IR35: The steps to take to ensure compliance with the off-payroll working rules

The first thing for organisations engaging off-payroll workers to do is to consider whether they are even in scope of the new rules.

The reforms only apply to clients who are:

• public sector organisations
• medium or large non-public sector organisations.

For public sector bodies, generally, the organisation will be subject to the rules if they are a public authority as defined by the Freedom of Information Act 2000.

Medium or large test

For non-public sector organisations – this includes voluntary sector organisations, such as charities – the rules only apply to those who are medium or large.

Most organisations (corporate entities), such as companies, limited liability partnerships and unregistered companies, need to consider the three-pronged test. Entities will be medium or large if, for two consecutive financial years, they meet at least two of the following criteria:

• turnover of more than £10.2 million
• balance sheet total (assets) of more than £5.1 million
• average of more than 50 employees.

Non-corporate entities, including partnerships or sole traders, need to simply consider the ‘turnover test’ (whether the £10.2 million limit is exceeded) in the previous year to determine whether the rules apply.

It is important to note that the exemption for small organisations applies only for small clients. If the client is medium or large, the size of any agencies or other parties in the labour supply chain is irrelevant.

Wholly overseas clients

If a client is ‘wholly overseas’, the reformed off-payroll working rules will not apply. ‘Wholly overseas’ means that the client is not UK resident and does not have a permanent establishment in the UK.

If the client is medium or large (or a public sector body), and is not wholly overseas, then it will need to consider the following steps to determine what obligations it may have.

The next step is to determine whether any of the arrangements with workers could be subject to the rules.

In an ideal world, clients will have now identified many of the workers providing services outside of the payroll. As soon as is practically possible, the client should consider whether the worker is working through an ‘intermediary’. This term is defined by the legislation and can be any of the following:

• a company
• a partnership
• an unincorporated association
• an individual.

Not all of the organisations referred to above are automatically classed as an ‘intermediary’. If the circumstances do not fall within one of A to C below, the IR35 rules will not apply.

A. An company will be an ‘intermediary’ if:

• the company is not associated company of a client
  
  and

• the worker has a ‘material interest’ in the company (meaning, either directly or indirectly, ability to control more than 5% of the ordinary share capital of the company, entitled to more than 5% of distributions or entitled to more than 5% of the assets in the event of winding up)
  
  or

• the worker has received (or is entitled to receive) a payment that can “reasonably be taken to represent” remuneration for the services that they provide to the client.

B. A partnership will be an ‘intermediary’ if:

• the worked is a member of the partnership
  
  and

• the provision of the services is by the worker as a member of the partnership
  
  and

• One of the below apply:

1. the worker (alone or with relatives), is entitled to 60% or more of the profits of the partnership
2. most of the profits of the partnership come from the provision of services for engagements with a single client and/or that client’s associates
3. the income of any partner is based upon the income generated by that partner from relevant engagements.

C. An individual will be an ‘intermediary’ if:

• a payment or benefit is received or receivable by the worker directly from the intermediary
  
  and

this payment can reasonably be taken to represent remuneration for services provided by the worker to the client.

Once engagers have identified the workers who are providing their services through a relevant intermediary, the employment status of these workers must be determined; this should be done on a case-by-case basis in order to meet the requirement in the legislation for the engager to use ‘reasonable care’ when undertaking this exercise.

Employment status determination

To determine whether the IR35 rules apply, the client must look at the relationship between themselves and the worker. If the worker would be an employee of the client if they were contracted directly, the IR35 rules apply. If not, the engagement is considered to be “outside IR35” but certain steps must still be undertaken.

When doing this, normal employment status principles are used. However, this isn’t as straightforward as it sounds. The employment status principles are based on case law that have developed over a number of years. Ultimately, clients will need to consider a number of factors and ‘paint a picture’ as to whether the worker would be an employee if contracted directly. This can be extremely difficult and is a subject that experts are continuously debating with HMRC.

