IR35 full steam ahead despite review - we answer the practical questions

Broadly speaking, IR35 applies where a contractor provides services to an end user via a personal services company or other intermediary (PSC) but, if the contractor was engaged directly, they would be an employee for tax purposes.

Currently, the contractor is supposed to operate PAYE and deduct NICs if IR35 applies. For any payments made on or after 6 April 2020 that is changing and, instead, the end user will be responsible for assessing if IR35 applies and operating PAYE and NICs (including paying employer NICs and the apprenticeship levy) where it does.

For more detail about the IR35 reforms, download our Inbrief.

The Government has now launched a review into the IR35 reforms.  Unfortunately, however, there is no indication in the review that the IR35 reform will be delayed. Instead, the review will focus on the smooth implementation of the rules, including looking again at HMRC’s Check Employment Status Tool (CEST) which was re-launched in November 2019. With a little under 3 months to go before the changes take effect and the results of the review unlikely to be available before mid-February, businesses continue to prepare for the changes.  

Implementing the IR35 changes is proving to be challenging for end users, agencies and contractors. Here are some of the common questions end users are asking us about the IR35 reforms, and our views on the current answers:

1. What must we do if we carry on using PSCs?

End users need to have solutions in place for the following:

(a) Status determination (assessing whether the contractor would be an employee for tax purposes if hired directly) and confirming the determination and the reasons for it in a status determination statement.

(b) Dispute resolution – i.e. a process for contractors/agencies to dispute the status determination.

(c) Template contracts with PSCs and agencies (see below for more information).

(d) Payroll – this needs to be set up to operate both PAYE and NICs and also VAT for contractors in scope of IR35 but without automatically including those contractors in other processes, for example, gender pay gap reporting. The payroll process also needs to align with the payment terms in the contract with the PSC. If using a UK agency, however, the payroll process will generally become the agency’s responsibility.

(e) Migrating existing contractors onto new arrangements if appropriate (if the contractor population is significant, this may need the same level of planning as a re-organisation).

2. What changes do we need to make to contracts with PSCs or agencies?

End users should make sure their contracts are IR35 compliant including for example the right to operate PAYE and NICs into contracts with PSCs. Template contracts should also include clear and robust tax indemnities.

In some cases, it may be possible to adjust working practices to take contractors out of scope of IR35 altogether. Any such adjustments need to be reflected in the contract, although changing the contract wording alone is not sufficient – the practice needs to change too. When considering adjustments, we recommend looking at the questions asked by HMRC’s CEST tool (Check Employment Status for Tax tool) as they show the main issues that HMRC are concerned about when assessing employment status for tax purposes.

Contracts with agencies/intermediaries should set out some ground rules. Will the agency be precluded from supplying individuals via PSCs, or will it just have to notify the end user in advance if it does so?  Can it pass the full cost of operating PAYE/NICs (and the apprenticeship levy where applicable) back to the end user?

Information-sharing with agencies is also important. Agencies may need to supply information to help the end user with the status determination statement, and will need to pass the statement on to the entity with which they are contracting.

3. Should we use CEST?

The HMRC CEST tool is an online tool for assessing if a contractor would be an employee for tax purposes if hired directly.  CEST was revised in November, and is now a more sophisticated and helpful solution for checking if IR35 applies. However, it still has flaws. In particular, it still fails to test whether there is sufficient “mutuality of obligation” in the relationship between end user and contractor, even though “mutuality of obligation” between parties is one of the necessary conditions of employment.  In its review the Government has indicated that it will re-look at CEST.

End users do not need to use CEST, and there are plenty of tools on the market offering alternative solutions. However, the overriding advantage of CEST is that, as long as the information is entered correctly and kept up-to-date, HMRC is bound by the result. We think CEST should be the starting point in the majority of cases.

4. What if CEST returns no result?

CEST currently produces no result in around 15% of cases, yet end users still have the responsibility to make the determination even when CEST produces no answer. End users who have decided to use CEST will therefore still need a way to make a status determination in the situations in which CEST produces no result.

There are various tools on the market to help. In our experience, end users need to decide who is going to make the assessment, not just how. Will HR have the final say? Will they have any additional training? The process needs to be robust enough to withstand pushback from individual managers or contractors.

