Is your organisation considered medium or large and uses contractors? Then you should be very aware IR35 has a deadline of the 6th April 2021. You should also well on your way to complying with the most significant upheaval in workforce management in the UK.
If you’re not, you need to read this and act quickly to avoid loss of talent, reputational damage, litigation and a very hefty fine by the taxman.
While we at CXC have been implementing 10-month action plans with our clients, there is still just enough time to ensure your contractors are compliant. In this article, we’ll highlight four key things your organisation needs to consider. But let’s start with a background to what IR35 is all about.
IR35 was introduced as the Intermediaries Legislation, back in 2000. Its purpose was to ensure that all contractors working in an organisation, in the same way as permanently hired staff – eight hours a day, five days a week – would pay the same tax and National Insurance Contributions as the full-time employee.
Most notable, the onus was on the contractor, to declare themselves to be within the IR35 status. This would mean the contractor would have to pay up to 25% more of their income in taxes. Add to that, the ambiguity in the IR35 status, and the legislation was a bit of a damp squib.
IR35 was given an overhaul in 2011 by the Coalition Government, including introducing a Business Entity Test (BET) to check the risk of a contractor selected for an IR35 investigation. However, it came under heavy criticism as the test showed most contractors to be at ‘medium’ or ‘high risk’ of investigation. The BET was subsequently abolished in 2015.
At this stage, the HRMC believed that non-compliance with IR35 was widespread (only 10% of contractors were compliant), and the Exchequer was losing hundreds of millions every year. To combat this, it was felt the responsibility should fall on the organisations to determine their contractors’ employment status.
In 2017, a clampdown was introduced on ‘off-payroll workers’ within public sector organisations. From the 16th April 2017, all public sector bodies were responsible for establishing and declaring contractors within the IR35 classification. They would then be responsible for deducting and paying the tax and National Insurance Contributions of those individuals. At this point, the amends to IR35 did not put any responsibility on private sector organisations.
A new IR35 employment status test was introduced in 2017 to help workers, agents (personal service companies) and clients determine whether they are within IR35. This has evolved into what is now known as the Check Employment Status for Tax (CEST) tool.
At the October 2018 Budget, the Chancellor announced private sector organisations, not defined as small companies, would become responsible for determining the worker’s employment status. Initially set for April 2020, the Government extended the tax law to 6th April 2021 due to Covid-19 restrictions.
There has been much controversy over IR35 since its inception. Representative bodies for contractors have long since deemed it unfair. In April 2020, the House of Lords published a report stating an extension of IR35 into the private sector was unfair on workers and put too much burden on businesses. Lord Forsyth of Drumlean, Chair of the House of Lords economic affairs finance bill sub-committee, said: “Our inquiry found these rules to be riddled with problems, unfairnesses, and unintended consequences.
An amendment to the Finance Bill to postpone reform until 2023-24 was put forward in July 2020 by Conservative MP David Davis, amongst others, but the motion was defeated.
Several criticisms were cited – the HRMC ‘privatising tax compliance’, no acknowledgement of the rise of the gig economy, and extra pressure on businesses already struggling with the pandemic.
Factors that determine whether someone is outside or inside IR35
There isn’t a clearly defined set of criteria to determine if a worker is regarded as an employee of the client for income tax purposes (i.e. inside IR35). However, Staffing Industry Analysts have listed various factors that should be weighed up to decide whether the relationship looks more like employment rather than self-employment.
- personal service
- mutuality of obligation
- financial risk
- part and parcel of the organisation
- opportunity to profit from sound management
- personal factors
- intention of the parties.
To help reach that determination, the HMRC developed the online CEST tool mentioned previously. However, mutuality of obligation, as listed above, is not even considered by the CEST tool.
Four things you need to consider in for IR35
1. Administrative burden and risk
Your organisation is now responsible for the tax classification of your contractors. Of course, the status will change regularly with contracts being extended or amended, new contractors coming on board, or the change in relationship with workers. But who exactly is responsible for making that classification, is it the worker’s manager, HR, finance or legal? All functions will have a role to play in amending procedures to be compliant. Make sure you identify the key stakeholders.
You’ll then need to map out your existing worker population and analyse risk against IR35. Be warned you open yourself up to potential litigation from the worker if they are classified incorrectly, and HMRC can investigate up to four years after the worker’s assignment.
Let’s explore some of the risks in more detail:
Concerning potential liability, please note if an accidental incorrect determination on IR35 status has been reached, HMRC confirmed in 2020 that they would apply a ‘soft landing’ to such mistakes for the first 12 months of implementation. However, it is unclear whether this will be HMRC’s approach in 2021, given that businesses have been given an additional year to prepare. Nevertheless, HMRC will require the tax to be paid going forward, most likely backdating PAYE and NICs’ liability to the beginning of April 2021 (and including any interest due).
However, suppose there is wilful neglect in making a determination or deliberate non-compliance. In that case, HMRC will have authority to recover the unpaid tax and issue fines, (and may pursue criminal penalties and prosecutions against the directors) based on the scale below:
- 30% of unpaid taxes if HMRC finds negligence or carelessness when applying the IR35 status.
- 70% of unpaid taxes if HMRC finds the organisation knew the relationship fell within IR35 but ignored it.
- 100% of unpaid taxes if the organisation seeks to hide the actual IR35 status.
You need to have buy-in from the key stakeholders at the outset and bring them along on the journey. Communication could make or break this process on many levels. For example, workers must receive a Status Determination Statement (SDS), and the end-user must allow workers the right to appeal the status determination. The worker has 45 days to appeal. During the appeal period, the original status determination will apply.
You must issue instructions and guidance for internal stakeholders to ensure the process is followed diligently and efficiently to ensure your organisation is fully compliant.
3. Loss of talent
Many contractors may have overlooked or ignored IR35, up until this point. If IR35 results in a significant decrease in their take-home pay, they may decide to become a full-time employee elsewhere. There may also be less talent available with the market.
4. Increased costs
There is no way to offset all the extra costs incurred by IR35, so there is an inevitable new financial burden from your contingent workforce. Have a plan and ensure it is consistent.
From 6th April 2021, HMRC will look through any written contract and assess the working relationship’s nature. Suppose a worker is considered inside IR35 by HMRC, but you as the end client user have assessed them outside of IR35. In that case, your organisation can be liable for all of the Employer’s NI, Employee’s NI and tax for the worker for any assignment inside IR35, post 6th April 2021.
Conversely, if a worker is outside of IR35, but you as the end client user have assessed them as inside, the worker can complain to HMRC to get their overpaid tax back, or they may have grounds for a legal case as mentioned in point 1.
What does the future hold?
We believe we’ll see the following in the coming years:
- Skills gaps
- More PAYE engagements
- Higher rates for clients – an estimated inflation rate of 30%
- Growth of Statement of Work or packaged work
- Higher levels of international remote work as UK contractors provide their services abroad
As you can see, compliance with IR35 is a vast undertaking, with a significant level of risk. Failure to prepare could result in mass fines, a detrimental effect on industry reputation, poor coverage in the media, court prosecutions and a loss of interest from the contractor population.
You must start preparing your strategy and approach now.
How can we support you?
- A compliant, technology-led, audit process for all Personal Service Company workers, using our online platform – CXC Comply
- Communications support
- Change management
- Status determination support
- Compliant payroll for Inside and Outside IR35 workers
- Efficient management of data and back-office activities
- Identification and management of misclassified /rogue spend
- Greater consistency of selection criteria, rates and management