How NOT to let IR35 ruin your business

IR35 is putting your business at risk

You’re probably already aware of the changes to IR35 that are coming in from April 2020. Organisations like yours who use contractors are going to be responsible for making complex employment status determinations on all engagements with ‘off-payroll workers”. If you get those determinations wrong, there are commercial and legal risks, as well as regulatory ones.

How will IR35 work post April 2020?

If the hiring organisation decides an engagement is outside of IR35 it can continue to pay a limited company contractor as before – gross, without making deductions for tax. If the hiring organisation decides IR35 does apply, it must ensure employment taxes are deducted from payments to the contractor. In other words, the contractor must be paid through the RTI system, just like employees.

Whether they determine IR35 does apply, or it doesn’t, there are potentially massive risks for your business.

Inside IR35

If you decide IR35 does apply, there is little risk of disagreement from HMRC, but there are significant commercial, resourcing and even legal risks.

Financial risks

If IR35 is applied, employment taxes and National Insurance Contributions must be paid. This includes Employers’ NI which is 13.8% on top of the amount paid to the contractor. The hiring organisation, which could now be deemed the ‘employer’ for tax purposes, will have to find an additional 13.8% in order to pay contractors – it’s a significant increase and will very clearly impact the ability of companies to hire the contractors they need.

Contractors will have to pay more tax too, and their businesses can no longer pay for legitimate expenses such as training, travel, equipment, business insurances and accountancy fees. This could make the engagement unviable for them, unless the hiring organisation is prepared to increase the amount it pays them. If IR35 is applied, hiring organisations will face pressure from contractors to increase their day rates, or risk the contractors simply terminating their engagements leaving your business without adequate resource.

There is also a risk that the supply chain fails to comply with the determination. If an agency or umbrella company pays the contractor, they are known as the ‘feepayer’. They must ensure the tax is deducted on any payments where the end-client (you) has determined IR35 applies, or take on the liability. But if HMRC cannot recoup the tax from that agency or umbrella company, the liability can and will transfer back up to you. So, there is a risk your business could be held liable, even when it has determined IR35 applies.

Resourcing risks

Many hiring organisations have made good use of contractors, enabling them to cope with peaks and troughs in demand and draft in expertise for specific projects, as and when it is needed. The flow of this flexible resource will be disrupted by an over-zealous approach to IR35 compliance.

Some organisations have already indicated they will not engage contractors on an outside IR35 basis at all. This approach is unnecessarily extreme and will result in good contractors simply seeking work elsewhere. 

In the public sector, where these rules have been in place since 2017, hiring organisations experienced significant difficulties as a result. According to research by the Chartered Institute of Professional Development, 75% of hiring managers in the public sector said it had become harder to recruit contractors, while 71% reported difficulties retaining contractors.

Commercial risks

Hiring organisations may be tempted to take an unthinking and hard-line approach on IR35, applying it to the majority of their engagements, without considering the facts. This is known as blanket assessment. But just because one company takes this stance, it doesn’t mean their competitors will. 

Once it becomes clear to contractors that working with Company X is likely to result in IR35 being applied, whereas competitor Company Y are taking a more pragmatic approach, they will go to Company Y. 

Hiring organisations that blanket assess engagements risk losing ground to their competitors who will attract the best contractors.

Legal risks

In order to determine whether IR35 applies, hiring organisations must assess the employment status of the worker. Broadly speaking, IR35 applies where the engagement has characteristics that are overwhelmingly consistent with employment. So, when a hiring organisation decides IR35 applies, it is essentially saying, ‘the worker acts like an employee, and we act the employer’. This leaves hiring organisations open to employment rights claims by the worker. 

IPSE has already successfully backed its members in making employment rights claims against their client when IR35 has been applied. In one case we even won a settlement from a member’s end-client – HMRC itself! We will keep backing these claims, and to offer guidance on how contractors can make claims of this nature for themsleves.

Outside IR35

If the hiring organisation decides IR35 does not apply, there is a risk that HMRC will disagree. The hiring organisation could then be held liable for the employment taxes which HMRC believe should have been deducted at source from payments made to the contractor. This risk can be managed and IPSE can show you how

Understanding IR35

IR35 is complicated, but a little bit of knowledge goes a long way. The main thing to remember is, it is perfectly possible to hire a contractor, place the engagement outside of IR35 and be fully compliant with the rules. There are three main factors to consider when determining IR35 status:

1.     Can the worker send a substitute to do the work for them? If they can IR35 does not apply. If they cannot, move on to question two.

