax efficiency.

While they don’t get employee benefits such as holiday and sick pay, they have flexibility and control over their work. And the end user doesn’t have to pay employer’s National Insurance Contributions, which can mean a significant tax saving on payroll costs.

The function of IR35 is to ask: if the contract was between the individual and the end user, would they be classed as an employee? If the answer is yes, this is referred to as disguised employment.

Genuinely self-employed contractors are deemed to be outside IR35, but if someone is inside the legislation, HMRC expects to receive the same tax and NI contributions as if the relationship was employer, employee.

The changes

In April 2017, the government amended IR35 legislation so public sector organisations employing contractors were responsible for deciding whether they were inside or outside of IR35.

The change in the public sector hasn’t been problem free.

Government tools, especially an online Check Your Employment Status Tool (CEST), developed to help end users determine IR35 status, have been criticised. HMRC itself believes it is only accurate in around 85% of cases. The problem with this is that the tool will confirm that a duck is a duck in a situation where this is already obvious.

Users need the tool to work when it is not immediately clear what form the creature takes, and this is where it falls down. However, it is currently being reformed.

And, now in April 2021, the private sector will follow suit.

In the 2018 budget, it was announced that the rules will be extended to medium and large-sized private sector organisations. The simplified test defines this as a business that has an annual turnover of more than £10.2 million.

The simplified test cannot be used by a company, a limited liability partnership, an unregistered company or an overseas company. In those cases, as well as the turnover limit, there are the additional conditions of having a balance sheet total of more than £5.1million and more than 50 employees. If two of these apply, the business is captured by the new regime.

This will mean that in most cases the end user — the employer — will have to determine IR35 status and will have to deduct the tax and NICs. They’ll need to exercise “reasonable care” when determining the IR35 position of any contractors engaged via PSCs.

A Scottish recruitment consultancy Be-IT survey found that only a quarter of those surveyed would be happy to remain as a contractor after the rule change, and almost half of employers believe this will lead to contractors looking for fixed-term engagement.

Indeed, given the penalties for making an incorrect employment status determination, some organisations may opt to make blanket ‘inside IR35’ decisions.

For example, it’s been reported Barclays will shift its entire contractor base to the Pay As You Earn (PAYE) system and no longer use off-payroll working.

Employment factors

Important factors which may support an employment, rather than a contracting, relationship include —

• Regular, fixed payments

• The end user supplying equipment the individual uses for work

• The individual being the only person carrying out work, or allowed to carry out the work

• Lack of investment or financial risk being assumed by the individual

• A significant degree of control for the end user

• The individual not working for any other clients

• The individual not being entitled to pick and choose which instructions to accept

This list isn’t exhaustive, and other factors may also be relevant in determining status.

Another way of looking at this brings us back to our feathered friend. Put simply, if someone’s role looks like that of an employee, and they operate like an employee, chances are they’d be seen as an employee under the updated legislation.

Once the determination’s made, the end user must inform the worker, agency, or other organisation it contracts.

What else should employers do to prepare?

They also need to look at contracts with intermediaries.

When drafting them, consider including a right of substitution, subjecting the intermediary to as little control as possible, and requiring the intermediary to provide his or her own equipment. Other mechanisms may also be appropriate and it’s important the contract reflects the reality of the business relationship.

Always remember that a paper trail is not enough. The contract must reflect how the relationship works in practice.

Businesses should also conduct a full review or audit of all staff and contractors currently working within the business to identify if IR35 applies.

A review of costs, in particular employer’s NICs, may reveal that it is no longer economically viable to have as many contractors or consultants working under the new rules.

Finally, businesses should be ready to implement new recruitment procedures: job adverts should make it clear whether the role is for a contracted period of work conducted by a self-employed individual or whether it is intended as a more permanent, internal role.

What next?

With only a short while until the legislation is extended, how will it impact the self-employed workforce, and how enthusiastically will employers engage with contractors in the future?

Time will tell, but for the moment, the best advice for businesses is to take steps now.