Changes to the IR35 Rules Explained
Significant changes are coming to UK employment law, though many firms are dangerously unaware of the impact they will have.
Claire Halle-Smith, Senior Associate in the Commercial Law team at Wright Hassall, explains the new IR35 rules and their implications for businesses.
Anyone reading an article about the new IR35 rules coming into force from 6 April 2021 must be aware about the changes, but this awareness is not universal.
A survey of medium and large construction businesses published in The Construction Index found that 26% of the respondents remained completely unaware of the changes, while only 44% were aware they needed to prepare and had begun doing so.
The fact that only 24% of the businesses actually understand the new guidelines is particularly concerning, given that the changes were originally intended to come into force in April 2020 and were postponed due to the impact of COVID-19.
Personal service companies confuse the picture
The introduction of IR35 in April 2000 was prompted by the rise of what HMRC dubbed ‘personal service companies’ (PSC). Whilst there is no legal definition, a PSC is generally considered to be a limited company with a sole director, usually a contractor, who owns most or all of the shares.
The publicity surrounding PSCs focuses on the tax advantages for the contractor themselves and their end-user clients, often ignoring that for many contractors, setting up as a PSC is a necessity as much as a choice. Clients take all the steps they can to ensure that there is no risk of a contract of service existing between themselves and the contractor, which is why many will refuse to work with contractors who aren’t set up as PSCs. This enables them to enter into a contract for services with a limited company rather than an individual, thus avoiding obligations such as Class 1 National Insurance Contributions.
A PSC is generally considered to be a limited company with a sole director, usually a contractor, who owns most or all of the shares.
IR35 was introduced because HMRC believed PSCs were being used mainly as tax avoidance vehicles, enabling businesses to effectively recruit employees but have them operate as contractors. The introduction proved to be highly controversial, with a representative group for contractors and freelancers seeking a judicial review, but losing in the High Court and on appeal.
By 2015 HMRC had become convinced IR35 was proving ineffective and too easily circumvented, which resulted in a change in the law which meant from 6 April 2017, the responsibility fell on public sector clients to decide whether their workers fell under the auspices of IR35 or not. If it was decided contractors were in fact employees, the client would become responsible for operating IR35 and deducting PAYE and National Insurance at source. From 6 April 2021 the same responsibility will fall upon large and medium sized businesses acting in the private sector.
There are exemptions to this rule for companies which meet at least two of these criteria:
- Having an annual turnover under £10.2 million
- Having a balance sheet total of less than £5.1 million
- Employing fewer than 50 people
Beyond these exemptions all organisations utilising contractors will be responsible for determining precisely what the nature of their employment relationship is.
HMRC learning from past mistakes
When HMRC has challenged organisations or contractors over the insistence that the relationship was not one of employer/employee – including cases such as Christa Ackroyd Media Ltd vs HMRC (2017) and Kickabout Productions Ltd vs HMRC the factors involved were generally:
- The level of control the organisation has over the contractor, including determining the nature of the work itself and when and where it takes place
- Whether the contractor would be able to substitute another suitably qualified person in their place
- The degree of financial risk carried by the contractor
- The concept of mutuality of obligation (MOO), where the organisation is obliged to give work to the contractor and the contractor is obliged to undertake that work
It should be pointed out that the online HMRC test which can be used to check employment status (CEST) doesn’t include any reference to MOO, because HMRC assumes this to be an integral part of any contractor engagement.7
Determine the employment status
Once an organisation has determined what the employment status of a contractor is, they have to provide a Status Determination Statement (SDS) which sets out the employment status of the contractor, as well as explaining how this decision was reached.
Until this is done and the contractor or any intermediary agency has received an SDS, the presumption on the part of HMRC will be that the organisation is liable for tax and NI contributions.
Although HMRC have stated that they will operate a light touch approach to issuing penalties for non-compliance with the new rules during the first 12 months, they will still actively pursue any tax which remains unpaid through non-compliance with IR35.
Many of the cases brought on this basis by HMRC have failed, but there can be little doubt they will have learned from their mistakes and any organisation seeking to avoid being caught out by IR35 needs to start working now to revise their employment policies in light of expert legal advice.
Amongst the more obvious steps which organisations and contractors can take in order to ensure that they stay outside IR35 are the following:
- Contractors should take out indemnity insurance
- The contractor should be taken on to work on defined contracts with clear end-points and deadlines
- The contractor should have zero access to employee ‘perks’ such as gym membership and invites to the Christmas party, as well as more fundamental signifiers of employment like pension contributions, paid holidays, sick pay and private healthcare
- Contractors should not utilise internal organisational communication channels, meaning they shouldn’t be given company email addresses or added to company tools such as Slack
- The ability of a consultant or contractor to substitute another in their place to deliver the services, is often considered one of the main indicators of true self-employed status.
The simple conclusion is to not be tempted to bypass IR35 by other means and treat any advice to implement a tax avoidance scheme with considerable caution, as most do not deliver the required outcome and do not have HMRC’s blessing.