IR35 reform in the private sector

IR35 reform in the private sector

The UK recruitment industry has recently been exposed to dramatic changes in the regulatory landscape which has led to staffing businesses needing to modernise their processes. [1]

In response to widespread non-compliance, the Government announced that the reform of the off-payroll working rules introduced for engagements in the public sector was to be extended to the private sector from 6 April 2021[2]. This has now been extended until April 2021 due to the COVID-19 outbreak. Under the current regime where the Personal Service Company (PSC)[3] of the contractor [4] declares whether it falls inside or outside IR35, HMRC has claimed that only 10 % of all PSC’s apply the current IR35 rules (and thus account for PAYE) and therefore the costs of non-compliance have been projected to reach £1.3bn in 2023-24.[5]

It is clear that the new legislation, which is expected to roll out in the summer of 2019, will leave its footprint on the white-collar professional services led sectors, especially in those sectors where the demand is increasing, such as Tech and Digital, where businesses rely on contractors with very niche skill sets, who in most cases would deem themselves to be genuine independent contractors.

With the anticipated changes it is clear that recruitment businesses and their clients[6] are not just expected to work alongside each other, but it is paramount that they partner up to successfully adhere to the new framework by 6 April 2021.

In this article David Korthals, Head of Compliance & Contractor Management, and Richard Norris, Technology Sales Director at Salt digital recruitment agency will:

(i) explore the current and proposed legislation

(ii) make initial observations on how the new framework will impact both recruitment businesses and their clients and

(iii) outline how to work in harmony to overcome some of the challenges that the new legislation presents.

Check out Part 2 of our IR35 updates and the interesting results of our Contracting and IR35 survey.

What is IR35?

IR35 is the name given to tax legislation in the Income Tax (Earnings and Pensions) Act 2003. It was originally introduced in 1999 to deal with alleged tax avoidance via the use of Personal Service Companies (PSC’s). IR35 is intended to ensure that contractors who work like employees[7] pay broadly the same employment taxes as actual employees, regardless of the structure under which they provide their services.[8]

Under the current regime in the private sector, the contractor has to determine whether they work ‘inside or outside’ IR35 when filing their annual Self-Assessment Tax return.

IR35 ensures that a contractor is subject to equivalent employment tax legislation as directly engaged employees if the reality of how they carry out the work is akin to employment. If they work ‘inside IR35’ the PSC must account for National Insurance Contributions and income tax (through the mechanism of PAYE on the contract rate.

To be considered outside of IR35 the contractor must be operating as a genuine (independent) business. Both the written contract and working practices (the day-to-day working relationship between the contractor and their client) need to be reviewed to adequately determine the IR35 status.

The IR35 test is based around four main criteria:[9].

1. Control

Does the client have supervision, direction, and control over the contractor? Is the contractor dictated as to how they undertake the work and how do they go about it?

2. Substitution

Is the contractor able to send a substitute to carry out the work?

3. Mutuality of obligation

Does the client have to provide work, and is the contractor obliged to accept and complete the work?

4. Financial risk

Will the contractor incur personal financial risk as a result of the performance of the work duties?

If,  for example, it appears that a contractor works under the control of the client, if they are not entitled to provide a substitute and are not able to determine their working hours, HMRC may classify the contractor as being ‘inside IR35’. It is, however, worth noting that this test is not a mathematical formula and can be viewed as open-ended, opinion-based and therefore unsatisfying in many cases.

If we look at what goes on in practice, one must appreciate that no assignment is the same and more often than not the distinction between a genuine client-independent contractor relationship and de-facto employment becomes blurred. For example, some contractors will be able to determine their working hours but may not necessarily be entitled to bring in a substitute, others can work remotely and have a list of specific milestones to complete within a defined time-frame but might be managed by and given day-to-day direction by the hiring manager.

In response to the 2017 reform in the public sector, HMRC attempted to simplify the test by virtue of the CEST Tool, an online questionnaire that is supposed to give contractors, recruiters, and clients a correct outcome in 85 % of the cases.  Although highly criticised[10], HMRC has announced that it intends to further improve the tool and tailor it for use in the private sector, so it will remain useful as a starting point to determine the status of each contractor.

What will the new IR35 legislation look like?

The current IR35 test will not change. However, under the proposed legislation, the ‘end-user’ and not the PSC will be required to decide the contractor’s status. The end-user is the ultimate beneficiary of the services provided by the contractor. When making its determination, the end-user needs to exercise ‘reasonable care’. The end-user may need to obtain legal advice in order to make a correct status determination. The status determination will need to be passed on to the ‘fee payer’ (this will usually be the recruitment business) by the time the contract starts or before the contractor starts to provide their services.[11]

If the end-user determines the assignment falls within IR35, the fee payer will need to make a ‘deemed employment payment’. This includes responsibility for levying income tax and accounting for NIC’s through the mechanism of PAYE, which means that recruitment businesses have to review their internal contractor management systems to ensure these deductions can be made. Alternatively, the recruitment business may elect to outsource the ‘deemed employment payment’ to a reputable umbrella company.

The government is currently reviewing the process in relation to status determinations and is currently identifying specifically what should happen if the contractor or the recruitment business challenges the client’s status determination.

The legislation will not apply if the end-user can be classified as a small business. This means that small organisations will not need to determine the status of the contractors, this would remain with the PSC. For the definition of ‘small business’, the Government intends to use the definition which is outlined in section 382 of the Companies Act 2006.  A company qualifies as small if two of the following conditions apply: The turnover will be no more than £ 10.2 million, the balance sheet total does not exceed £ 5.1 million and the number of employees is lower than 50. As many end-users in the Tech & Digital Industry who rely on the contingent workforce will not meet this threshold, we expect that the exception will be of little relevance.

