Medium and large businesses now have less than eight months to prepare for changes to tax rules on off-payroll working that will shift the burden of categorising contractors’ tax status on to the companies that hire them.
In July, the government officially confirmed that, from April 2020, businesses in the private and voluntary sectors will become responsible for determining whether their contractors fall inside IR35 and need to be taxed like employees – including deductions for income tax and national insurance, on top of employers’ national insurance contributions. HR departments will be required to make and justify decisions on status, communicate with individuals and manage the workforce planning and recruitment implications.
The change was controversial when it was introduced to the public sector, with many previously self-employed individuals surprised to be caught in the legislation. But getting it wrong could be expensive and time-consuming for employers. People Management explains what happens next.
What exactly is IR35?
IR35 legislation was originally introduced in 2000 as a tax avoidance measure to prevent employees resigning from their role and returning as a contractor, a practice that had become prevalent to lower tax rates.
The problem, says Matt Fryer, group compliance director for Brookson Legal, is that HMRC has never had sufficient resources to police all the estimated 500,000 personal service companies (PSCs) in the UK to ensure they are operating on behalf of legitimately self-employed people – hence the new shift in emphasis to the purchasers of services.
Businesses with more than 50 employees or a turnover of more than £10.2m will be affected. And with the difference in tax rates between being inside or outside IR35 running as high as 25 per cent, the stakes are significant.
How do you know if someone falls inside IR35?
The first step for any company is to identify its contractors – any individual that provides their services directly through a PSC or regularly bills their time to an employer. That sounds straightforward but, if they are not clearly categorised on a finance system, it could involve multiple conversations with commissioning managers.
If you use agencies or recruiters to source such workers, it is worth discussing the situation with them. “If you’re directly hiring those individuals, you might want to look at your purchase ledger and speak to hiring managers or the procurement function,” says Fryer.
There is no single or absolute test to determine who falls inside IR35. “Each case turns very much on its own facts,” Yvonne Gallagher, partner at Harbottle & Lewis, wrote in a People Management online article. But there are a few guidelines. The first is how much autonomy the contractor has in terms of how they deliver a project. A high degree of control indicates an employment relationship, whereas a low degree may point towards self employment.
Second, organisations should consider whether there is a right to substitution in the contract. In an employment relationship, a named individual has to fulfil the employment, while someone who is genuinely self employed will usually have a provision in their contract allowing them to provide a substitute.
Finally, there is the concept of ‘mutuality of obligation’: is there an ongoing requirement for both parties to continue to offer and accept work? If a contractor is hired to complete a defined project or deliverable with an end date, and they then move on or are re-engaged under a new project, that indicates a lack of mutual obligation. However, an open-ended contract where an individual is asked to perform different tasks may more closely resemble employment.
There are also a few lower-level indicative tests, including the degree of integration the contractor has with the business and the financial risk they assume.
How do businesses start preparing?
Begin budgeting for the change now, says Fryer. “We know what the rules are and now is the time to start putting those project teams together and working through the plan,” he says, suggesting that HR should work with other departments including finance, procurement and legal. Firms should also involve hiring managers.
While blanket-assessing everyone as inside IR35 would effectively eliminate the tax risk, businesses that choose to do this may have to increase their pay rates to compensate for the reduction in take-home pay for contractors, and may find they have issues attracting or retaining them. “We saw the NHS and Transport for London in particular had big issues because that’s the approach they initially took,” says Fryer.
Instead, companies should undertake a wider assessment of what skills they need, and where they require flexibility. “UK businesses should be asking themselves what permanent skills they need, who their outsourced providers will be for extra support and what skills they can adjust alongside business demand,” says Colin Morley, group professional services director at Harvey Nash.
Fryer agrees. “Some businesses are finding they’ve had contractors for 20 years doing the same job. It is now time to take stock and think: ‘Should we really employ these people?’” he adds. “The challenge here is trying to mitigate the risks, but also retain flexibility to scale up and down when needed.”
However businesses decide to proceed, they need to be able to show they have taken reasonable care in their assessments. “HMRC will look at the size of the business, and if it has got significant human and financial resources, they’ll expect them to have really put some time, effort and cost into getting this right,” says Fryer.