It’s not often you’ll hear amiable Scottish television presenter Lorraine Kelly raised as a point of discussion in an HR meeting. But in recent months, Kelly’s victory at a tax tribunal – after she appealed a tax bill of around £1.2m – will have no doubt featured on many a business’s agenda as they prepare for changes to the controversial IR35 regulations.
Or at least it should have. Worryingly, though most HR professionals will have a vague sense of her plight, many might not have a particularly strong sense of this relating to IR35. Nor will they, more troublingly, necessarily have a sense of exactly what IR35 will mean to them when it comes into force in the private sector from 6 April this year.
The rules, which were rolled out to public sector employers in 2017, shift legal responsibility for determining workers’ tax status and collecting the appropriate level of tax and national insurance to employers. The legislation itself has been around since 1999, but the onus had always been on the contractors to prove their status and ensure they were paying the right tax.
HMRC estimates that, outside the public sector, only one in 10 people who should be paying tax under the current off-payroll rules are doing so correctly. It hopes the reforms will bring in £3bn for the Treasury by clawing back taxes from ‘disguised employment’. And yet despite such arguably admirable intentions – and despite the new legislation’s introduction being just weeks away – a People Management readers’ survey, conducted exclusively for this piece, uncovered a mixed picture when it came to IR35-readiness. While a reasonably encouraging 48 per cent of private sector respondents said they felt ‘quite prepared’ for an April 2020 rollout, a sizable 32 per cent reported feeling ‘not very’ prepared and 5 per cent not at all.
This is undoubtedly down in most cases to an assumption that private sector IR35 would be postponed. In response to concerns around not enough support being given to businesses and contractors to ensure a smooth implementation, the government announced a consultation in January. Its status-checking tool – check employment status for tax (CEST) – has undergone multiple iterations and attracted criticism for its reliability. And recruitment and freelancer bodies have called for private sector IR35 implementation to be delayed until 2021. Yet, despite relaxing the rules to only apply to contracts carried out after 6 April 2020 in February, the government has insisted the changes will nevertheless come into force in April, prompting experts to urge HR to use these last precious few weeks to get up to speed.
“There are some in the private sector that assumed it wasn’t going to happen,” says Martin Tiplady, CEO of Chameleon People Solutions and former HR director. “Some are focused on avoidance, while others are looking more holistically, saying: ‘It’s here, let’s take it on the chin.’”
Matt Fryer, head of legal services at Brookson Legal, adds: “What we don’t want is businesses being so overwhelmed they go into paralysis. This is just good project management; an opportunity to sort out the things you’ve been ignoring.”
There is a strong imperative to do so. Knee-jerk reactions to IR35 from some employers have provoked angry reactions across the contractor community – reactions that could see organisations’ efforts to attract top talent in future seriously hampered. An information-sharing website, Offpayroll.org, was set up early this year for contractors to report on clients’ policies after a number of household names, primarily in the banking sector, announced they would no longer engage with contractors working through personal service companies (PSCs) and that they were bringing everyone on to the payroll. People Management’s survey found 9 per cent of respondents will no longer work with contractors as a result of IR35, and 43 per cent intend to enlist fewer.
Companies are graded on Offpayroll.org with a traffic light system and Tripadvisor-style reviews – ranging from “there’s a lot of confusion”, to “a recipe for contractors to go elsewhere”. On the flip side of this, a browse of the comments on Offpayroll.org reveals some employers adopting a fair and reasoned approach and attracting positive feedback. Amit Kapoor, director of Mindful Contract Solutions, argues IR35 is in fact “an opportunity to become a client of choice” if you handle it sensibly. “You can have the cream of contractor talent,” he says.
So how can you properly – and speedily – get to grips with the changes? “If you’ve not done an audit by now, you need to prioritise that. Knowledge is key,” urges Anna Cope, employment partner at law firm CMS. Think about how work is organised: who your contractors are, what they do and how much they are paid, she adds.
Crucially, get familiar with the legislation or find someone who already is, advises Matt Tyler from contractor insurance company Larsen Howie: “Ninety per cent of the battle is knowledge. You’d use an accountant for taxes and accounts so why should IR35 be any different?”
In the meantime, People Management has compiled a handy IR35 survival guide, unpacking some of the most common strategies your firm is likely to consider, where these will each work best, and pitfalls to bear in mind…
Survival strategy one
Separating contractors into groups
The final months of 2019 saw a stream of IR35 policy decisions from the financial sector hinting they would impose blanket off-payroll bans. Contractors at Barclays, for example, received a letter saying the bank had “reviewed its third-party resourcing arrangements and… decided that it will no longer engage contractors who provide their services via a PSC, limited company or other intermediary”. For employers with hundreds of contractors on their books, operating one policy does sound like the simpler solution. But it could also backfire.