It is anticipated that HMRC will hold the end-user liable if no status determination is made or communicated (in a timely manner) or if the end-user did not exercise reasonable care when making a determination. Equally, the recruiter may pay the price if it ignores the status determination or applies the wrong status determination, so it is paramount that the entire supply chain teams up in order to adhere to the proposed regulations.

Working towards IR35 compliance: A concerted effort

Below we have outlined some initial thoughts on how the recruiter and the client can work together to overcome the biggest hurdles.

Reviewing current and future workforce

Recruiters and clients need to identify and review their current engagements undertaken by PSC contractors.[12] Well-informed recruitment businesses should be in a good position to help in identifying which contractors work via their PSC and moreover they can assist with reviewing which PSC contractors are likely to fall within the scope of IR35. This would consist of assessing existing assignments that are expected to be pending post-April 2021 and having in-depth conversations with contractors and hiring managers about these assignments and associated working practices. For clients, it is also worth considering the financial impact on hiring contractors post-April 2021.

Communicating status determinations effectively

It is furthermore key that recruiters, intermediaries, managed service provider’s[13] and clients (including end-users) get a process in place that enables recruiters to receive a status determination from the end-user (directly or indirectly) before the start of the assignment. Ideally, the end-user provides the status determination and the reasons for this, the input and output of the CEST screening and a named point of contact within Legal or Procurement who made the determination. This is useful should either the contractor or the recruiter seeks clarification or wishes to challenge the status determination. Recruiters and clients should also incorporate the status determination in their onboarding process and contractors should not commence their assignment until they have received and accepted the status determination.

Regular meetings

It is desirable that both the recruiter and the client engage with each other regularly to review current and upcoming assignments and specifically to assess if working practices reflect status determinations on an on-going basis. This becomes particularly important when one considers that contractors who currently deem themselves to be outside of IR35, can be classed as working inside IR35 from 6 April 2021 onwards. It is furthermore key that early 2021, both the client and the recruiter need to inform the contractor of the upcoming changes in legislation, advise them of their status, how this impacts their payments and give them a platform to voice their concerns or ask questions.

Training and awareness

Recruiters and clients should train their staff to ensure they are up to speed with the new legislation. Recruiters will have to ask for a status determination prior to the assignment commencement. They need to understand how this determination may impact the pay and charge rates and communicate the status to the contractor, explaining the rationale where necessary.

Working practices

Clients also need to educate their hiring managers to create a working environment that is not inconsistent with the status determination. The hiring manager should not manage or supervise a contractor if a status determination was made that the contractor was working independently, i.e. outside IR35. It is furthermore recommended for the client and the recruiter to introduce policies that reflect working practices for the external workforce and to ensure that all members of staff act in accordance with those policies.

Pricing negotiations

Both recruiters and clients need to factor in the costs of the Employer’s National Insurance deductions when determining the applicable pay and charge rates if the role is deemed to be within IR35.

Statements of Work

If a contractor is deemed to be working outside of IR35, then both working practices and paperwork need to reflect that the contractor carries out the work independently. The recruiters and client may wish to consider drawing up an appropriate Statement of Work (outcome-based contract) in which it is clearly outlined what the services are that are to be delivered and which milestones or deliverables need to be completed within an estimated time delivery against a fixed price.  This Statement of Work needs to be in line with the factual reality of the assignment, it should not be used as a contrived arrangement.

How can Salt help?

It is clear that recruiters and clients need to work together to communicate status determinations quickly and efficiently to contractors and to make appropriate deductions where relevant.

However, in order to attract and retain the most talented Tech & Digital contractor workforce, it is crucial that the rationale behind those status determinations are well-considered and transparent for all stakeholders.

Salt is keen to have conversations with you to help prepare for the changes in legislation to ensure you are still able to attract the very best digital talent.

David Korthals
Head of Compliance & Contractor Management

Richard Norris
Technology Sales Director

[1] Examples of this are the 2017 UK Criminal Finance Act, the 2017 off-payroll working rules in the public sector as outlined in the 2017 Finance Act and the 2018 General Data Protection Regulation 2016/679 which was transposed into the 2018 Data Protection Act.

[2] HM Revenue & Customs ‘Off-payroll working rules from April 2020’, Policy Paper and consultation document, 5 March 2019, page 2.

[3]  HMRC describes a PSC as the worker’s own limited company.

[4] The term ‘contractor’, ‘worker’ or ‘individual’ are used interchangeably throughout this article and refer to the person who carries out the work for the end-user.

[5] HM Revenue & Customs ‘Off-payroll working in the private sector, Summary of Responses’, 29 October 2019, page 4.

[6]  The term ‘client’ in this article refers to both clients and end clients (under the expected legislation defined as ‘end-users’).

[7] IR35 does not apply to contractors who are employed by an umbrella company or work via a recruitment business as an agency worker.

[8] This does not mean that a contractor would automatically qualify as an employee and therefore be entitled to any associated employment rights if they are deemed to work within IR35.

[9] Please note that this list of considerations is not comprehensive and other factors may be considered including but not limited to the use of equipment, absence procedures, contractual termination rights or the continuity of the assignment.

[10] See KPMG’s response to HMRC’s/HM Treasury’s consultation on off-payroll working in the private sector, paragraph 2.5.

[11] HM Revenue & Customs ‘Off-payroll working rules from April 2020’, Policy Paper and consultation document, 5 March 2019, page 2.

[12] As outlined before umbrella company contractors fall outside the scope of IR35 as they are employed by the umbrella company.

[13] A managed service provider is a business that manages the client’s workforce, payments and relationships with suppliers. They usually pay the recruitment business on behalf of the client and/or end client.

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