Employer FAQs: Your questions answered
Richard Harris, Chief Legal Officer at Robert Walters, answers some of the probing questions surrounding the incoming IR35 legislation.
Download our full IR35 guide to prepare your contractor population.
What is IR35?
IR35 legislation was designed to assess whether a contractor is a genuine contractor rather than a ‘disguised’ employee, for the purposes of paying tax.
In simple terms, this occurs where an individual, who for all intents and purposes, would be an employee of an end user “client” but who operates through an intermediary vehicle such as a personal services company (PSC) to avoid income taxes and to manipulate national insurance contributions. IR35 comes into effect on the 6th April 2021.
What does 'inside' IR35 mean?
To be 'inside IR35' means that you are considered, for tax purposes, an employee of your end client and therefore subject to PAYE
What are the risks of being non-compliant with IR35 legislation?
Employers should be aware of financial and non-financial impacts of IR35 non-compliance, including:
- Reputational and brand damage
- Financial impacts from non-compliance - a potentially higher wage bills
- Operational impacts from non-compliance - the need to ensure continuity of resource to deliver
- Staff satisfaction - uncertainty and concern across your Limited Contractor population
How do you know whether a contractor is inside or outside of IR35?
There are four key tests you should consider when determining if your contractors fall under the new IR35 legislation or not.
Mutuality of Obligation
This is a key test to determining whether a contractor is truly self-employed. Can the contractor, as the worker, accept and reject work? As a contractor, can they decline an assignment or a piece of work. If mutuality of obligation exists, they could fall outside of IR35.
Substitution
Does the role allow for the contractor to substitute themselves, at their own cost? For example, if the contractor is taking time off for medical reasons, can they send someone in their place, at their own cost. If they can’t send someone else, they could be within IR35.
Supervision and control
A contractor agreement that specifies terms like mandated hours they are required to work, is one that points towards employment (inside IR35) rather than self-employment. If they are providing services for the agreed job but also working on different tasks, the contract could be outside of IR35.
Part and parcel
If contractors are embedded in the company structure this is more employment rather than self-employment, and therefore likely inside IR35
Here are a few further questions to consider when determining the IR35 status of your contractors:
Technology
Are they using company equipment such as laptops and mobile devices? HRMC often says if the contractors are using client equipment, they are a disguised employee.
Risk
Are your contractors required to have professional indemnity insurance? Like most businesses, self-employed contractors are typically prepared to take on some level of financial risk.
Which IR35 tests are grey areas?
Supervision and control
Do you as a business instruct contractors what to do but how to do the job? The more control you exert over your contractors, the more weight is given to an ‘inside IR35’ ruling. The key thing to think about here is the level of expertise you’re bringing into your organisation. The more expert the resource, the less probable they will be controlled – an organisation will state the project deliverables but not supply the means to reach those agreed outcomes.
Part and parcel
Are your contractors treated like employees? Consider privileges such as giving your contractors company email addresses, allowing them access to facilities, paid bonuses - If your contractors look like typical employees, the greater the likelihood they will fall inside IR35. Also consider your long-term contractors, the longer a contractor is onsite, the more likely they are to become part of your organisational structure. On the other hand, practices such as contactors using personal devices, using lanyards, or working clearly within an external project management structure, adds more weight to the ‘outside IR35’ determination.
Which assessment tool should I use? Is CEST fit for purpose?
Each role needs to be individually determined using an IR35 assessment tool.
“CEST” (Check Employment Status Tool) is the digital questionnaire designed by HMRC to help organisations determine employment status and decide if a worker falls inside or outside the scope of IR35.
However, employment status is not easy to define. A whole industry has grown around trying to qualify the status for independent contractors. HMRC has struggled to create a test which simply resolves the question. HMRC’s “CEST” (Check Employment Status Tool) is widely regarded as inadequate, even by its creators, not because it is inconsistent – but because it is often inconclusive.
What’s alarming for businesses is that the updated CEST tool is providing opposite conclusions for clients that had already taken a decision based on their previous CEST tests. So the question arises, who is taking the test, and how have they come to their conclusion? It’s the set of justifications that are made throughout the test that are key here, not just the outcome. Should an HMRC investigation take place, businesses still run the risk of ‘not having performed the test properly’ without the audit trail of conclusions made the professional, who may have, by this time, left the business.