From HMRC’s perspective, blanket decisions do not constitute the ‘reasonable care’ it expects from employers in checking workers’ status for tax, so they could be in breach of legislation and served a tax bill for any contractors incorrectly assessed.
A more measured option for organisations working with huge volumes of contractors and so in need of a pragmatic, rules-based approach, might be to group people by role. “Identify pools and try to group them as far as possible,” advises Matthew Sharp, senior associate in the tax disputes team at law firm Fieldfisher. “Then within those groups you can assess individually. There will be factors within teams (such as line management responsibility) that will differentiate one contractor from another, some of which will be more likely to indicate an employment relationship.”
Survival strategy two
Bringing contractors in-house
People Management’s survey found 23 per cent of private sector respondents intend to bring contractors in-house in response to IR35. This could be the right approach in some cases, but firms must consider the potential extra costs involved.
Although contractors typically shoulder many of the risks of self-employment – no sick pay, occupational pension or holiday pay, for example – their rates often compensate for this. “If a contractor is subject to PAYE taxes and the burden of employers’ national insurance contributions is also indirectly passed on to them, they can take home anywhere between 20 and 30 per cent less than they might when working outside IR35,” says Seb Maley, CEO of IR35 specialist Qdos Contractor. “So businesses have a decision to make: if they insist on forcing contractors on to the payroll, do they accommodate what would be a significant increase in costs to retain these workers?”
For many contractors, however, it’s the flexibility and variety offered by a freelance career that outweigh the financial considerations anyway. “Many contractors choose to work that way because of work-life balance, lifestyle, to escape corporate politics – it’s not just about the cash,” says James Poyser, CEO of InniAccounts. “It will be hard to convince many of them to go permanent as they’d lose all that.”
If bringing contractors on to PAYE or permanent contracts is your preferred strategy, communicating the benefits of being an employee – whether that’s security or access to greater employment rights – should be a priority. “Communicate the outcome of the determination and any appeals process,” advises Charles Cotton, the CIPD’s performance and reward adviser. “Then you need to consider what you’ll say if they ask you to increase their rate, or the ‘what if’ scenario of all of your contractor workforce wanting more money. It’s both an employee relations issue and a payroll issue.”
Survival strategy three
Finding new ways to work with contractors
Having done an assessment, there will likely be contractors that fall inside IR35 who you want to hang on to – and this is where it may be time to negotiate new ways of working. There may be ways to amend working arrangements so freelancers fall safely outside the legislation and retain their independence. “One of the key tests of employment status for tax is substitution – whether the firm would accept a substitute for the contractor if the need arises,” says Kapoor. “Having a policy on this should be a priority – considering questions such as: does the substitute use the same equipment, entry passes, passwords and such? How long does this take to set up?” Cope describes this test as whether it has to be ‘a’ contractor or ‘the’ contractor; if it’s the former, you’re able to use a substitute.
And this is where Lorraine Kelly comes in. At her tax tribunal, HMRC claimed ITV had the final choice over whether Kelly could send a substitute for her weekday morning show, while her lawyers successfully argued she was instrumental in choosing substitute presenters, and could determine the length of interviews or how she presented the subject matter so also exerted a considerable element of control. She could work for other broadcasters and drove the ratings, leading the judge to conclude the relationship was a “contract for services”, and therefore IR35 did not apply.
So factors HMRC considers besides the substitution test include whether the contractor is able to (and does) work for other clients, whether they can turn work down and how much control the hirer has over their work. Cope adds: “If the contractor wants to continue working through a PSC, it needs to be in the correct way. Go back to the tests, but be mindful that there’s no one determining factor and it’s not clear cut.”
Some employers have voiced concerns that by effectively changing contractors’ status from one week to the next, there could be legal risks such as claims for backdated holiday pay. This is highly unlikely but not impossible, says Fryer: “HMRC is clear that what is employment status for tax only affects that. The danger is if a contractor receives a status determination statement that shows they’re an employee – could they take that to a tribunal and use it as evidence?”
