What should businesses do about IR35?

What should businesses do about IR35?

 

Rock and a hard place

 

Up and down the country, medium and large businesses are scratching their heads and wondering what to do about IR35, otherwise known as the off-payroll working rules.

Unless there is a change of heart from the government – not implausible now that Boris Johnson and Sajid Javid are prime minister and chancellor of the exchequer respectively – hiring organisations in the private sector will for the first time have to wrestle with this complex legislation and make difficult status determinations that could dramatically affect their businesses.

The rules, which come into effect from April 2020, require hiring organisations and end clients to decide whether IR35 should apply to each of their engagements with self-employed contractors. If they decide the engagement within IR35, PAYE tax and National Insurance will have to be deducted at source from payments made to the contractor.

The responsibility for deducting these sums will fall to the fee payer, which might be the client or it might be an agency in the supply chain. However, if the client is a small business (two of: less than £10.2m turnover; £5.1m balance sheet or 50 employees), they are not affected and the contractor remains liable for all IR35 compliance. 

 

Just the beginning

 

So far, so complicated. But that is just the beginning of the complexity. The real difficulty lies in working out whether IR35 should apply.

This will require you to consider murky aspects of case law such as ‘mutuality of obligation’ and ‘personal service’. You will also have to understand whether the contractor is ‘in business on their own account’. For that, you will need to know about the contractor’s other engagements: information the contractor may not want to share.

Faced with such technical and convoluted requirements, companies might be tempted simply to say that IR35 applies to all engagements, regardless of the working practices. The legislation forbids it, but no one expects HMRC to be anything other than entirely content with such an outcome. Companies who take the blanket ‘everyone’s inside IR35’ approach, however, should be aware of the risks. These range from serious commercial problems to never-ending internal disputes. 

Contractors have been dealing with IR35 for the past 20 years. Many of them have a good understanding of it and frequently take steps to ensure they are compliant. If their client tells them in April that IR35 applies, they will not take it lying down. Many of them will terminate their contracts with immediate effect, leaving crucial projects undelivered. This is not just because they do not want to have tax deducted at source: they also fear a retrospective investigation from HMRC. That is because if they are prepared to accept IR35 applies from April, HMRC will almost certainly want to know why it did not apply before that, when it was the contractor’s responsibility.

Some contractors will stay, but are likely to demand an increase in their day rate to make up for the additional tax burden. There will also be an employer’ National Insurance liability that will have to be met by someone, and the obvious candidate is the client who, according to the IR35 tests, will then be acting as an employer. That is a 13.8% increase in costs for every contractor engagement deemed inside IR35.

Then there are the arguments that will inevitably ensue after an ‘inside’ determination. The new draft legislation makes provision for a ‘client-led dispute resolution service’. This means companies will have to put a process in place that would allow contractors to challenge determinations. Contractors will almost always disagree with them. IR35 is so complex and nuanced that there is always another side to the story. Companies will quickly be bound in red tape while they argue over IR35. 

 

Public sector

 

There is no need to take my word for it either. These rules have been in place in the public sector since 2017, and we have seen the impact they have had there already. From the NHS and Transport for London to the Ministry of Defence, they caused major disruption. Much of it – but by no means all – was reported in the press. In early 2018, IPSE conducted joint research with the Chartered Institute of Personnel Development into the effects of IR35 in the public sector. The results were concerning:

  • 51% of public sector hiring managers had lost skilled contractors as a direct result of the changes to IR35;
  • 52% of hiring managers said they had witnessed cost rises, delays and even project cancellations;
  • 80% of hiring managers said they had seen a substantial increase in the workload involved in engaging and paying contractors;
  • 71% said they were now struggling to hold on to their contractors; and
  • 75% of hiring managers said it is now harder to recruit contractors.

 And last but not least, companies will have to worry about employment status claims. The government insists IR35 is exclusively about tax and has no bearing on employment status, but it’s hard to buy into that line when the IR35 determination rests on employment status tests. This new iteration of IR35 requires that client companies analyse the employment status of their contractors. If they decide the engagement is really employment, they must ensure employment taxes are deducted, but there is no obligation to employ them. 

 

Employment status dispute

 

So people who are told they will be treated like employees by their client – and taxed as if they are employees – will receive no employment rights. That does not sit well with a lot of people in the era of Uber disputes and the Taylor Review, and it is likely to lead to people asking the legitimate question: ‘If I’m employed for tax, why I am not employed when it comes to holiday pay and pension entitlement?’

Last year a contractor at HMRC, Susan Winchester, who had been deemed ‘inside’ IR35, asked exactly that question. The dispute went to tribunal but was settled at the last minute for the full amount she was claiming. If HMRC itself has no confidence in how it applies the rules, businesses will have to tread very carefully. We can expect to see many more of these claims if and when the rules are extended to the private sector. 

 

Bleak outlook?

 

So it seems that companies are caught between a rock and a hard place: either they decide IR35 does not apply and risk having HMRC breathing down their necks, or they decide it does and have to incur increased costs, reduce their access to flexible labour – reducing the ability to innovate – and manage major internal disruption and status claims. The picture looks bleak, but corporates and mid-sized companies can minimise their risks by revising the way they use contingent labour.

If a client wants a contractor, they should hire a contractor, ensure they treat them as a contractor and determine that the engagement is firmly outside IR35. As long as the engagement is truly one for service, not of services, as the lawyers say, IR35 will not apply. The client will be 100% compliant with the rules, and able to deliver on the projects they need to have completed.

By contrast, if they want someone they can treat like an employee, they should employ them. If it sounds simple, it is because it is. The idea of hiring a contractor, then putting the engagement inside IR35 makes no commercial sense. Companies are opening themselves up to disruption, disputes and employment rights claims. Either they want an independent contractor and the flexibility this brings or they do not – the halfway house of IR35 ultimately causes problems for all parties.

Of course, what businesses really want is for this whole problem to go away entirely. While the former chancellor was intent on pushing forward with the April 2020 changes, it remains to be seen whether the new incumbent at no 11 might reconsider take a different approach. Certainly he is under pressure to reconsider from contractors, agencies, hiring organisations and trade associations such as the IPSE and the CBI. In the meantime, business must prepare, but they should be aware that when it comes to IR35, over-compliance could be just as costly as under-compliance.

 

This article was written by Mandy Clarke, Director of IPSE, the Association of Independent Professionals and the Self-Employed. Visit www.ipse.co.uk.

 

The article was originally published in Taxation, a LexisNexis company.

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About the author:

Amy is an established writer and researcher, having contributed to publications, such as The Law Society, LPM, City A.M. and Financial IT. Her role at LexisNexis UK involved leading content and thought leadership, as well as writing research reports, including "The Bellwether Report 2020, Covid-19: The next chapter" and "Are medium-sized firms the change-makers in legal?"