The fact remains that the CEST tool is still critically absent of one of the most important considerations – mutuality of obligation, and a continued emphasis on substitution. While the CEST test may give you a level of ‘comfort’, it shouldn’t be relied upon in isolation, due to its widely reported deficiencies and inconclusive results.
There are comprehensive assessment tools on the market to audit your contractor population that can:
- Include checks for areas such as Mutuality of Obligation, Control and Substitution
- Provide an independent, balanced review of employment status
- Provide a full audit trail in the event of any HMRC investigation
- Further investigate for assessments where risks are highlighted for certain contractors
What are IR35 options are available following assessment? What happens when a contractor is inside of IR35?
Once you have completed an audit of your contractor population, you can determine what options are available to you:
Pay as you earn (PAYE)
Contractor can convert to become a PAYE engaged individual.
Umbrella
The contractor becomes an employee under a reputable umbrella company, and the umbrella company withholds the appropriate taxes, thus mitigating IR35. You may well be engaging contractors through umbrella companies today.
Deemed model
The contractor can remain a contractor and can remain as the director of their PSC (Personal Services Company), but for this particular assignment, is “deemed” inside of IR35, and the “fee payer” then has to withhold the appropriate taxes.
Permanent
Is there a portion of the contractor population that it would make sense to offer roles as full-time employees?
Remain outside of IR35
There will be a portion of the contractor population that will be deemed outside of IR35.
Statement of Work (SOW) solution
If a piece of work can genuinely be delivered through milestone and deliverable based outcomes, then SOW is a viable solution. Our SOW Managed Solutions provide employers with a means to gain visibility, compliance and cost control over their services procurement spend.
Is a Statement of Work (SOW) a compliance short-cut?
A SOW is established between a consultancy and a client, outlining project deliverables, outlining costs, timeframes and deliverables, rather than contractor rates. A private sector organisation that has “contracted-out services” – like a genuine SOW - will not be required to consider the IR35 legislation.
However, proceed with caution, a SOW does not necessarily put you in a better position to negate IR35. The third party delivering the “contracted-out services” will be required to consider whether the off-payroll working rules apply, and if they do, will be responsible for deducting and paying the appropriate tax and NICs. The service must be genuinely outsourced and not a provision of labour simply masked as a consultancy agreement. If HMRC detects a SOW has been implemented while the reality of the engagement reflects a contractor and client agreement, there’s a strong chance the IR35 rules will apply.
What are the priority steps to prepare for IR35?
As we approach the twelfth hour, for businesses that have not made a move on IR35, your first priority should be assessing your current workforce. A comprehensive IR35 assessment service should manage IR35 throughout your supply chain, providing an audit trail to justify determinations in the event of any HMRC challenge. Get in touch to understand which assessment tools are available, and the most appropriate routes we can support you through in the event of contractors deemed ‘on-payroll’.
Communicate across the supply chain to make sure IR35 decisions are made and understood as a collective. It’s conceivable that HMRC could approach any one person in the chain, so it’s important that you are joined-up. In your organisation, think about who is conducting the test - decisions will sit across procurement, legal, HR, tax and finance so you need to engage all internal stakeholders in the process to ensure IR35 outcomes are backed by your staff.
How will IR35 impact the contractor market?
We expect IR35 to cause disruption to the talent ecosystem, the degree to which, will depend on factors such as the number of business adopting ‘blanket bans’ on contractors. A skills shortage and talent drop-off are pending, and it’s more difficult to predict the behaviour of contractors that are not yet engaged in your IR35 compliance roadmap.
Robert Walters gained insights from over 500 contractors to bring you the IR35 Contractor Survey, of which over 86% of respondents were Limited Company contractors. The top three changes that contractors considered were becoming permanent employee (70%), moving to another contract position (45%) and joining an umbrella organisation (23%).
In light of the small company exemption, we expect to see a shift of technology PSCs to FinTechs and IT start-ups, with larger organisations struggling to source top technology talent. What’s clear, is that a talent drain may not be completely unavoidable but curtailed for businesses that refrain from blanket bans and persist with taking the appropriate steps in time for the changes. There is no reason why businesses should not continue to engage with genuine contractors: if the supply chain is engaged, and the contract is solid, any assessment will stand up to scrutiny.