Survival strategy four
Working with contractors through an umbrella company or consultancy
Another option for contractors wishing to continue working in the same way is to do so through an umbrella company. Here, they become an ‘employee’ of the umbrella scheme and you as the client pay the scheme (or agency, if it’s being managed by a third party). They receive a salary after deductions for tax, national insurance, expenses, the umbrella fee and any other pre-agreed costs. “Umbrellas can be the safe option and offer flexibility for the contractor,” says Fryer. “However, the market is unregulated so be wary of any that have not been audited as the liability would fall on you as the end-user.”
A further possibility is to change to a consultancy relationship. Jonny Hiles, solutions director at recruitment specialist Sanderson, says: “Many companies are considering ‘statement of work’ consultancy relationships, particularly in IT. In essence, this is a packaged piece of work with a deliverable, sometimes paid in stages. So when you go through CEST, questions around supervision, substitution and control are no longer relevant as the focus is on the project, not the individual.” Shifting whole projects to a team of consultants could prove more expensive, but it’s a viable option.
These strategies all come with the crucial caveat, however, to keep arrangements under review as projects change and new needs arise. Just because the deadline has passed, does not mean arrangements or determinations are set in stone, warns Cotton. “Work changes have an impact on how projects are managed in the workplace – people could be dipping in and out of IR35 depending on what they’re working on, even with the same employer,” he says. IR35 status also needs to feature in workforce planning, he adds: “If you start to lose people, how long would it take to replace that individual? You have to think about the impact that would have.”
Still confused? Here are five critical test questions, devised in partnership with Brookson Legal, to consider in relation to your contractor workforce:
What do you need the contractor for?
a) Fixed-term project
b) There’s a job opening
c) We desperately need people with this skill
Consider the ‘why’ for the role. If it’s a), could it be packaged as a ‘statement of work’ project and offered on a consultancy basis? Or with b) perhaps this contractor role is better off as a permanent position. With c) where the need is great, run an employment status assessment on the contractor and, if they wish to continue working through a PSC or umbrella, negotiate how you can do this in a compliant way.
How will you engage them?
a) Through an agency, which handles their pay
b) Directly, through a limited company
HMRC will look at how the worker was engaged and who handles payroll, but ultimately liability for determining whether a contractor is inside IR35 lies with the end-user. If they are engaged through an agency, that agency will need to make the right tax and national insurance deductions based on the end-user’s determination. If the end-user fails to communicate the worker’s status or when determining the status fails to take reasonable care, they’ll still be liable. If you do not have visibility on how the agency is ensuring the right levels of tax and national insurance are paid (they may be outsourcing this), you should audit this supply chain as any underpayments could come back to you.
How will you work together?
a) There are set hours and they use our equipment, on our premises
b) We decide where and when they work
c) We give them clear instructions and guidance if something is wrong
d) They sometimes work for other clients and are able to refuse work
‘Control’ is one of the key principles of HMRC’s employment status for tax tests. So if a), b) and c) apply, it is arguably more likely the contractor could be found to be inside IR35 and an appropriate level of tax and national insurance should be paid. Where contractors can work autonomously, when and where they like and for other clients, as well as being able to turn down work, it is more akin to a self-employment relationship so would likely be outside IR35.
Does it have to be them?
a) Yes, it has to be them
b) It’s written into their contract that they can send a replacement or substitute individual
c) We’d like it to be them but it’s not a deal-breaker – it’s the skills we’re after
HMRC will also look at whether the contractor is able to send a substitute to do their work, as this is more likely to indicate the person is outside IR35. So, if it’s a) then it is the personal service of the individual contractor that you require, which points more towards an employment relationship. If it’s c), consider whether you can draft new terms to support your view that they can send a substitute, as this could go a long way to evidence that they are not subject to IR35.
How is the work offered?
a) They turn up, are paid every week and do whatever we tell them to do
b) If they refuse work, we look elsewhere but are happy to engage with them again
c) The contractor is not granted sick/holiday pay and covers their own tax liabilities and insurers against the risk of having to correct defective work
d) They have access to some of the same perks as employees
As with control and substitution, mutuality of obligation and integration are other key principles of the status test. HMRC would look at the reality of the working relationship. A regular ongoing relationship with no fixed deliverables and weekly payslips suggests they work for the company continuously (as in a)) – as will being integrated into the business and treated ‘like employees’ on a day-to-day basis (as with d)). It would also look at whether the worker is prevented from offering services to other clients during the contract, with a b) or c) situation more likely to fall outside IR35.
For more information, see the HMRC employment status manual at hmrc.gov.uk
Disclaimer: It is important to note that employment status is determined by considering a number of factors ‘in the round’. No one factor is determinative in its own right.