HMRC’s Check Employment for Tax tool

The most commonly used and most talked about source of help is HMRC’s Check Employment Status for Tax tool (also known as CEST). This is an anonymous online questionnaire that, when completed, provides HMRC’s view on the employment status associated with the engagement. This service is free and HMRC will stand by the results of the tool if the information entered into it is accurate and complete.

However, the tool is quite basic and reflects HMRC’s own view of the arrangement: recent tribunal judgements illustrate that HMRC’s view isn’t always correct, particularly on key parts of the evolving case law. The other major downside is that for many borderline cases, the online tool will produce an ‘unable to determine’ result, leaving clients to make the ultimate determination which may mean they need to obtain professional assistance.

Other sources of help

HMRC also has a wealth of material included in their Employment Status Manual, which, although helpful in understanding how employment status is determined, is not too useful in ‘painting the picture’ case law requires to arrive at a determination.

Some tax advisors and other websites have produced their own tools to produce an employment status determination. Of course, these tools do come at a cost, and it isn’t clear how much they actually differ in practice from HMRC’s free tool. And if they do differ, HMRC is not bound to agree with the determinations.

Professional advice

Rather than relying on an automated tool, which is unlikely to pick up the nuances of each worker’s particular circumstances, many will find that a professional view of the employment status is extremely useful, particularly in borderline cases. This will allow the client to rely on an expert view and will also go a long way to show that the client has taken reasonable care when considering IR35 – this is important to minimise any potential liability and something we will come to in a later step.

With IR35 specialists in our Employment Tax team at Crowe, we are able to assist in making determinations on behalf of clients.

If the off-payroll working rules could apply, clients will need to consider their risk appetite and organisational need to retain the workers who could be in scope of the rules. This process is likely to involve all functions and departments to make decisions on how to react to the changes in the rules.

Risk appetite and organisational needs

Organisations who are risk averse are more likely to accept that the rules apply to the arrangements with workers or could change the way workers are engaged to remove the obligations and risks that the IR35 rules carry – this could include:

• employing the workers directly
• engaging directly with self-employed workers instead (i.e. with no intermediary) although in this case there is already a requirement to determine the individual’s employment status for tax purposes
• engaging with workers through agencies or umbrella companies (with no intermediary) who deduct PAYE and NIC on payments to workers already.

Each of these alternatives will have pros and cons, and should be carefully considered before being chosen as an alternative to engaging workers through a personal services intermediary.
When making these decisions, organisations need to consider their commercial requirement to continue engaging with these workers beyond 5 April 2021. In addition, the value of contracts and costs may change if the rules do apply.

Budgets set for departments will need to be carefully thought through before deciding on future engagement methods for flexible workers, given both higher costs in terms of new employers National Insurance Contributions and the impact on apprenticeship levy liabilities, but also in terms of increased administration requirements. This is particularly the case where off-payroll workers are more common in specific departments.

Internal stakeholder communication

It is unlikely that one function within an organisation can make these decisions on their own. It is extremely important that all relevant business functions are involved in the decision-making process.

In our experience, organisations who have been most successful in preparing for the changes were those who:

• worked with their department heads, Finance, HR and Procurement teams to identify relevant off-payroll workers and determine whether the rules apply
• discussed the necessity and implications of continuing to engage off-payroll workers following the changes to the rules
• involved finance colleagues to explore the financial implications of different engagement methods going forwards.

Organisations should take a holistic approach to identifying off-payroll workers and whether the rules apply to each of them.

The full range of responsibilities for clients will depend on two things:

1. whether or not the off-payroll working rules apply or not
2. the make-up of the labour supply chain.

However, in this step, we will cover the responsibilities that all clients have, regardless of the above scenarios.

Taking reasonable care

As we have explained earlier, it is always the client’s responsibility to determine whether the IR35 rules apply, based on whether the worker would be an employee if engaged directly. However, this determination should not be taken lightly. Clients are required to take reasonable care when making this determination. This could include using HMRC’s CEST tool in line with their guidance or seeking a professional view on the determination. If HMRC deem that reasonable care has not been taken, the client could be liable for any income tax and NICs due, and potentially higher penalties.

