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It is now more than 12 months since changes to the off-payroll working rules known as IR35 finally came into force for medium and large private sector businesses in the UK.

Designed to crack down on so-called ‘disguised employees’, the new rules shift the onus from individuals onto end client businesses to determine the employment tax status of their contract workers and decide whether IR35 applies to an engagement, where such an individual provides a personal service via an intermediary. If it does, the individual will be treated as a deemed employee for tax purposes and income tax and national insurance contributions must be deducted through PAYE.

The rule changes were delayed by a year and finally came into effect on 6 April 2021, so end client businesses should have been complying for the past year. HMRC acknowledged that it would take a light touch approach to enforcement and penalties during the inaugural year of the changes unless
there was deliberate non-compliance.

This light touch approach could now be about to change. Nathan Williams, a corporate tax partner at Trowers & Hamlins, says: “Historically, HMRC does like to litigate on this, so organisations cannot afford to be ambivalent.

“We are aware that HMRC has already raised IR35 non-compliance issues with end clients operating in certain sectors and given the continued stream of tax tribunal cases being heard (albeit under the ‘old’ IR35 rules), we anticipate HMRC will continue to enforce and will be stricter on any noncompliance, even if it is accidental.”

One of the biggest challenges of IR35 compliance is the lack of a clear test to establish whether an engagement falls within the rules or not.

Imogen Reseigh, a senior associate in the Employment & Pensions team at Trowers, says: “There is no precise or simple test to ascertain if someone is a deemed employee for tax purposes, even though there are a number of indicators that will point towards that and these are reflected in the HMRC’s online ‘Check Employment Status for Tax’ tool, known as CEST.”

As a minimum, for someone to be inside IR35, there needs to be a personal service being provided by the individual who is working via an intermediary. Control by the client organisation and mutuality of obligation are also key indicators. If the individual providing the services is subject to supervision, direction or control in how they carry out the work, and there is mutuality of obligation, they are less likely to be self-employed and more likely to fall within IR35.

Reseigh says: “Even a year on, many organisations are finding the rules difficult to navigate, either because they are not confident in applying them or they are simply confused about when they apply and whether they should be doing an IR35 assessment.

“Anecdotally, there is still quite a lot of criticism of the CEST tool, which often gives inconclusive results that cannot be relied on and some of the questions are ambiguous and open to interpretation. CEST is a tool to be used as part of the assessment rather than a definitive answer.”

Other factors that should be considered when assessing if an individual is a deemed employee for tax purposes or self-employed include the number of engagements the individual has with other businesses, the extent to which they are integrated within the client organisation, how they are paid for their services and whether they provide their own equipment and materials.

Williams says: “CEST is really only as good as the information you put into it and how you interpret that. IR35 is placing a massive administrative burden on end client businesses, who are being expected to do assessments that are at times very complex from a legal perspective and where it is not always easy to apply particular facts of a specific contractual and operational arrangement to the blunt tool that can be CEST.”

This is borne out by the recent report of the Public Accounts Committee which has identified high levels of non-compliance with the rules by the Government’s own departments and the poor implementation of the new rules by HMRC and states that “despite years of reforming the IR35 rules, there are still structural problems with how they work in practice”.

The administrative burden and non-compliance risks become even greater where there are multiple operators in the labour supply chain. It is common for end clients to engage contractors via multiple agencies who themselves may engage with other agencies, umbrella companies, PSCs and others operating in the labour supply chain.

Williams says: “You have got to know who you are dealing with and how you are contracting with them to properly understand your employment law risks and your tax risks. It is about underlining that importance at every stage of the supply chain ensuring visibility of the right information and having the contractual ability to obtain what you need to make a status determination on an ongoing basis. Arguably, this also applies to employment agencies who will have to ensure that they can comply with the requests of the end client and effectively pass on certain of the obligations down the chain.”

A further challenge arises where umbrella companies are used in labour supply chains, either as payroll operators, employers of staff, or as agencies. The role of these companies can be difficult to define and the opaqueness of some arrangements has prompted HMRC to issue a ‘call for evidence’ on their use in labour supply chains. While there are plenty of legitimate and compliant businesses operating as umbrella companies, HMRC fears this is an area ripe for employment tax avoidance and which is clearly a new area of focus and one to watch for the potential for further regulation.

For now, an ongoing area of confusion for businesses relates to the interplay between what it means to be employed or self-employed for tax purposes, and what that means for employment status under employment law principles.

A recent poll conducted by Trowers found only 48 percent of those asked felt confident that they could assess if someone was providing services to their organisation as an employee, a worker or a self-employed individual.

“IR35 assessment is about considering if someone working via an intermediary is deemed to be an employee for tax purposes, and not for the purposes of employment rights,” says Reseigh. “For tax purposes, there are only two categories of status: self-employed or employed.

For employment purposes, there are three categories of status: the self-employed, who have no employment rights; workers, who have some employment rights such as the right to the National Minimum Wage and holiday; and employees, who have the whole host of employment rights. Therefore, whilst the tests for tax and employment purposes are similar, they are not exactly the same, unfortunately, and there is recognition from Government that this causes confusion and needs addressing in the future.”

In practical terms, it is often useful for end client organisations to take a step back from the particular arrangements and to sense check the needs of the business. Given that the IR35 rules are predicated on there being a personal service, often it is the right of substitution that is critical to the determination of any deemed employment status, meaning whether a contractor can realistically send someone else to do the work in their place. If the individual can sub-contract the work and the client organisation will accept that and only cares that the work is done rather than by whom it is done, then the engagement will usually fall outside of IR35. It is also worth looking at the contract and services supplied and whether they amount to a fully contracted out service to be outside IR35 entirely. In some cases, the needs of the parties may have changed so that it is acceptable and appropriate for the business make a direct offer of employment to a particular contractor.

Particular circumstances may also allow for parties in the supply chain to help each other with the administrative burdens of IR35 compliance, such as creating policies and operating systems (including apps and software) to deal with the flow of information and assessments and/or the potential delegation of status determinations. In this regard, whilst it may in theory be possible for end user organisations to make bulk determinations and/or outsource the status determination process, care will need to be taken by the end user organisation to ensure it remains compliant and that it continues to act with the necessary level of reasonable care in undertaking the determinations, particularly as it cannot contract out of its statutory obligations and reliance on the enforcement of contractual indemnities can be expensive in itself. Unfortunately, there are no easy work arounds to the IR35 compliance burdens but client organisations and those operating in the labour supply chains can help each other with the aim to streamline processes and information gathering.

Williams says: “HMRC likes to litigate over IR35, albeit with varying success, and there is nothing to suggest that appetite will diminish.

“Aside from the tax costs, there are real reputational risks to consider regarding tax non-compliance and avoidance. Businesses need to undertake proper risk assessments to understand how their contractors are engaged, have people within the organisation responsible for IR35 assessments both at the outset of engagements and on an ongoing basis, and make sure there is proper record-keeping in place. Where relationships allow, working collaboratively with agencies and others in the labour supply chain may also help to alleviate some of the administrative burdens.” 

He concludes: “This remains a difficult area for businesses to navigate particularly when they are also trying to juggle other regulatory pressures, as well as dealing with staffing and supply issues themselves, but it is one that they cannot afford to overlook.”