An Essential Guide to IR35: What does your organisation need to know?

First introduced in 2000, the IR35 regime aims to minimise the avoidance of tax and National Insurance Contributions (NICs) where an individual contractor is engaged by a client via the contractor’s own intermediary such as a personal service company (PSC).

Historically, the rules provided that the responsibility for assessing tax status and, where appropriate, deducting income tax and NICs, lay with the PSC (and de facto the individual contractor).

In 2017 this changed for all public sector clients, with the responsibility for assessing tax and making appropriate deductions shifting to the public sector client as the “end-user”. In 2021 we saw the responsibility for determining tax status similarly shifted to both private and third sector clients, with the exception of private and third sector organisations that are classed as small.

Under Liz Truss’ premiership, Kwasi Kwarteng’s Growth Plan 2022 included a headline commitment that from 6 April 2023 contractors would once again bear the responsibility for determining their own tax status, as part of a pledge to cut taxes and reform IR35. Importantly, however, these reforms were repealed before they came into force.

Client organisations (other than businesses and third sector organisations classed as small) are therefore required to determine the correct tax status of any contractors engaged via their own intermediary and, consequently, to pay the correct tax and NICs – including employer NICs and, if applicable, the apprenticeship levy.

How does it work?

Client organisations (other than businesses and third sector organisations classed as small) engaging individual contractors via the contractor’s own intermediary, such as a PSC, are required to carry out an assessment of the contractor’s tax status. This is also the case if there are other parties in the chain, such as agencies.

The steps to carry out your obligations regarding tax status will include:

• Carrying out an employment tax status assessment;
• Confirming your findings to the contractor via a Status Determination Statement (SDS); and
• Putting in place a dispute resolution process in the event that the contractor or another party in the chain disputes your conclusions.

If, following this assessment, the contractor is considered to be in ‘deemed employment’, which means that they would have been considered an employee for tax purposes if they had been providing their services directly to the organisation (rather than through an intermediary), then income tax and NICs will need to be deducted from the fees paid to them for their services.

If the engagement of the contractor is direct (with the contractor via their own PSC) rather than through an agency, you as the client will be responsible for deducting income tax and NICs. As stated previously, employer NICs (and the apprenticeship levy, if applicable) will also be payable.

If the engagement of the contractor is through an agency as another party in the chain, then the agent will be responsible for paying the contractor their fees and, consequently the agent will be responsible for deducting income tax and paying any NICs or apprentice levy.

However, even where an agent is used the client is still the responsible party when it comes to carrying out the SDS and providing a dispute resolution process. The client must notify and provide that SDS to the agency to ensure compliance with its responsibilities. Otherwise, the onus for deducting income tax and paying NICs will remain with the client and not the agency.

It is worth noting that, where an agency is used, HMRC may still transfer the responsibility of paying the correct tax and making NICs to the client in circumstances where there is no reasonable prospect of recovery from the agency by HMRC within a reasonable period.

Could my organisation be affected?

If your organisation engages with contractors and off-payroll workers, you could be impacted by IR35, as it is likely that you will be engaging some individual contractors via their own intermediary such as a PSC.

However, if your organisation is a business or third sector organisation classed as small, IR35 does not apply, and PSCs will continue to be responsible for compliance with the regime. You may be asked to confirm that you have determined that your organisation is small. Small for this purpose is defined in the Companies Act 2006 as an organisation which meets two of the following three criteria for two consecutive years:

• An annual turnover not exceeding £10.2 million
• A balance sheet total not exceeding £5.1 million
• An average over a year of not more than 50 employees

Note here that ‘balance sheet total’ according to HMRC means the total gross amounts shown as assets in the company’s balance sheet before deducting any liabilities.

For charities it is important to note that the definition of ‘turnover’ is intended to have the same meaning as defined in Section 474 of the Companies Act (turnover is the amount derived from the provision of goods or services within the company’s ordinary activities after deduction of trade discounts, VAT and other relevant taxes). Therefore, charities which receive donations and other voluntary income which does not derive from the provision of goods and services, should not count this towards their turnover.

How do we know whether there would have been an employment relationship and if the contractor is in ‘deemed employment’?

Unfortunately, you can’t just rely on what the contract says. To get to the crux of this question, organisations will need to consider the reality of all aspects of an individual contractor’s working arrangements.

