The way that IR35 legislation will be applied to the private sector will change next year.
Around 35% of the workers we place with our clients here at Vallum are placed as contractors rather than permanent employees. Increasingly, our clients and contractors alike are asking what IR35 means for them. This article aims to provide a brief overview of what the changes might look like. I say might, because the government has not yet published any formal guidance, but assuming that the changes impact the private sector the same way they have impacted the public sector, here are a few things to keep in mind.
Disclaimer: This is NOT legal advice and should not be relied upon as such. It is an overview of Vallum’s current understanding and preparation for IR35.
Note: The term ‘worker’ is used in the article to mean a person who might be considered either a ‘contractor’ outside of the rules of IR35 OR a ‘disguised employee’ inside the rules of IR35
The term ‘client business’ is used to mean the business that is either engaging or complying the worker.
What is IR35?
IR35 (intermediaries legislation) is a tax law that came into force in April 2000.
It was designed to deal with the (perceived) problem of ‘disguised employment’ where a worker provides services to a client business through an intermediary e.g. a personal services company (PSC) or other limited company; but would be considered an employee if that intermediary did not exist.
Disguised employment is targeted by HMRC because:
A client business could engage ‘disguised employees’ and so evade paying employer NICs and employee benefits
A disguised employee pays significantly lower income tax and NICs than an employee.
HMRC IR35 inspectors can investigate records going back 6 years, which can have significant financial impact on any contractor or company caught by IR35. Disguised employees caught out by IR35 can expect their income to drop by up to 25%.
IR35 legislation has attracted considerable criticism as a confusing and ineffective piece of legislation. When it was first implemented, the then chancellor, Gordon Brown anticipated it would bring in an additional £200 million per year in NICs. While the government has been reluctant to release figures, a Professional Contractor Group’s freedom of information request revealed that between 2002/3 and 2007/8 only an additional £1.5 million was collected through IR35. However, this criticism has not been heeded by any subsequent government.
IR35 has been in place since 2000, so why the fuss now?
In April 2017, new legislation, referred to by HMRC to as ‘off payroll working rules’ was applied in the public sector.
The most recent budget confirmed that ‘off payroll working rules’ will be applied to the private sector in in April 2020.
This new legislation changes the way IR35 is enforced, and shifts the responsibility away from HMRC and onto the client business. In practice this means that the final determination of the worker’s status will be determined by the client business, and not by the worker.
The legislation puts the burden of responsibility of determining IR35 status on the entity that pays the worker. For workers placed through recruitment agencies, this means that the recruitment agency will be liable.
Things we (think) we know about how IR35 will apply to the private sector
The budget confirmed that IR35 will apply to the private sector in April 2020.
It won’t be retroactive.
It won’t apply to client businesses where two or more of the following apply:
Annual turnover under £10.2M
A balance sheet under £5.1M
Under 50 employees.
In these cases the PSC (the worker’s limited company) rather than the client business will continue to decide whether IR35 applies.
Client businesses larger than this (medium and large companies) will decide whether IR35 applies.
Where they determine that a worker is ‘inside’ IR35, then the entity paying them, either the client business or, if applicable, the recruitment agency, will be responsible for deducting PAYE and NICs
In what circumstances will IR35 apply?
The worker provides services to a client business through a PCS (personal services company)
The worker personally performs these services and and/or is under an obligation to personally perform these services for the client business.
The contract under which these services are performed is not between the worker and the client business but through an intermediary e.g. a PCS or other limited company.
The terms of the contract are such that if the worker’s services were provided directly under a contract with the client business, the worker would be considered an employee of the client business or a holder of an office in the client business
The IR35 ‘test’
A worker will be less likely to be considered to be inside the IR35 criteria in these circumstances:
Substitution: IR35 will be less likely to apply where a personal service by the worker is not required by the client business, and the the worker has the option to send a substitute in their place.
Control: IR35 will be less likely to apply where the client business does not have significant degree of control over what, how, when and where the worker completes the work
Mutuality of obligation: IR35 will be less likely to apply where the client business is not obliged to offer work, and the worker is not obligated to accept it.
Financial Risk: IR35 will be less likely to apply where the worker is in a role where they claim significant expenses and/or risk significant costs to rectify any errors they make.
‘Part and Parcel’: IR35 will be less likely to apply where the worker’s role is not a ‘part and parcel’ of the client business’s organisation structure: i.e. not fulfilling key role in the structure of the business.
Other factors: IR35 will be less likely to apply where there are no other factors that make a worker’s contract resemble employment e.g. clauses in the contract as to a notice period, the provision of a uniform or equipment etc.
