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IR35 Demystified

Katherine Miller

03 February 2021

by Katherine Miller

( Words)

Most people are aware of IR35 and how it works now, but a lot has happened since it was first announced. Our recent IR35 Demystified event discussed common topics of confusion for employers and end users ahead of April’s implementation. To read general advice and FAQs for clients and contractors, please head to our IR35 hub.

In this blog:

How ready is the private sector for the upcoming IR35 changes?

According to a survey of more than 3,000 contractors by IR35 Shield, 52% of those currently in work are yet to have their IR35 status assessed by their client. Although this still leaves a lot to be done, considering COVID and general tendency in many companies to leave assessment to the last minute, this number is encouraging.

Compared to last year, clients are leaving it a bit later to start assessing – we’ve only really seen increased pick-up in the past month or so. COVID pressures and market speculation as to whether it will actually go ahead mean people are delaying, however our experts advise that this is a risky idea – lots of admin may be required post-determination so companies need to factor this in to their processes.

If you haven’t started IR35 proceedings yet, it’s crucial to take action now. Speak to our in-house IR35 specialist Katherine Miller to learn how we can help you.

Should I outsource assessment to ensure minimal risk?

Although there are lots of offerings in this space from external companies, some may still be unreliable providers who want to be an intermediary for the sake of margins, so exercise caution. Nevertheless, the majority of assessment providers are reliable and a good way to save money if you have a lot of contractors. Our experts advise double-checking outcomes on a random sample audit, as the Criminal Finances Act requires end users to take reasonable steps to avoid tax evasion.

Employers should also consider the operational and financial risks tied to working with a third party – if they get it wrong, their PI cover won’t necessarily give you a payout, so you need to ensure they’re reputable and take an active role in the process for the sake of due diligence and having the right oversight. Primary liability still lies with the end users and, in the case of IR35, suing for negligence is not easy.

For any insurance-led assessments, it is also advised to exercise caution, as there may be implications under the 2006 Managed Service Company (MSC) legislation. We suggest speaking to your internal legal team or reaching out to us for more detail in this area.

If you do everything correctly, you don’t need insurance, but firms like IR35Shield can provide this as an add-on if needed. Firms should be careful to avoid appearing to be in the area where they’re not paying tax and think they can insure against this, and equally, any insurance should be a safety net that backs up due care and diligence.

Above all, employers should ensure that any services they use are not in any way marketed towards helping contractors to operate outside of IR35, as this is difficult to justify to a judge!

 

Is HMRC trying to make PSCs an unviable option for end users?

Although the new legislation may seem to many end users as being a deterrent from using PSCs, this is not HMRC’s objective; the intention is to make sure that tax rules are applied properly.

Previously, when left to individual contractors, many were taking risks due to not thinking they’ll get caught or not understanding the risk in the first place. As such, our experts believe that the changing view among employers is due to the changing risk profile. HMRC believes that 25% of the contractor market should be outside, and that clients can engage with PSCs if they’ve taken reasonable care to ensure contractors are outside. Some risk-averse companies will choose to not take the risk at all, but this is a personal choice.

Due to macro trends and external factors such as COVID however, all businesses are currently forced to look at how they engage workers. With many looking at employing temporary or flexible labour workers, use of PSCs and contingent workers will likely still grow.

 

What can we expect to see after IR35 comes into effect?

Due to the evolving risk profile and uncertainty around how strict the new legislation is, we can expect to see an initial decrease in PSC use by end users, but this should steadily increase over time as we become more comfortable with the rules.

For those continuing to use PSCs, we are likely to see an initial jump in compliance. As companies who’ve been cautious see that their contractors are being used by less risk-averse companies and begin to re-engage, compliance is likely to drop, before being followed by a smaller bump when the first claims are raised by HMRC.

Ultimately, HMRC policing will define the path forward, but the first tribunals will likely not occur for a few years and will first focus on companies who have most obviously not assessed with due diligence.

In about five years, we could see 50%+ of contractors operating outside, depending on how individuals tailor their service offering. In addition, once firms start seeing that project costs have gone up (due to the added costs of retaining employees instead of hiring contractors) they may take a different path.

 

How can I retain my contracted workers?

If your organisation has decided to make a blanket determination (all inside IR35/no PSCs), it’s wise for hiring managers to consider the impact to the individual’s take home pay in order to avoid losing business-critical workers.

This starts with separating contractors into three categories and considering the following:

  • Essential – what do we need to increase rates to in order to keep them happy? This generally applies to around 10-15% of contractors but can vary from business to business.

  • ‘Nice-to-have’– meet halfway and increase the employer’s NI but let them pick up their PAYE and employee’s NI

  • Non-essential – make no compromises on rates and let them take the full hit or decide to terminate their employment in order to recoup costs

Contractors deemed ‘non-essential’ may claim that if they are being deemed ‘employees’, they have the right not to have their pay rate reduced (net pay will decrease if they begin paying more NI and other contributions). This could kick up historic tax complications, so our experts advise that end users terminate any PSC engagement on or before 5th April and start a new contract with the worker on 6th through PAYE or an umbrella company to avoid any issues.

