What businesses need to know about the ongoing challenge of IR35

Nick Bustin and Dinesh Pancholi explain how employers can ensure they remain compliant as the end of HMRC’s year of ‘light touch’ enforcement draws nearer

It’s now more than six months since changes to IR35 legislation came into effect in the private sector, making thousands of businesses responsible for how they treat the employment status of contractors working for them via an intermediary (typically the worker’s Personal Service Company [PSC]). Following these changes, large and medium-sized businesses must now determine which contractors carrying out work for them are deemed to be inside IR35, and which aren’t. 

This is a considerable challenge for HR departments who must now ensure that robust controls, processes, and governance structures are in place to comply with the new requirements.

IR35 was first introduced in 2000 to ensure that any contractor who was effectively working like an employee paid the same levels of income tax and National Insurance as the employee, regardless of the structure in place.

Despite certain sectors and trade bodies calling for the system to be scrapped over the last 20 years, the government has always contended that the additional revenues accrued from IR35 are too valuable. 

The recent changes to the legislation follow on from the rules already in place within the public sector, which came into effect in 2017. Since April, only small businesses do not have the responsibility for determining the employment status of each contractor. This responsibility still sits with the intermediary. To be classified as a small business, they must meet two of the following:

  • Annual turnover of less than £10.2m (including turnover of all associated companies including those overseas);

  • A balance sheet totalling no more than £5.1m;

  • No more than 50 employees.

What do the changes mean?

One of the primary effects of the legislation changes is that the end client is now required to review the employment status of the worker. If this deems the contractor to be inside IR35, the fee payer is responsible for accounting and paying the income tax and NIC required via PAYE. 

The payroll costs will also increase for the fee payer since it will pay both the employer NIC and apprenticeship levy costs, if applicable.

Additionally, the end client must now ensure that a Status Determination Statement (SDS) is provided to the worker and the intermediary company. This should set out its conclusions for the decision taken. Until this has been provided to all relevant parties, the end client and not the fee payer is responsible for any income tax and NIC liabilities.

HMRC can recover any unpaid tax or NIC from any ‘relevant person’ in the chain. This can include anyone above the fee payer. Therefore, everyone in the chain must retain compliance responsibility.

Early effects of the changes

Research from the Association of Independent Professionals and the Self-Employed shows more than 35 per cent of UK contractors have either become permanent employees, retired, moved to work overseas, or are simply no longer working since the introduction of the new legislation.

There are a variety of reasons for this, such as reduced pay, end clients making blanket rulings or insisting that the contractors are engaged via an umbrella company or an agency. These go a long way to explaining some of the labour shortages we’ve recently seen, most notably in the logistics and supply chain sector.

HMRC policing

HMRC has stated it will support organisations to comply with the IR35 changes, taking a ‘light touch’ approach to any businesses found to be non-compliant in the first year unless there is a deliberate evasion. However, given that we’ve already seen businesses in the energy and finance sectors being targeted for IR35 compliance checks, it is likely this could be extended to other sectors in the not-too-distant future.

Further review

The future of the IR35 legislation remains uncertain, especially in the light of a new inquiry being conducted by the House of Lords concerning how the legislation is being applied within the private sector.

How can organisations remain compliant?

There are number of steps that can be taken:

  • Establish an employment status policy that clearly sets out the process, controls, and governance;

  • Ensure all relevant stakeholders have employment status training;

  • Check contracts work in practice. HMRC and the courts will see through any sham contracts for services (ie, self-employed);

  • Ensure the process for undertaking employment status review is robust;

  • Ensure a valid SDS is given to the contractor/agency/any other intermediary;

  • Monitor each contractor’s status and re-run the determination every six months, when a new contract commences, or when there is a change to the engagement;

  • Complete due diligence on the labour supply chain compliance, especially if an umbrella company is used;

  • Check any fully contracted-out service (exempt from IR35) is based on the commercial reality of the arrangements and not on labelling the contract as ‘contracted out service’ or ‘statement of work’;

  • Ensure that the payroll department is aware of the correct reporting and compliance requirements for those inside IR35.

With the Treasury and HMRC keen to make up for the high levels of public spending during the Covid crisis, HMRC activity will only increase further. All liable organisations should therefore take note; while these changes may be burdensome to enact now, they could save organisations a hefty penalty in the long run.

Nick Bustin is a director and Dinesh Pancholi a senior manager, both at haysmacintyre