A Review of the Recent Changes to the IR35 Legislation

The IR35 Legislation  

The term IR35 'off payroll working' refers to a rule that was first proposed in a HMRC release numbered IR35 in 1999 to stop the avoidance of tax and national insurance contributions used by intermediaries, particularly personal service companies owned by an employee through which their services were provided as contractors. This particular intermediary was required to pay tax and national insurance contributions through the PAYE system. Under these arrangements, the worker is the employee of their personal service company or intermediary and the bulk of their income is drawn as dividends rather than salary, thus saving tax and national insurance contributions and depriving the Exchequer. In October 2018, the Chancellor announced in his autumn statement that he would reform the off payroll regulations operating in the private sector.

Chapter 10 of part 2 of the Income Taxes (Earnings & Pensions) Act 2003 also known as the 'off payroll working rules' were introduced to apply to the private sector from the 6th April 2021. The legislation applies to services provided to the private sector hirers/clients who are medium and large businesses which have a UK connection. Chapter 8 of the same Act applies where the services are provided to small private hirers/clients.

How Does IR35 Operate in Practice?

The traditional model of engaging individuals through an employment relationship has changed with the emergence of a professional contracting market some 20 years ago, and has escalated particularly with the emergence of the gig economy and flexible working. Hirers/clients often don't want to grant employment rights to individuals and bear the cost of employment particularly paying employer national insurance contributions.  You can find this particularly in highly paid services such as in IT, specialised pharmaceutical services in the field of pharma co-vigilance, certain healthcare or other sectors, and contractors who want to continue providing their services through the use of an intermediary for beneficial tax reasons. However, those on lower incomes in the gig economy are also now beginning to provide their services, albeit in different circumstances through a personal service company, but not always through choice.

Although an intermediary is normally a personal service company, it could also include services provided through an individual or partnership. IR35 dictates that if upon a proper analysis the worker provided their services directly to the hirer/client without the presence of the intermediary, they would be regarded as an employee for employment tax purposes.

In those circumstances, the payments being made by the hirer/client to the personal service company or intermediary, up until 5 April 2021, was treated as earnings in the hands of the recipient intermediary. The intermediary was also responsible for making payments of taxes to HMRC as well as interest and penalties on late payments of tax and national insurance contributions.

However from 6 April 2021, if the worker services are provided through their intermediary to hirers/clients who are not small companies within the definition of section 382 of the Companies Act 2006, they will have to undertake a status determination statement of the working relationship or the assignment in question. For a hirer/client to avail themselves of the small company exemption, two of the three of the following must apply:

• Their turnover is less than £10.2 million.
• The balance sheet value of the company is less than £5.1 million.
• There must not be more than 50 staff.

Thus under the new regulations, the burden of accounting to HMRC for employment taxes and national insurance contributions has shifted away from the intermediary to the medium and large hirer/client. If a recruitment agency is involved in the labour supply chain then the obligation will pass onto HMRC for employment taxes, since the agency will be the payer of the fees to the intermediary. For the purposes of off payroll, they will be the deemed employer for deducting employment taxes.

What Is the SDS?

From 6 April 2021, hirers/clients who are medium or large companies conducting business with intermediaries will be obliged to conduct a status determination statement also known as an ''SDS'. It will have to determine whether the arrangement with the intermediary is caught by IR35. HMRC guidance dictates that any SDS must be conducted using "reasonable care" and reasons should be given to the intermediary and worker with the outcome as to whether or not the arrangement is caught by IR35 requiring a deduction of employment taxes and national insurance from any payments due to the intermediary.

In determining whether the arrangement or assignment is inside or outside IR35, the hirer/client will need to refer to various HMRC guidance and in particular, to the HMRC online tool being the check for employment status for tax tool, also known as 'CEST'. This online tool can be used anonymously by either party or the supply chain to obtain an indication from HMRC as to whether the arrangement is likely to be subject to IR35 or not. However if a party wants to rely upon the outcome from the CEST tool, then full disclosure of all relevant information is required to be inputted into the tool - otherwise HMRC will not be bound by the automated decision.

As the burden of accounting for tax and national insurance rests with the hirer/client who are not small companies, they should consider also undertaking a wider risk assessment so as to justify their position, if maintaining that the relationship is not caught by IR35 and that no taxes should be deducted. If HMRC deem that the hirer/client approach was such that reasonable care wasn't taken or that a complete or thorough assessment of the arrangement wasn't undertaken, then it will continue to be responsible for any unpaid taxes, employer and employee national insurance contributions plus any apprenticeship levy.

A wider risk assessment beyond CEST would include the hirers/clients examining their own business operations and the nature of their business, which may or may not lend itself to engaging with contractors. In particular, a hirer/client should:

• consider whether there are other workers within the organisation that are employees and have similar duties to the contractor and justify any differentials
• compare any proposed terms with a contractor to those of an employee within the organisation undertaking similar responsibilities
• acerate whether the worker has previously been engaged by it and if so on what basis
• consider the relevant HMRC guidance and various employment status manuals (ESMs)

ESM 502 involves a hirer/client considering control and rights of control over the intermediary and supervision aspects, as well as any codes or regulatory requirements governing the assignment.

From a number of reported employment and tax cases over the years on employment status, the following factors should also be considered in determining whether the proposed relationship is one of employment without the presence of the intermediary namely:

• whether there is flexibility
• set hours or days of working
• the arrangements in place to cover absences and holidays
• how is the work to be done?
• is there a right of substitution?
• who pays the substitute?
• who provides the equipment for the assignment?
• is the worker in business on their own account and is there a financial risk to the worker in the proposed assignment?
• the structure of any payments under the assignment
• whether payments are subject to reaching targets, milestones or penalties etc
• the exclusivity of the arrangement
• mutuality of obligation and the length of the assignment

Hirers/clients will also have to introduce the dispute process if the outcome of the SDS is disputed by the intermediary or worker, and give 45 days to respond to an adverse decision.

What Are the Effects of IR35?

The intended effects of the IR35 changes are such that hirers/clients who are in any doubt as to whether or not IR35 applies to a proposed assignment or project are unlikely to agree to engaging workers through an intermediary, since the burden for deducting employment taxes will remain with them.

Contractors whose intermediaries are subject to IR35 will have all employment taxes, including employer and employee national insurance contributions deducted before payment and be financially worse off than being in employment. Yet they will have no employment rights as they are employees of their intermediaries.

It will be some time before we know what approach HMRC will take when examining these working relationships and holding hirers/clients to account where they disagree with the outcome of an SDS.

In April 2021, an all-party parliamentary group published a report titled 'How contracts should work' and recommended that the Government should commission a review to investing the best way to structure, remunerate and tax professional contracting and freelancing.

Furthermore the Government should also legislate to ensure that anyone who is taxed as an employee should receive corresponding benefits. Those individuals who are subject to employment tax deductions arising from IR35 should, as a minimum, receive full agency worker rights including a right to holiday and sick pay. This of course, raises the issue as to who would pay for such benefits when the intention on the part of a hirer/client was to move away from a traditional employment relationship in the first place to avoid such costs, particularly if it is the hirer/client who wants to engage a worker in this way.

First published in Tolleys Company Secretary’s Review

For more information or help regarding the IR35 legislation changes, please contact Michael Delaney in our Employment Law team on 07909 912564 or complete the form below.