An explanation of the upcoming IR35 changes. What are they? Who do they impact? What do you need to do to make sure that your business adapts to the changes well. Alex Evans gives you the answers to these questions alongside his thoughts on the matter

April 6^th is nearly upon us, meaning that the IR35 changes are as coming soon. In general, while I would rather slam my head repeatedly in a door than do anything to do with tax law, this is different. The current changes the government has made is aimed to combat “widespread non-compliance” with the old off-payroll working. It begs the question: what is IR35; what are the changes; what do you need to do, and (because apparently people care) what do I think?

What is IR35?

Put simply, it is the rules surrounding tax of off-payroll working. This brings up more questions than it answers, and the answers to those questions are not going to get you invited to any dinner parties. However, we need to understand them thoroughly

Introduced in the early 2000s, the key behind IR35 was to tax independent contractors who were working like employees as employees. It is not uncommon for professionals in certain sectors, particularly in IT, to set up their own Personal Service Company (PSC, this may be referred to in other documents as the “intermediary”, but we all mean the same thing.). The advantages of this being that payments to them were paid as dividends, not wages, meaning a lower taxation rate, no National Insurance contributions and the ability to off-set certain expenses. While the advantages had decreased in recent years, it was still advantageous.

The original IR35 was designed to stop HMRC being short-changed by employees masquerading as independent businesses. The regulation set out certain criteria to determine whether the PSC was acting, in a certain contract with a client, as a self-employed contractor or as a worker. The issue with the determination was that it was for the individual PSC to decide whether he was inside IR35 regulations, meaning the higher “employee” level of tax was to be paid, or outside, so the lower “independent business” level of tax was to be paid. One does not need legal or accountancy qualifications to guess which way the majority of PSCs determined: they were independent businesses.

In some situations that is fine. Think of a business engaging an electrician or a plumber to fix certain aspects of the office (remember when they were something to worry about!); the engagement is for a fixed result. He will decide what he wears, will have control over the work and the payment will be due for specific obligations. You cannot ask “while you are fixing the wiring, do you mind dusting my shelves?”. The distinction is not so obvious in other situations. If you ask the contractor to follow your policies, wear uniform, control how he does the work and do not allow him to allocate responsibilities to others, suddenly he looks a lot more like an employee than an independent business. That is what the new rules are trying to combat. HMRC estimate only 10% of those who should be paying the IR35 tax are doing so.

What’s New in IR35?

To whom does it apply?

The changes apply to all Medium and Large businesses, meaning only small business are exempt. If two of the following three factors apply under S382 Companies Act, you are a small business and therefore do not need to follow the new IR35 regime. The old one stands.

• Less than 50 Employees
• Turnover of less than £10.2 million
• Balance Sheet total of no more than £5.1 million

Note this only applies when you are engaging with a PSC. It does not impact business relationships with employment agencies.

The question you might be asking, is “what exactly is a personal service company?”. I wish now I could provide an answer, but after spending an extraordinary amount of time on HMRC website, I could not find any concrete legal definition. The closest thing to a definition in law is found in the Select Committee on PSC’s who says PSC’s are “generally understood” to be made up of the following:

• A Limited Company;
• Where the sole or main Shareholder is also the Director; and  
• The director operates through that company concluding contracts with clients directly.

What Are the Changes?

Whereas before the PSC determined the application of IR35, now the “end client” (that is, the medium or large business) determines its applicability. The consequences of non-compliance lie with the end client. HMRC hold them liable for failure to deduct relevant sums from payments. The result of this will be the exact opposite to the previous situation.

How do I tell if someone is an employee or genuinely self -employed? The Status Determination Statement

Fortunately, the government has provided a Certification of Employment Status Test (CEST for short). Unfortunately, for us and the civil servants who came up with that acronym, it is a CEST-pit (pun very much intended.). The questions are highly confusing and will not be relevant to all businesses. Even taking that aside, in all bar the most obvious of situations the results are inconclusive and recommend that the business seeks alternative help. Fortunately, the indications provided largely cover current jurisprudence regarding employment status which I covered in my very first blog post. Below are the key factors to examine. This examination must be done on a case-by-case basis; a business is not allowed to generalise.

Key Factors

Note: in the following analysis I refer to an “indication of being an employee”. With this, I mean the individual will fall inside IR35 requirements and deductions will be made for national insurance and income tax.