Status Determination Statement

Regardless of whether a worker is subject to the IR35 rules or not, the client must provide the worker with a Status Determination Statement (SDS). This is a written statement that confirms whether, in the client’s opinion, the rules do or do not apply, along with the reasons for that determination.

The SDS should be passed to the worker and, if applicable, the agency that the client contracts with for the worker’s services. We also advise that it is sent to any other parties in the labour supply chain, for completeness.

Disagreement process

Once the SDS is passed to the worker and other parties, they are entitled to disagree with the conclusion that has been reached. They must do this is writing (or via email).

If a client receives a representation from a worker, or other party in the labour supply chain, they are required to respond within 45 days of receiving it. If the client does not respond in 45 days, they will be liable for any tax and NICs liabilities until they do respond.

The response must state whether the original decision still stands or whether it has changed, along with the reasons for this decision and whether it has changed.

Clients should ensure that an efficient process is in place to receive and deal with disagreements from workers. This can include a dedicated mailbox for disagreements and a clear end-to-end process for considering and responding to disagreements.

Duty for clients to confirm their size

Similar to the disagreement process, workers or other parties are entitled to ask a client whether they fall into the small or medium/large category for IR35 purposes. If they do, the client will have 45 days to respond to this request.

Similar to the disagreement process, a process should be put in place to respond to such requests. If the request is not responded to within the time limit, there are no tax consequences. However, the requestor can take out an injunction to require the client to provide this information, which is clearly something that all clients would prefer not to happen.

The responsibilities covered in step 5 are fixed, regardless of whether the off-payroll working rules end up applying or not. If the off-payroll working rules do apply, another set of responsibilities then come into play, which will differ depending on the make-up of the labour supply chain.

Fee-payer responsibilities

Generally, the fee-payer is the person who pays the worker’s intermediary. The fee-payer is the entity responsible for deducting and paying the appropriate income tax and NICs to HMRC.

In a simple labour supply chain – where the client contracts with and pays the worker’s intermediary directly – the client will also be the fee-payer. In this scenario, the client will provide the worker with the Status Determination Statement (see step 5) and will also deduct and pay the appropriate taxes before paying the worker’s intermediary, i.e. they are the deemed employer.

Where other parties (e.g. agencies) sit between the client and the worker’s intermediary, the deemed employer will usually be the party who pays the worker’s intermediary. The main exceptions are if:

the fee-payer is not resident in the UK for tax purposes
• the fee-payer is controlled by the worker (or their associates)
• the worker has a material interest in the fee-payer
• the fee-payer has not received a SDS.

In these scenarios, the deemed employer is the lowest entity in the labour supply chain that doesn’t come within any of these exceptions. Therefore, if the client doesn’t issue a SDS, they will always be the deemed employer, regardless of what the labour supply chain looks like.

On the other hand, if a fee payer is expecting to receive a SDS but do not, then they can pass on any outstanding payments to the next party in the labour supply chain without deducting tax or NICs. However, it is recommended that they enquire with the party above them in the labour supply chain as to why they have not provided a SDS.

The deemed employer is responsible for deducting and paying the appropriate income tax and NICs to HMRC; the income tax and NICs due is calculated in a similar way to that when the worker is an employee, but there are some more complex steps to take, including how to deal with VAT and expenses paid by the intermediary. Similarly, the deemed employer is responsible for paying employer NICs and may also be responsible for paying the apprenticeship levy on the payments too.

Employment law responsibilities

If the deemed employer is responsible for employment taxes, are they also responsible for the employment rights of the worker? The short answer is: it is unlikely.

While the worker is essentially treated as an employee for tax purposes, if they continue to contract through their own intermediary (such as their personal service company) they are not an employee of the client for employment rights purposes.

This means that the worker is not entitled to any traditional employment rights. In addition, the deemed employer is not responsible for deducting any student loan repayments or paying statutory payments, and the worker should not be included on any pension schemes arranged via auto-enrolment. The worker should ensure that any such applicable payments are made via their own intermediary.