One clear difference in 2021 is the change in market conditions brought by the pandemic. More candidates are open to permanent/contract roles in niche areas than 12-18 months ago, and with competition for jobs a lot higher in 2021, those in roles now are generally more open to continuing if they are seen as inside, as a drop in take-home pay is better than looking for another job.

What happens if contractor says they disagree with an end-user or agency? To what degree should we rely on the CEST tool?

Firstly, exercise caution: the CEST tool is not law, it’s guidance from HMRC. It is not overly detailed and is missing some areas of focus.

For example, if contractor is inside IR35 but believes they are outside and that they can substitute, the tool will automatically deem them to be outside. They can dispute on account of their own CEST assessment, but they still need a material reason why they think it was wrong so it’s advisable to look over all their answers.

You will have to give a reasonable explanation within 45 days, but ‘we don’t rely on the CEST tool’ is a valid response, as it is a one-size-fits-all measure for all industries so is not always relevant.

If you’re seeing lots of disputes, it might be advisable to re-evaluate your internal process – you may be doing yourself a disservice and not getting access to the right talent because you’re over-cautiously pushing people inside.

 

How important is the right of substitution?

CEST, the government’s IR35 assessment tool, bases its determination strongly on the right of substitution (with a contractor being deemed inside if a client expects them to personally provide the services). However, this should not be relied on by clients – seeing as it is very unlikely that a company will be happy for just anybody to turn up, this right is not always as much of a sticking point as it seems.

Note: The need to run DBS and health and safety checks on a worker does not mean that you are relying on that individual.

IR35 Shield examined the assessment data they held from over 100,000 assessments conducted via their technology over the past 10 years and discovered that in actuality, less than 2% of contractors had ever substituted. Although this survey did not account for variables such as swapping vs replacing, or those who were unwilling/unable to swap, it is understandable that with the contractor having to find, engage and pay a substitute (in addition to getting sign off from the client) the reality is often more hassle than it’s worth.

Instead of relying on hypotheticals such as the right of substitution, the real key factor for end users to consider is control – is the individual in charge or being told what to do?

Control is roughly split across four key assessment areas:

  1. How are they working? – usually a mutual agreement

  2. What are they doing? – this is a key measure: if someone is hired for fixed amount of time to do what the client wants, and are guaranteed to get paid if there’s no work, they will likely sit inside. If the scope of work is already agreed and set in stone at the beginning of the project or SoW, the contractor will likely sit outside

  3. Where are they working? – does it matter if they are onsite or remote? Depending on the sector, there is sometimes a legitimate reason/need to be onsite

  4. When are they working? – does the contractor have control over their hours? (This can be neutral, for example if their work requires mainframe access)

If the client/end user is determining these things is free to dictate what the contractor does on a day-to-day basis, they are more akin to an employee than an independent service provider.

Clients set on hiring contractors who are outside need to understand what this entails – the contractor will have discretion over what work they do and when they work, so it’s important to decide whether you want this or whether what you really want is an employee.

 

Fixed price payment and mutuality of obligation

Fixed price payment is a valid approach for engaging contractors outside of IR35, so long as workers are only paid when they deliver. However, clients also need to be careful when setting terms to ensure they’re not simply dressing up a contract as being fixed price when it is in fact an offering of a guaranteed amount of work over a period of time – this is more akin to mutuality of obligation (MOO).

Within IT especially, it is often difficult to discern requirements with fixed price agreements, so in some cases, a mix of ‘time and materials’ pay alongside a fixed price for delivery may be preferable. In essence, these can be seen as two separate projects written into the same contract so overruns are on T&M basis. Inspector might say first bit is outside and next inside, sort of two sub-assessments/contracts

Mutuality of obligation is a key factor in employment law but is difficult to determine in some contracted assignments. In traditional employer-employee relationships, there is an expectation of continued work and delivery, but this can also be the case with long-term contracts so it should not be relied on either way – focusing on control is a much better measure. It truly depends on whether the worker is obliged to do work if it’s offered to them, and whether there are a minimum set number of days and hours agreed. Is the worker being paid to be available whether there’s work or not (employee) or just getting paid for work done (contractor)?

Planning a digital transformation? La Fosse Digital Outcomes offers SoW-based contracts that are guaranteed to sit outside of IR35 - for more information, head to our website.

 

Closing advice – what needs to be done now to prepare?

  • Finish your assessments in good time to allow for communication or communicate if you’re stopping using PSCs. Ensure all assessment is completed by end of January and begin any necessary rate conversations in February.

  • Watch out for issuing contracts that straddle 6th April – anyone currently engaged on a contract which runs past the implementation date should be working as if it were 6th April.

  • If you are engaging with umbrella companies, factor in onboarding time and give contractors any choices by beginning of March.

  • Be aware of umbrellas that seem too good to be true, as they likely will be! Look for a cooperative and open umbrella company and carry out checks to avoid tax evasion. Get cooperative and open umbrella. A lot of bad cases have been centred around bad umbrellas, so make sure you’re not caught out.

Thank you to Kevin Barrow,Daniel Haslam and Dave Chaplin for sharing your knowledge and advice at this event.

​For more information what the new legislation means for your business and how we can help you prepare for the changes, please don't hesitate to get in touch:

Katherine Miller
Commercial Support Manager 
katherine.miller@lafosse.com 
020 7932 1643

Alternatively, please send any general enquiries to:

ir35@lafosse.com