Control

HMRC focuses on the capacity to control in 4 areas:

• What a worker does à are they engaged for a single event or can the employer ask them to adapt to other situations?
• For example, an employee tasked on a project can be redirected as from day-to-day and have to comply with all reasonable instructions from the employer.
• A genuinely self-employed individual is charged with doing a particular task. Asking an electrician to take your bins out would be outside his remit.  
• How the work is carried out. This can be shown in any number of ways. HMRC tends to focus on whether the end client can tell a worker in which way the work is to be done.
  Again, using the example of an electrician, you can tell him you want him to fix the wiring, but are unlikely to know how. He is genuinely self-employed.
• When and where the work is carried out. The more flexibility they have, the more likely they are to be self-employed; the less flexibility, the more likely to be an employee. 

Substitution

Is the work entirely personal? That is to say, is the end client engaging with the worker in question and will not accept any other person doing the work other than the worker they have hired. If there is an ability to substitute another individual, even subject to a qualification test, then the worker is more likely to be genuinely self-employed. Hiring other workers is more indicative the contract with the PSC is a genuine “company” rather than a   front for employment status.

Financial Risk

Another important factor: who takes a financial risk? This is deemed as a significant expense incurred because of a contractual requirement, not due to personal preferences, that the worker in question receives no direct renumeration for. The more of a financial risk one takes, the more likely it is you are  self-employed.

For example, someone genuinely self-employed will take the risk in buying substantial materials for their job. A decorator does not show up to your house asking you to provide ladders, overalls, his van to carry the equipment around. While the client in this case indirectly pays for them through quoted price, there is no “expenses mechanism”. Moreover, he takes the risk that the job might require him to buy more materials and become unprofitable for the stated price. For an employee, an expenses account would be allocated and certain key components necessary to do the job, apart from the trivial and incidental will be paid for.

As a general rule, an employer will ‘take the hit’ if something goes wrong due to the work of an employee. Someone genuinely self-employed will either have to rectify the issue or pay compensation through professional indemnity insurance.

Integration

This question essentially asks whether the contractual and practical arrangements are consistent with the findings of the contract of employment. The following questions should be asked:

• Does the worker have to follow the end-clients’ procedures, practices and policies, including the end-users uniform? If so, it is an indication he is an employee.
• Does he retain any benefits from the employer? Holiday pay, sick leave, bonuses or expenses? If so, it is an indication he is an employee?
• Does he market his services to the world, or does he work exclusively for one end-user? The former is an indication of being an employee, the latter an indication of genuine self-employment.  

Communicating the Status Determination Statement

The decision must be communicated to the contractor in writing before the first deduction is made. The contractor has until the final payment is made, to challenge that determination of status. The worker can request the Status Determination Statement that has to provide reasons of the decision. Run your statement through CEST and see what the outcome is. If, as I suspect it will be, it cannot come to answer, the best chance is to seek legal help. Then approach an employer with your reasons why deductions should not be made. The end client has 45 days to respond.

I would love to provide you with more detail but that is all the information that we have. Given that previously IR35 status could only be challenged by HMRC so there is no guidance thus far for a challenge by a PSC.  

I’m a business and I’m confused: A 4-point plan summary of what to do

1. Ask – have I got a contract with someone working through a PSC that will go beyond 6^th April 2021?
   1. If yes see the following
   2. If no – thank you for getting this far through the blog! But you have nothing to worry about. Best to double check
2. Use CEST – go through the questions with the contractor to make an assessment. This has to be done about each potential contractor who work though their own PSC.  
   1. If you get a conclusive result – apply that result and communicate this with the contractor in a Status Determination Statement
   2. If you do not get a conclusive result – either use the indicators mentioned to determine IR35 status. Again communicate this to the contractor
3. After the Status Determination Statement your contractor will either
   1. Agree – all is well; or
   2. Disagree – allow the contractor to make representations about the disagreement. Consider these thoroughly before communicating your final result.
4. If you’re still confused, don’t worry! At the Legal Stop we offer a one-off Status Determination one-off for just £450!  

My Thoughts on the matter

Well, you survived tax law! Congratulations! So what do I think?

It is no secret that paying taxes is one of life’s greatest miseries, so any excuse you can find to minimise tax is understandable. It is also no secret that tax avoidance and evaders (I know one is illegal and the other is immoral but as far as I am concerned, they are both reprehensible) are awful people. Should I come to power anyone found doing either will be subjected to literally one billion years in prison.