Relevant issues that should be considered include:

• Does the client exercise a high level of control over the individual?
• Is there a right of substitution or does the service have to be provided by the individual contractor?
• Is there a mutuality of obligation?  Is the client required to provide work and is the individual contractor required to perform it?
• Is the individual contractor ‘in business on their own account’? i.e. can they make a profit or incur a loss?
• Does the individual contractor provide their own equipment and insurance?
• Is the individual contractor integrated into the workplace? E.g. do they share the same perks as other employees and do they line manage other staff?
• Does the individual contractor work for other clients?
• Are the terms of the contract consistent with an employment relationship?

To assist with determining an individual’s tax status, HMRC has developed an online tool to help clients check the employment tax status of their contractors (Check Employment Status for Tax (CEST)). However, the tool has been criticised for being biased towards making a finding that the off-payroll rules apply (even where a court would disagree). In complex cases, the tool may also conclude that the individual’s status is “undetermined”.

Seeking legal advice and carrying out further analysis will therefore be prudent, particularly in borderline cases or where the parties want to explore what legitimate changes can be made to the relationship such that it does not fall within IR35.

What happens if we conclude that there is an employment relationship for tax purposes?

In the first instance, you will be required to communicate your conclusion to the contractor via a “Status Determination Statement”, along with your reasons. This will be the case whether you find that the individual is genuinely self-employed for tax purposes or if you find that the employment relationship is more closely related to that of an employee. 

The contractor, or any intermediary in the chain responsible for collecting and paying the fees (such as an agency), must be given the opportunity to challenge the status determination.

If the determination is challenged, you must respond within 45 days, either confirming the original determination or replacing it with a new one and giving reasons. Failure to respond within this time frame may increase the tax liability faced by the client.

It may be that both parties are strongly committed to an arrangement that falls outside of IR35. In those cases, it will be appropriate to explore whether the arrangement can be changed such that the contractor’s work is no longer considered ‘Deemed Employment’. This may not always be feasible or realistic.

It is worth noting that an individual may be an employee for tax purposes, but not for employment law purposes. The test under employment law and tax law are not uniform.

How should my organisation prepare?

Dealing with IR35 for the first time is no small task and there are several preparatory steps you can take now to ensure that your organisation is ready:

• Train – Provide training to any parts of your organisation that are proposing to engage contractors to ensure they are familiar with the new requirements.
• Gather information – Establish a process for receiving the information you require from your contractors, e.g. a working practices questionnaire. This will need to be issued to, and completed by, your contractors as well as the manager engaging the contractor (often with HR input).
• Analyse – Analyse the information provided and determine whether the contractor is within IR35. Provide a Status Determination Statement setting out the reasons for your conclusion.
• Resolve – Prepare and publish a Status Disagreement Process.
• Develop – Develop a system for recording and keeping status determinations under review.
• Adapt – Review your current systems (e.g. payroll, contracts) to ensure that they are fit for purpose.

Do you have any top tips?

The IR35 rules are not straightforward and organisations will face a steep learning curve when dealing with the rules for the first time. However, here are our top tips on how to stay compliant with the IR35 rules:

• Take care when determining an individual’s status. If your organisation makes a mistake, it is less likely that HMRC will take an aggressive stance if it can be shown that reasonable care was taken in making and issuing the SDS. This can include seeking legal advice on complex cases.
• Know the limits of the tools you are using. HMRC has acknowledged that the CEST Tool does not always provide the correct answer, therefore, the risks need to be weighed up as to whether a more thorough examination is required by the circumstances.
• Avoid blanket determinations. Not only will it be difficult to demonstrate that there was reasonable care in making the determination, but it can also be particularly damaging to morale and can hinder recruitment efforts.

How can Bates Wells help?

Here at Bates Wells we have a strong team of experienced IR35 experts who are on hand to help organisations understand and ensure compliance with the IR35 rules. We are happy to assist with all stages of the compliance process including:

• preparing a Status Disagreement Policy;
• designing a working practices questionnaire;
• performing status reviews;
• preparing a Status Determination Statement;
• monitoring status determination;
• reviewing contractor agreements; and
• talking through potential changes to your contractor arrangements.

We also offer an in-depth webinar (‘An essential Guide to IR35: What does your organisation need to know?”) and supporting materials such as an employment status checklist and a template SDS. To learn more about having the webinar delivered for your team, please email [email protected].

If you have any questions, or require any assistance, please don’t hesitate to contact Paul Jennings ([email protected]).