These criteria are flexible, and in practice HMRC have had leeway to interpret them as they see fit.
The HMRC CEST Test
The HMRC ‘CEST Tool’ is a quick self-test workers can use to see if they are outside HMRC. It has been widely criticised by contractors and their agents.
Under the CEST test, IR 35 does not apply if the worker
Has a clear right of substitution
Is independent from control in terms of how they fulfil the contract
Is undertaking a financial risk
Unless all criteria are met, IR35 is assumed to apply to the worker
Most workers will NOT ‘pass’ the CEST test, but many more will be found to be outside IR35 when assessed in more depth (by an expert)
Even when a worker legitimately passes the CEST test, these results have been overruled by HMRC and by the courts in cases involving the public sector. The CEST test has been shown to be unreliable using HMRC’s own data, so cannot be relied upon as anything more than an indicator (at best).
The client business’s responsibilities
These responsibilities apply to clients in the public sector. It is not certain that they will be duplicated exactly for the private sector, but it is likely.
The legislation puts the burden of responsibility of determining IR35 status on the entity that pays the worker. This will be the client business or, for workers placed through recruitment agencies, the recruitment agency is likely to be liable. In practice, the recruitment agency will ask the client to provide an opinion on IR35 status, and at Vallum we are establishing a way to work with our clients to make this process as simple as possible.
The entity that pays the contractor (if it is not the client business) can request the client business’s view on whether a worker is within IR35 in writing. The client business is statutorily obligated to provide an answer within 31 days.
The client business is assumed to be an employer and the worker is assumed to be inside IR35 if no response is received.
The client business must take ‘reasonable care’ in determining if a contractor is inside or outside of IR35. Again, at Vallum, we are working with our clients to make this process as straightforward as possible.
The fee payer’s (client business or recruitment agency) responsibilities when a worker is inside IR35
These responsibilities apply to clients in the public sector. Again, it is not certain that they will be duplicated exactly for the private sector, but it is likely.
The legislation puts the burden of responsibility of determining IR35 status on the entity that pays the contractor. For contractors placed through recruitment agencies, this means that the recruitment agency will be liable for that determination.
The fee payer is required to treat all payments to the contractor as earnings, deduct VAT and expenses and then apply employment income tax and NIC’s on the contractor’s fees.
The fee payer is required to pay the tax and NICs as well as employer NICs to HMRC through the RTI system.
The question of whether the fee payer will also be accountable for
the NICs will depend on the contract, but it is possible (and something the client business’s will probably push for in any given contract)
What does this mean for recruitment agencies? For workers placed as contractors with a client business outside of IR35, recruitment agencies need to:
Be able to demonstrate that they have done due diligence in classifying a job as being outside IR35. This is their liability NOT the client business’s (albeit that agencies will likely seek client business’s view and in most cases be guided by it).
Have written confirmation from the client business that the worker’s job is considered by them to be outside IR35.
Have confirmation from the worker that they are operating through an intermediary e.g. a PSC.
Have written confirmation from the worker that they have been assessed and are happy operating outside of IR35 (most will not wish to operate any other way).
Continue to submit VAT returns and EI reporting in respect of the business client’s payments to the contractor.
Ensure that the contract between the recruitment agency and the worker mitigates risk by:
Defining the worker’s status as a contractor operating outside payroll in unambiguous terms
Defines the worker’s responsibility for actions or omissions on assignment
Stipulates that the recruitment agency “
(The recruitment agency)
(The recruitment agency)
Ensures that they are properly indemnified against any risk of liability for both direct and indirect losses caused to the client by the worker.
For workers placed as contractors inside of IR35 legislation (disguised employees), recruitment agencies will need to
Assume accountability for the worker’s pay, deducting the VAT, and expenses, then deducting income tax and NIC’s.
Assume accountability for deducting the client’s employer NIC’s and – potentially – funding the employer’s NIC’s
This is likely to:
Pressure recruitment agencies to increase their margins and costs
Put pressure on recruitment agencies to protect their cash flow to invoice for pay at the same time (in facts a few days before) the worker is due theirs.
Require recruitment agencies to accept liability for, and insure against, loss, whether direct or indirect, caused by the worker to the client business
Require recruitment agencies to review their insurance portfolio to make sure that it provides the right cover for all eventualities in the case of placing contractors inside of IR35.
The reality is that most client businesses will not wish to take on workers inside of IR35 legislation, most workers who operate as contractors will not wish to accept such work, and most recruitment agencies, if they are involved, will not wish to continue their involvement in such an arrangement.
At Vallum, we are and will continue to work hard to ensure our clients and our contractors are as informed and prepared for IR35 as is possible. Contact us at [email protected] to find out more.