All jokes aside however, rather than fixing the situation the government has simply shifted their own lose-lose situation to employers. It has been pointed out that end-clients are obviously going to air on the side of caution and deduct income tax and national insurance contributions from contractors as if they were employees. Given that the government’s own CEST mechanism cannot determine employment status, the business is left with three options in a situation that is not entirely clear-cut. Number 1: do not deduct tax and national insurance contributions and hope that HMRC does not engage in expensive and lengthy legal proceedings against you. Number 2: pay lawyers to determine the status in each individual contract. Or number 3: deduct the tax and national insurance contribution meaning the only financial hit is not taken by the company but the PSC worker. It is reasonably obvious which one they are going to take.

Multiple sources have argued that the ambiguity is deliberate. HMRC can take advantage of these grey areas and scare end-users into making national insurance and tax deductions. In its consultation paper, they estimate that the treasury has thus far lost around £13 billion in tax contributions due to the old IR35 regulations, expanding to £1.3 billion a year by 2023-24. In making determination, the business has to have the tax collector on his shoulder. Given the hit HMRC has taken this year, and government repeatedly saying how it will soon be time to “balance the books”, we can expect HMRC to take a fairly hard -line on IR35 determinations. The decisions being made therefore will not fair, impartial or balanced.

I would make two main changes to the IR35 process. None of which will happen, but the interests of justice and fairness demand it.

Firstly, there must be proper external appeals procedure. I have no issue with an automated system like CEST, but it must become more usable. The system must do more to combat its glaring inadequacies in ambiguous determinations and questions more apt for conundrums in the world’s worst riddle book. However, the government has defended the attacks on CEST, saying it has had “positive feedback” and made recent improvements. While these have yet to be seen, I am sceptical. The guidance must be made more accessible and a better reflection of real life.

Failing this, HMRC must provide some sort of “fast track” conciliation and arbitration mechanism between the two sides held before a professional arbitration panel. The government’s excuse for not doing so is that if one does not like the determination, you can walk away from the “bad deal” if you are a genuine business (good to know they have changed their tune from Brexit.). This to me seems wrong. The majority of PSCs will not be in a position of equal bargaining power with medium and large businesses. The larger end-clients have nothing to lose by determining a PSC is within IR35, and the worker takes the brunt of the fall without any conceivable benefit. However, the cost of arbitration and potential delays might be prohibitive to smaller PSCs.

Failing that, there must be a more impartial forum able to determine the correct relationship between the parties to take. Even failing that, HMRC should take a “range of rational responses” approach to IR35 determination. They should ask when auditing whether the determination was one that the end-user was reasonably entitled to make on the facts in front of him at the time. The decision is not always obvious. It took a Supreme Court appeal to determine the correct status of Uber drivers! This would give a broader margin for error and take the tax-collector off of the end-user’s shoulder.   

Secondly, even if none of the above are followed, if one is taxed like an employee, he should be treated like an employee. The current approach to Labour Law is too binary: you are an employee or you are not. There has to be more room for the grey areas that reflect the reality of modern working. A Court in California recently noted that the currently Courts are being asked to place a “square peg” in a round hole. Yes, on one hand you have someone who has been at the company for years, being paid through a PSC who is obviously essentially an employee. On the other, a PSC engaged for a particular service or result now is taxed but not treated like an employee. The best solution would be further government intervention. This should guarantee equal pay for work of equal value, pro rata holiday entitlement and a guarantee of sick leave at a minimum for contractors within IR35. At least then there will be some “cost” for an end user in determining a PSC is within IR35. There is something for them to lose and thus the consideration may be made more carefully.

In Conclusion, this is just another example of a lack of nuance in modern legislation. Spin and three-word slogans have replaced nuance. While the old system was by no means perfect (it cheated the tax- payer out of billions) the current system has replaced one type of unfairness with another kind. The lack of clarity from HMRC and lack of ability to appeal will only operate detrimentally ultimately to PSCs. Jesus said in the Parable that those “who humble themselves will be exalted”; in this case, those who exalt themselves before a big business will be unjustifiably humbled.

We provide IR35 Status Determination Check and Statement (SDS) where for a one off fixed fee of £450.00 an Employment Lawyer will ensure your IR35 Compliance, for more information click HERE.

The contents of this article do not constitute legal advice and are provided for general information purposes only.

The Legal Stop provides fixed fee legal services and legal and business document templates for individuals and businesses. Our services include:

• Legal and Business Document Templates   
• Request a Template Service  
• Fixed Fee Bespoke Document Drafting
• Fixed Fee Legal Services  
• Free Legal Documents and Information 

We aim to make the law and provision of legal services accessible and transparent to people and businesses alike!