2.     Does the worker have control over how, when and where the work is done? If they have control, IR35 does not apply. If the client has control, move on to question three.

3.     Does ‘mutuality of obligation’ (MOO) exist between the worker and the client? This is the most difficult of the three concepts to understand and the meaning of MOO is disputed. HMRC say MOO always exists when there is a contract in place, however, the courts have consistently rubbished this view. The best way to think about MOO is to consider whether the hiring organisation is obliged to offer work beyond the agreed project, and whether, having been offered it, the worker is obliged to accept it. If the obligations between the parties do not extend to this, MOO is not present and IR35 does not apply.

If any one of the above three can be demonstrated at a tax tribunal, the tribunal will find that IR35 does not apply. This is the key to IR35 compliance.

Get a good contract in place

You will need clear and strong contracts in place that reinforce the decisions you make about the IR35 status of your contractors. Working with the renowned legal practice, Travers Smith LLP, we have developed a suite of template contracts that will enable your business to remain compliant whilst also attracting much needed freelance talent. This service is completely free to you.

Your business must be careful to ensure that contracts are clear on the services that the contractor will deliver, in order to ensure a smooth commercial relationship and avoid disputes later in the day. The contract must also be clear in defining the relationship between the contractor and the client, thus avoiding falling foul of IR35.

Statement of Work (SOW) contracts are another alternative, and could be helpful as a strong pointer away from IR35, but a contract alone will not determine the status of an engagement. The actual, on-the-ground, working practices must back up what it says in the contract.

Ensure the working practices are consistent with the contract

If the contract clearly defines the project, or states the worker will have control over how the work is done, or indeed, that the worker has a right to send a substitute, then it is important that the engagement operates in accordance with those principles. Essentially it should be clear to everyone inside the organisation that the contractor is not treated as ‘one of the team’ or just another employee. They are there to provide a specific service, as stated in the contract, and the parties should act in accordance with that agreement.

It’s also important that the parties are careful to ensure that contractors are treated differently to employees. As a rule of thumb they should not:

·       Have a line manager – though it would be expected for them to have a ‘client contact’

·       Have line manager responsibilities for other staff

·       Make use of company facilities e.g. gym, canteen or even car park

·       Be provided with an employee pass – they may have to sign in, every day, if required

·       Be provided with employee-type benefits such as sick pay and holiday pay

HMRC are not the arbitrators of IR35 – that is for the courts

HMRC is just as confused about IR35 as everyone else and frequently get it wrong. Of the eight IR35 cases that have gone to tribunal since 2018, HMRC has lost six of them. HMRC have been trying to tell contractors that IR35 applies to their engagements for the last twenty years, and IPSE have helped them to defend themselves. IPSE can help hiring organisations too.

It is almost certain that HMRC will pressure hiring organisations to place their engagements inside IR35, but that is not their decision. It is up to hiring organisations to decide status and when those decisions are questioned it will ultimately be the courts that do the questioning, not HMRC.

Use the CEST tool sparingly

When the government changed the rules in the public sector it brought out the Check Employment Status for Tax (CEST) tool. CEST is an online tool that asks a series of questions about an engagement and, in 85% of cases generates a determination. It has been roundly criticised by experts for its inaccuracy, but it has been used by several public sector clients who are attracted by HMRC’s commitment to ‘stand by the results of CEST’. 

CEST is not mandatory and HMRC do not keep a record of the results. If you use it and it provides the result you want, it might be helpful to keep it on file. If you disagree with the result generated by CEST, you do not have to tell HMRC that you used it at all.

In almost every case, there are better ways to determine IR35 status. Following the guidance above is a good place to start.

About IPSE

IPSE, the Association of Independent Professionals and the Self Employed, is the voice of the UK’s self-employed population who make up one in seven people working today. We were formed twenty years ago in direct opposition to IR35 and have been helping our members with IR35 compliance ever since. IPSE has approximately 74,000 members and associates.

IPSE is here to help

IPSE has unparalleled experience in defending our members against HMRC and helping them to stay on the right side of IR35. We can help hiring organisations too.

IPSE wants to enable hiring organisations to safely keep engaging their contingent workforces, avoid losing the contractors they need, avoid legal disputes over employment rights, and remain fully compliant with IR35

Call IPSE today at 020 8897 9970 and ask for our IR35 compliant contract templates to ensure you are prepared.