6 April 2021 saw the IR35 regime change for large or medium sized private and third sector organisations. As the first year anniversary of these changes approaches, in this and subsequent articles, we consider the impact the changes have had so far.
For our first article in the series, we consider whether organisations are applying the rules correctly and what common mistakes are being made. Subsequent articles will consider how effective the new rules are, what approach tribunals and HM Revenue & Customs (HMRC) are taking to enforcement, where this leaves contractors generally and what organisations need to be on the lookout for when taking on a new business.
Summary of the changes
As a reminder, since 6 April 2021, where a consultant provides services through an intermediary, such as a personal service company (PSC), the end user client must determine the tax status of the consultant. The end user client must then inform both the individual and the party with whom the end user contracts of the outcome and the reasons for it in a status determination statement.
If, because of that determination, there is deemed employment status for tax purposes, the fee payer (being the party immediately above the intermediary in the contractual chain) must account for payroll taxes in respect of payments made to the intermediary. Liability for accounting for payroll taxes can pass up the contractual chain to the end user client if the fee payer does not meet its obligations. So where are organisations falling foul of the rules?
In the run up to the changes in the IR35 regime, HMRC announced that it had updated Check Employment Status for Tax (CEST), its tool for helping organisations to determine whether a consultant has deemed employment status for tax purposes. Taking the organisation through a series of questions, CEST then gives a decision on whether there is deemed employment status. Although there is no obligation on organisations to use the CEST tool, if they do, they are entitled to rely on the outcome, provided they have answered the questions accurately, honestly and with reasonable care. For many organisations, this appears to make the process very simple. However, there is a danger in relying too much on CEST.
Firstly, several the questions asked are open to interpretation or misunderstanding. It is essential that CEST is completed using HMRC’s employment status manual as guidance to try and reduce such errors but even then, misunderstandings can occur. Not only can this undermine the outcome of CEST but can also mean that HMRC will not stand by the outcome on the basis it will argue the questions have not been answered accurately. Secondly, in many cases, CEST will be unable to provide a conclusive answer, meaning that organisations have no option but to look elsewhere to help make a status determination.
Passing responsibility onto others
It can be difficult for an end user client to complete the CEST questionnaire or reasonably carry out a status determination where they do not have access to the necessary information about the way the contractor is working. This can be particularly difficult where there are complex supply chains and information is not readily available.
As a result, many organisations ask the intermediary or consultant to carry out the status determination themselves and simply rubber stamp the outcome presented to them, without checking how the determination has been carried out or whether both the contractual terms as well as what happens in practice has been taken into account.
Such an approach is unlikely to meet the test of ‘reasonable care’ which an end user client is required to take when carrying out the status determination and this could have significant consequences for the end user client, not least because it can result in them becoming responsible for the payroll taxes themselves.
As a result, organisations should have clear contractual provisions requiring the intermediary and/or consultant to provide the necessary information to enable the end user client to carry out the status determination and to keep that information updated throughout the term of the engagement. Where there are complex contractual supply chains, such clauses should also include a requirement on any contracting party to have reciprocal provisions in the agreements they have down the contractual chain.
Many organisations have been tempted to take a blanket approach to determining the status of any contractors they engage via an intermediary. Rather than carrying out a status determination in respect of each separate engagement, organisations have decided to treat all contractors as either inside or outside the IR35 regime.
However, HMRC has frowned upon such an approach as employment status will differ from contractor to contractor depending on the particular facts of each case. Indeed, even apparently similar facts can result in different outcomes. As a result, such an approach is unlikely to pass the ‘reasonable care’ test and again can result in liability for tax remaining with the end user client.
Equally, many individuals will not want to be deemed employees for tax purposes and simply classifying them as such to avoid going through a status determination process is likely to result in contractors leaving or refusing to take on work.
Using schemes to avoid IR35
Whilst there are many schemes that have been set up to help organisations with IR35 compliance, some of these constitute tax avoidance schemes and organisations need to be wary of falling into the trap of using them.
For instance, some schemes attempt to use workers engaged overseas. Another popular arrangement is the use of an umbrella company. The umbrella company employs the contractor and is responsible for paying a salary to the consultant, making the appropriate deductions for tax and providing them with applicable benefits such as paid holiday. Whilst many such arrangements are compliant with tax rules, some use tax avoidance schemes, such as passing on earnings other than through salary. End user clients should ensure they carry out proper due diligence on the contractual chain to understand whether such arrangements are genuine or not.
Failure to train
Another common area causing compliance issues is a failure to properly train those within the organisation who may engage contractors in what they need to consider and the steps they need to take prior to the engagement starting. Many organisations leave it up to HR but this is not always appropriate and HR may not always be aware of what recruitment is taking place.
It is important that recruiting managers understand the situations in which the IR35 regime may apply, and the need to complete a status determination, so that they are properly equipped to identify potential issues and understand the impact of the decisions they take.
Our next article in the series will look at what approach HMRC is taking to IR35 in the private sector and how the tax tribunals are responding to the new regime.