Picture a scenario where a client meets all of their responsibilities: they identify a worker, determine that the off-payroll working rules apply and provide a SDS to the worker and to the agency they contract with for the worker’s services. You might think that because the client has done all they should that they won’t end up being liable for the tax and NICs liabilities, right? Wrong.

A particular point of note is the rule on ‘recovery from other persons’. This is a power that allows HMRC to collect the tax and NICs liability from other parties higher up in the contractual chain if “there is no real prospect of recovery within a reasonable period” from the deemed employer.

The power allows HMRC to instead collect the liabilities from:

• the first agency in the chain (the agency the client contracts with and the second highest person in the contractual chain – referred to as ‘agency 1’)
• the client (the highest person in the contractual chain).

The legislation that contains this power is very broad and could be used in a wide range of circumstances. However, HMRC’s guidance on this subject does provide more detail on when HMRC intend to use the power.

When will the power be used?

The guidance states that HMRC will not seek to recover from agency 1 or the client where the failure to account for tax and NICs by the person who should initially have paid it (the deemed employer) is as a result of a genuine business failure on the part of that person. The guidance provides some examples of what is and isn’t genuine business failure.

This means that HMRC will instead be looking to use this power when the failure to pay by the deemed employer is as a result of tax avoidance or deliberate non-compliance, even in the event that the client or agency may not have had knowledge of this.

This power may be seen as unfair, however it is unlikely to change, so it is essential that clients and agencies are aware of who they are contracting with and can assure themselves that agencies in the labour supply chain are acting faithfully and are compliant.

The additional cost of undertaking this due diligence is likely to be outweighed by any unexpected income tax and NICs liabilities that a client could face if HMRC decide to apply this power.

It is important that, once all off-payroll workers have been assessed that the process doesn’t simply end there. There are ongoing processes that are extremely important, both in terms of existing and future off-payroll workers.

For any existing workers who have been assessed and provided with a SDS, it is important that periodic reviews take place to ensure the determination doesn’t change (e.g. if the working arrangements change over time). With this in mind, annual reviews should be carried out to check that existing determinations remain valid.

For any future workers, it is imperative that an efficient process and policy is implemented to ensure any prospective contractors are assessed in real time and all obligations are met.

As above, any procedures should bring together Finance, HR and Procurement functions (at the very least), and should focus on an assessment being required prior to sign-off of any worker contracts or procurement. This way, no engagements can begin before the full picture of tax compliance is considered.

Rules governing the way in which off-payroll workers are taxed were introduced in 2000 and were set out in an HMRC document known as ‘IR35’ which has given them their name. IR35 comprised of a set of tax rules that are designed to address the lower amounts of tax and National Insurance Contributions (NICs) being paid by certain workers, and the firms hiring them. The rules apply when a worker supplies their services to a client via an intermediary, such as a limited company, in circumstances such that they would be an employee if they contracted directly with the client.

Before the recent off-payroll working changes were brought in (and for any engagements out of scope of the new rules), it was the responsibility of the intermediary to determine whether the IR35 rules apply and pay the appropriate amount of tax to HMRC.

HMRC believed the IR35 legislation was not working effectively claiming that 'non-compliance is widespread'. They estimate that only 10% of intermediaries that should have applied the legislation were actually doing so. As a result, the government reformed the off-payroll working rules (IR35) in the public sector from April 2017, and these changes have now been tweaked and extended (to working arrangements in the private (and charity) sector. The reforms were intended to take effect from 6 April 2020, but the government deferred their introduction due to the COVID-19 disruption until 6 April 2021.

Under the new rules, the responsibility for operating the off-payroll working rules moved from the worker’s intermediary to the ‘client’ (the organisation engaging the worker).

Broadly speaking, the reforms require medium and large private (and other) sector organisations to identify and review the employment status of all workers engaged through intermediaries, including those workers provided via an agency or third party. If the client determines that the rules apply, the worker will be treated as a deemed employee for tax and NICs purposes.