In our last article IR35 Tax Reforms-The Essentials (Part 1), we looked at the changes to IR35 coming in on 6 April 2021 for the private sector. In Part 2 we focus on the determination of employment status and the practical implications of the new rules.
IR35 comes into force on April 1 next year and with it a number of changes. In our second article, we focus on the determination of employment status and the practical implications of the new rules.
What are the considerations for making an employment status determination?
A client will need to carefully consider both the written contract detailing the arrangements for the provision of the services as well as usual day-to-day working practices of the arrangement.
The three main factors determining employment status are whether there is mutuality of obligation between the parties, how much control each party has over the engagement, and the extent personal service is provided and whether there is a right of substitution. Other factors such as financial risk and integration into the business will be relevant, but there is no definitive list to tick off. The tax tribunals have consistently stated that all factors must be considered, and a picture painted of the whole arrangement to arrive at an employment status determination.
Point of note
It is important that as well as the written contractual terms demonstrating a relationship with a self-employed worker, the day-to-day working practices and the practical reality of the arrangement align with the written terms, for self-employed status to remain upon status determination.
How would an employment status determination be made?
HMRC has developed an online tool on their website, known as the Check Employment Status for Tax (CEST) tool, to support clients in making employment status determinations. Following concerns raised about its reliability, CEST was enhanced and updated in November 2019. CEST should be completed using HMRC’s employment status manual as guidance. The CEST tool should be used when entering into each new engagement with a contractor, and re-run if the working practices or terms of the engagement change.
HMRC has committed to standing by the results reached by CEST, if questions have been answered accurately, honestly and with reasonable care, and if CEST is used in accordance with the guidance issued by HMRC. A CEST outcome can be used as a valid status determination statement.
In some cases, CEST will be unable to provide a conclusive answer and clients will need to consider further factors of the working relationship to arrive at its own conclusion.
Shoosmiths has prepared its own questionnaire and detailed guidance on the relevant factors to be considered, and we are regularly supporting clients to help them reach a conclusion on employment status.
Points of note
Whilst the government will stand by CEST results, crucially, CEST does not contain any question of mutuality of obligation, one of the decisive factors relied on by tax tribunals in employment status cases, and CEST has been criticised for remaining so reliant on the right of substitution. Despite its recent update, CEST continues to be difficult to navigate, with questions giving rise to different forms of interpretation. The use of CEST may need to be supplemented by additional advice in arrangements which are more than completely straightforward.
The government has recognised that there remain some concerns over whether using CEST would be sufficient to demonstrate ‘reasonable care’ and also about HMRC’s understanding of mutuality of obligation; this may indicate further amendments to CEST are to come.
What will be the risk of getting it wrong?
Clients must take ‘reasonable care’ when making employment status determinations. HMRC’s employment status manual clarifies that clients should “act in a way that would be expected of a prudent and reasonable person” in the client’s position, and this will be interpreted differently, depending on a client’s circumstances, experience and abilities. For example, a larger organisation would be expected to take a greater degree of care, than a relatively smaller one.
HMRC has also provided a non-exhaustive list of what would amount to not taking reasonable care, including:
- blanketly applying determinations and not considering the different working arrangements for each worker;
- inputting inaccurate information in CEST;
- the individual tasked with completing a status determination statement not possessing the knowledge required to complete it or does not have the necessary level of support;
- absence of any proper training.
Clients who fail to take reasonable care will be responsible for the employment taxes and any apprenticeship levy, even if they are not the fee-payer.
Point of note
In order to allow for businesses to adjust, no penalties will be imposed on clients for errors relating to off-payroll in the first year from the introduction of the new rules, except in cases of deliberate non-compliance. HMRC has also previously made promises to focus on educating businesses, including helping Clients to correct errors when these have been identified and to ensure status determinations are correct going forwards.
Can a SDS be challenged?
Either the contractor or the fee-payer has the right to appeal the SDS.
Legislative requirements are minimal. The appeal may be made verbally or in writing. The client must review its decision and respond (stating reasons) to the appeal within 45 days of receiving it. During this time, the client should continue to apply the rules in line with their original determination. Following the review, a client needs to confirm whether or not the determination has changed. If the client agrees that the original SDS was wrong, it must issue a new SDS confirming the date from which it is valid and state the withdrawal of the original SDS. If it misses the deadline, the client will be treated as the fee-payer.
A disagreement regarding a status determination can be made at any time until the last payment is made for the worker’s services. Failure to respond within the 45 days will result in the contractor’s tax and National Insurance contributions becoming the client’s responsibility.
Point of note
Clients should ensure compliant policies and procedures are in place to determine how to resolve any disputes and specifying clear time limits for which the worker or fee-payer must challenge the status determination outcome reached.
Will the new rules apply if the supply chain is based outside of the UK?
The rules will not apply to clients or agents who are offshore businesses with no UK presence; the individual contractor would still have to apply the old IR35 rules.
Where the client has a UK presence and the contractor is based outside the UK, whether the new rules apply largely depends on where they are paying their taxes. If a contractor is subject to UK tax and NICs, then the engagement will be subject to the new rules. This is a complex area and would most likely require an examination of the specific setup and circumstances of the respective parties.
Point of note
In more complex chains where there are offshore agencies involved, including an off-shore fee-payer, the liability to account to HMRC for any appropriate taxes moves to the next UK person above them in the supply chain.
Where there is an offshore agency in between two UK agencies, the first UK agency will need to ensure that the SDS is passed to the next UK agency lower down in the supply chain in order to avoid liability as fee-payer.
Further considerations in tackling IR35
In summary, therefore, organisations are well advised to carry out the following steps in order to prepare for April:
- Carry out a full audit of their existing contractor workforce, to identify who may be subject to a status determination under the new rules;
- Open dialogue with contractors who have been identified as having employee status for tax purposes, as part of the process of identifying the way forward;
- Implement an IR35 policy and procedure for a consistent approach to the on-boarding and use of contractors;
- Train managers on IR35 compliance;
- Keep detailed records of all decisions and processes, including a live up-to-date list of contractual arrangements and the individuals involved so that you know the extent of your off-payroll workforce; there is an ongoing duty to review the ‘status’ of the relationship, if there are any changes to the nature of the work that should be taken into account and considered;
- Review contracts with any third-party agency/intermediary to ensure relevant warranties and indemnities are provided in respect of IR35 compliance obligations;
- Update privacy notices to provide for sharing of information under IR35;
- Assess the financial impact of the new rules to help you inform your future approach to the structure of your workforce and how business need may be met. Costs will inevitably increase where there is deemed employee status due to the increased tax burden on the contractor and employer NICs borne by the fee-payer. Considerations include:
- deciding which party/parties will bear the increase in costs;
- whether to terminate engagements and re-engage individuals on employment contracts, providing them with statutory employment rights. Whilst IR35 and the new rules determine employment status for tax purposes only, there is a large overlap of determining factors (for example, mutuality of obligation, control, personal service) on employment status in employment law tribunal cases; recent cases have found contractors to be workers, entitling them to backdated holiday pay. Individuals who are found to have employee status for tax purposes may be inclined to claim they are an employee with unfair dismissal rights on termination of an engagement, if they continue to contract through their PSC. By terminating the contractor contract and re-engaging as an employee, this eliminates the risk of workers asserting either during or at the end of the engagement;
- whether the way the engagement is delivered may be restructured, to put the contractor into self-employed status;
- outsourcing any deliverable, outcome-based work which does not require personal service to be given, eliminating the need to make employment status determinations.
Click here for the first part in the series, a look at the private sector.