5. What should the status determination statement look like?

The status determination statement must confirm whether the contractor is within or outside IR35 and should set out the reasons for the determination.  It should be sufficiently detailed to show that the end user has taken reasonable care in making the determination. Using CEST offers the advantage that it produces a print-out which can be used as the basis of the status determination statement.

6. Do we have to assess individual contractors? Can’t we assess general role types instead?

End users with significant contractor populations make the reasonable point that they could speed up onboarding and reduce friction if they were able to assess general role types as in or out of scope of IR35 in advance of hiring any particular contractor.

However, as stated above, the legal obligation is to take reasonable care over each status determination statement and the only compliant approach is to carry out an individualised assessment in every case. In addition, the CEST tool asks questions about the individual contractor (for example whether they’ve had a previous contract with the end user and whether the contract will absorb all their working time) and cannot be used on a wholly contractor-blind basis.

A middle ground option is to make a provisional IR35 assessment for each role, which at least means that assignments can be positioned and advertised as “on an IR35 basis” or not. However, we would still advise that an individual assessment is carried out once a contractor has been identified, particularly if the status determination statement anticipates attaching a print out of the CEST determination.

7. What should the dispute resolution process look like?

End users have to provide contractors (and agencies where applicable) with a process for challenging the status determination statement. There is currently little guidance from HMRC about this. In our view, it’s best to have a simple process and avoid designing something akin to a grievance procedure involving in-person hearings and an extra right of appeal. End users need to decide who should respond to any challenge. It could be the person who made the original assessment, but there is a risk mitigation argument in favour of having another manager.

8. Will contractors shop around for work which is not considered in-scope of IR35?

We think it’s too soon to say, but it is certainly possible. Contractors are concerned about the cost and cashflow impact on them if IR35 applies. Some may be able to negotiate a new “grossed up” arrangement, but this is unlikely to be the norm. They are also worried about how this affects their tax affairs for previous years if they have been operating on the basis that they are outside IR35. HMRC has said that, in the absence of fraud, it won’t automatically investigate the past affairs of contractors who are now assessed as in scope of IR35, which is of some comfort but stops short of being a guarantee.

9. What are the implications of the contractor’s status determination for employment rights?

A contractor’s tax status is not determinative of their employment rights, and IR35 does not change a contractor’s status for employment rights purposes. However, the reality is that contractors will have less to lose by trying to claim employment rights if they are already in scope of the PAYE/NICs regime, and some may ask to be migrated onto employment contracts. The existence of a PSC still mitigates the risk of a claim for employment rights, but we can expect more confusion and potentially more Employment Tribunal litigation in this area.

10. What are the other non-employment options for sourcing talent?

Some end users are looking at requiring any contractor using a PSC to go through an agency. This is a good solution for the various payroll challenges associated with IR35 but (a) the end user remains responsible for the status determination statement and dispute resolution process and (b) the agency will inevitably seek to pass the increased cost of operating PAYE and NICs (and the apprenticeship levy where relevant) back to the end user as well as charging its own mark-up.

For those reasons, other end users are considering requiring that contractors go through an agency or other intermediary but do not use their PSC. Instead, they are hired directly by the agency or via an accredited and tax compliant umbrella company. This mitigates the risk of employment rights and also takes the contractors out of scope of IR35.

Another route, which avoids any intermediary, is for the end user to hire the contractor directly as a self-employed contractor or possibly as a “non-employed worker”. (“Workers” are individuals who have contracted to provide work or services personally to someone who is not their client or customer. The category encompasses both employees and those who do not meet the tests for employment but not the genuinely self-employed.) With no PSC in the mix, the IR35 requirements are not triggered, but the risk of claims for employment rights increases (and consideration of whether the individual should be taxed as an employee still needs to be made).

There’s no doubt that implementing the proposed IR35 changes will be a demanding project for everyone involved. In this article, we’ve tried to set out what, in our view, would normally be a sensible approach. But please do remember that circumstances will vary enormously and the right action to take will be very dependent on the specific situation and context. We’d be delighted to give advice specifically tailored to your situation, so please do get in touch.