Changes to IR35 legislation in April 2021

There are now less than six months to go until the new IR35 rules are implemented. Individuals who work as contractors through a personal service company and private sector businesses that hire contractors via a personal services company must be aware of the upcoming changes to the IR35 legislation.

What is IR35?

IR35 is tax legislation designed to combat a form of perceived tax avoidance, by which self-employed contractors supply services to clients via an intermediary commonly known as a personal service company (PSC). The worker benefits by avoiding the need to pay tax and National Insurance Contributions (NIC) by arguing that they are self-employed rather than an employee. IR35 seeks to ensure that workers who disguise themselves as contractors, but in reality operate as employees, do not benefit from such tax advantages.

What are the changes?

Before April 2017 — the onus was on the worker to determine their employment status and it was for the PSC to account to HMRC for any outstanding income tax and NIC.

From April 2017 — the rules changed in the public sector, so that onus moved from the contractor to the public authority to assess the employment status of the workers it engages and, if deemed to be an employee, the public authority would be responsible to account for tax and NI at source. Currently, in the private sector, the onus remains on the contractor to determine their IR35 status but that is about to change.

Changes to the IR35 legislation were due to be implemented in April 2020, but they were delayed because of the impact of COVID-19. Instead, the changes have been deferred to 6 April 2021. From this date, the changes will align public and private sector rules; the onus will fall on medium and large-sized companies in the private sector that engage contractors through a PSC to determine the IR35 status. They must therefore account for tax and NIC in the same way as the public sector.

In essence, the burden of responsibility is shifting from the PSC to the company hiring the individual. Importantly, the engaging company will be held liable if HMRC decides the employment status has been incorrectly assessed.

Small company exemption

These changes will not apply to small companies in the private sector. Contractors working for small companies will continue to determine their own employment status. Under Section 382 of the Companies Act 2006, “small companies” are companies that satisfy two or more of the following criteria:

• Annual turnover not more than £10.2 million
• A balance sheet total not more than £5.1 million
• Not more than 50 employees.

What should you do now?

Medium or large-sized businesses in the private sector should:

• Undertake an audit of the terms on which the self-employed contractors are engaged under a PSC
• Review how the working relationship operates in practice
• Review the written terms of the contractual relationship
• Issue a Status Determination Statement.

What is a Status Determination Statement (SDS)?

An SDS is a comprehensive statement made by the client who is engaging the contractor, which seeks to declare a contractor’s deemed employment status following an IR35 assessment. The SDS must provide reasons for reaching the conclusion.

From 6 April 2021, an SDS should be completed for each new PSC engagement and each existing PSC engagement due to receive a payment after this date.

Crucially, the legislation states that the requirement for an SDS is not met if the business fails to take ‘reasonable care’ in arriving at its decision. Should this be the case, the client will assume the position for the fee payer, and will therefore assume liability for tax deemed unpaid as a result of the engagement. They also assume responsibility for reporting and deducting tax for payments made to contractors. Consequently, for hiring organisations, providing a valid and accurate SDS is essential to meet statutory obligations and to mitigate any financial risk.

What does failure to take reasonable care mean?

A business could be said to fail to take reasonable care where it makes an IR35 status decision without conducting an assessment, or where it assesses a role and applies the status determination to a number of contractors, rather than looking at each contractor on a case-by-case basis.

Our view is that businesses should review each contract based on the guidance that HMRC has issued, and consider not only the contractual relationship, but also look behind the contract and determine the reality of the situation.

What are the consequences of failing to take reasonable care?

• Responsible for deducting tax from the contractor’s income if deemed to be employed rather than self-employed
• Liable for NIC
• Liable for outstanding tax if HMRC successfully challenges a status decision
• Further potential repercussion; if HMRC investigates because it suspects that reasonable care has not been taken, it may argue that the client has been careless in making the assessment, which means that the liability could go back 6 years rather than 4 years and thereby increasing the tax risk even further.

What should an SDS include?

• It should be in writing (an email will suffice)
• It should identify all parties in the supply chain (contractor, worker and the end client)
• It should start with a finding of the determination i.e. whether work is inside IR35 or not
• It should set out a reasoned argument for the determination outcome
• It should include a process to appeal in the event that the contractor disputes the determination. It should allow a response within 45 days
• It should provide details of the process to determine the outcome.

What will HMRC look at when considering employment status?

The key factor in determining whether IR35 applies is to ignore the existence of the PSC, and then test whether there is an employment relationship (as opposed to a self-employed/consultant relationship). The following factors should be considered when determining whether an employment relationship exists:

Personal service

For a worker to be an employee, the individual must be obliged to provide services personally. If a worker is entitled to provide a substitute to do the work, this may point away from an employment relationship.

Mutuality of obligation

In a typical employment relationship, there will be an obligation on the worker to provide their services and a mutual obligation on the engager to provide the worker with work and pay them for their services. A contractor relationship will not have that obligation.

Right of control

• How — if a client controls an individual and how they do their work, then there is an employment relationship
• What — if a client can move a contractor from one project to another, or instruct them how or when to complete the work, this is a further indicator of control
• When — if a client can dictate when services are delivered, this is an indicator of control and an employment relationship
• Where — if there is no significant reason for an individual to deliver the services at a specific place, and yet the client demands that you do so, this can also be an indicator of an employment relationship

Financial risk

Being subject to financial risk is an indicator of being in business and therefore self-employed. Employees do not usually face personal risk. If a contractor is obliged to fix any errors in their work without charging further fees, this indicates a degree of financial risk. The risk of making loss is a strong indicator of self-employment and can be decisive in its own right.

Integration

Is the individual part and parcel of the organisation? I.e. being managed, having appraisals, attending social events, work email address etc. If so, they are likely to be an employee

Length of contract

Unlikely to be determinative in its own right, but a lengthy contract could establish an employment relationship

Provision of own equipment

A self-employed contractor would generally provide whatever equipment is required to carry out the role.

Benefits

If a contractor does not have the right to any benefits such as holidays, sick pay, pension, private medical insurance etc., they are unlikely to be deemed an employee.

All of the above factors are not exhaustive and, ultimately, HMRC will always look at the actual relationship between the parties rather than exclusively looking at the agreement. It will always help if the agreement reflects the reality and it shows a genuine contractor-client relationship.

What about CEST?

There is an online employment status tool provided by HMRC called CEST. It is designed to be a helpful aid in determining employment status for tax, but there is no obligation to use this online check. HMRC will be bound by the decision if generated through CEST, provided that the answers have been provided accurately.

CEST asks a number of questions largely based around the factors outlined above, namely: aspects of the engagement (e.g. the right of substitution, the tasks that the worker undertakes and the basis on which they undertake them, scheduling, location, provision of equipment, materials and how the worker is paid). There are criticisms regarding CEST as to whether it determines the status correctly.

IR35 is complex legislation and continues to be a challenging area. It highlights the importance for contractors to carry out their due diligence before and during a contract as well. Both contractors and businesses need to be fully aware of the law, and should obtain advice from IR35 experts to ensure they are compliant rather than face significant penalties and fines.