Following months of fierce lobbying by contractors, recruitment agencies and tax experts, last week the government announced the commissioning of a review of the extension of IR35 reforms otherwise known as the Off-Payroll rules into the private sector.
Many commentators and contractors have grave concerns over the changes to IR35, which will make end-clients responsible for assessing their contractors’ IR35 statuses and the deduction of PAYE employment taxes at source for any IR35-caught contractors.
With the HM Treasury IR35 review underway and due to conclude by mid-February, we will be taking an in-depth look at the main concerns that the industry has with the proposed legislation in a series of articles. In today’s part, we look at the top five:
1) Hiring contractors will become prohibitively burdensome
The Off-Payroll rules place onerous responsibilities on the hirers of contractors and create new liability risks across the supply chain. The hiring of contractors currently gives organisations access to talent on a flexible basis without any of the administrative burden involved in taking on permanent staff; the Off-Payroll rules threaten this. As the Institute of Chartered Accountants of Scotland put it:
“The main problem for employers, whether in the public or private sector, is that none of them is an expert in employment status, but the new IR35 regulations for the public sector and now for large and medium sized employers place an obligation on employers to suddenly have a comprehensive understanding of an unfamiliar and complicated legal and taxation concept, where in a majority of cases, none was required before. Widespread non-compliance may therefore ensue due to a lack of understanding – or alternatively – incorrect status decisions may be made.”
The easiest and safest way for businesses to adapt to the new rules is to simply avoid them by ceasing to hire contractors. There is an argument to be made that a company that doesn’t use contractors may find itself at a competitive disadvantage to a business that does, but the situation is opaque at best; if all of the major players in a particular sector decide not to use contractors post-April there would be no disadvantage, for example. The rules also make the outsourcing of work to large consultancies a much more attractive proposition, and indeed, Aviva and Specsavers have apparently decided to use consultancies instead of contractors at least as an interim measure.
Another way of avoiding the rules is to force all contractors onto PAYE – a policy that many major hirers of contractors have reportedly put into place already. HM Revenue & Customs have said that such “blanket” policies are non-compliant with the rules, but the likelihood of HMRC actively helping contractors to get out of the PAYE system is low. Instead, contractors must rely on a dispute process that will be led by the client itself, which raises obvious conflict-of-interest questions.
2) Rates are likely to go down as a result of National Insurance liability
Under the current IR35 regime, an IR35-caught contractor is not only liable for income tax and employee’s National Insurance on 95% of their contract revenue, they are also liable for the employer’s National Insurance (currently 13.8%) that is usually paid by employers aside from their employees’ gross salaries.
The logic for this was that the contractor’s (usually self-owned) limited company would carry the liability if they chose to operate 100% PAYE through their company.
Under the proposed new rules, however, the “fee-payer” (usually the recruitment agency that sources the contractor) will be liable for deducting PAYE from the contractor’s rate at source, and they will become the liable party for paying employer’s National Insurance. This creates a substantial cost to the fee-payer (13.8% of the contractor’s rate above £8,424 per annum) which will inevitably be offset by the recruitment agency or client by reducing the rate paid to the contractor.
However, the risk that IR35 may apply for assignments which were assessed “outside IR35” initially would likely mean that such lower rates are charged regardless, with the difference held in the event that employer’s NI is ever charged, or retained by the “fee-payer” in the event that it is not.
3) Lack of employment rights & benefits for IR35-caught contractors
The Off-Payroll rules will align IR35-caught contractors much more closely with employees of the organisations that they work for in terms of pay rates and taxation treatment. However, the rules do not address a complaint that contractors have had since the introduction of IR35: contractors who are “employed” for tax purposes generally do not receive any of the statutory employment rights or benefits available to employees, such as sick pay, holiday pay, maternity/paternity leave, protections over dismissal, etc.
IR35-caught contractors have historically accepted this as part of the nature of contracting, as they received distinct financial benefits that employees did not enjoy: higher rates of pay and a 5% allowance for expenses in the “deemed payment” calculation.
The Off-Payroll rules scrap the 5% allowance for IR35-caught contractors and, as detailed above, their pay rates are likely to become much more closely aligned with those of employees of their client – but, they will still be ineligible for statutory and corporate employment benefits.
However, the rules that govern IR35 status are the same for tax as they are for employment disputes. In November 2018, a site manager who had been forced by his company to work via a limited company arrangement successfully argued at the employment tribunal that he was an employee of his client and received around £15,000 compensation for unfair dismissal, net notice pay and accrued holiday pay. The new rules may lead to myriad more such employment tribunal cases.
In addition, the Association of Tax Technicians (ATT) have said they believe it “unlikely that fee-payers would wish to get involved with pension contributions”.
4) CEST unfit for purpose
Recognising that making IR35 status decisions is a highly complex process, HMRC launched an online tool to assist end-clients in making the assessments when they rolled Off-Payroll out into the public sector in 2017.
The tool, called Check Employment Status for Tax (CEST), takes the form of a questionnaire and is supposed to give an unequivocal status decision in 85% of cases. HMRC have pledged to stand by its results.
CEST has come under substantial criticism since its launch for being inaccurate, too simplistic and for not even considering one of the main IR35 criteria, mutuality of obligation (MOO).
The Association of Recruitment Consultancies (ARC) has called CEST “unfit for purpose” and the Institute of Chartered Accountants of England and Wales (ICAEW) said
“the rules are too complicated for a yes/no checklist to be able to provide the right answer in all cases”.
ContractorCalculator.co.uk tested CEST against existing IR35 case law in the summer of 2018 and claimed that it gave the wrong answer in 7 of the 24 cases tested (29%).
In July of last year, the Chartered Institute of Taxation issued a press release calling for urgent improvements to CEST in order to avoid uncertainty and disputes.
CEST has since been updated, but still fails to test for Mutuality of Obligation, a factor that has caused HMRC to lose IR35 tribunals due to their flawed interpretation of the criterion.
A commercially available alternative to CEST produced by Grant Thornton uses artificial intelligence to form status decisions, whereas CEST applies an algorithmic approach.
The real problem with CEST is that the courts have consistently rejected a “checklist” approach to assessing IR35, a fact that is stated in HMRC’s own manuals. In producing the tool, HMRC are tacitly accepting how difficult a burden they are placing upon the hirers of contractors by offering them a fundamentally flawed solution.
As High Court Judge Mummery put it in the case of Hall vs Lorimer:
“The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole. It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details. Not all details
are of equal weight or importance in any given situation. The details may also vary in importance from one situation to another. The process involves painting a picture in each individual case.”
5) Difficulty in accurately assessing employment status at outset of assignment
Currently, IR35 status is assessed at year-end when the contractor’s tax returns are due. This allows the contractor to review the actual working practices of the assignment and (in theory) accurately judge whether they were working on a self-employed basis, or as a “disguised employee”.
IR35 should not be assessed on the terms and conditions of the contract alone; contractual stipulations may not be adhered to, and there are usually multiple contracts in the supply chain which can muddy the waters. IR35 is supposed to be assessed by “looking through” the written contracts, looking at the real-world relationship between contractor and client and considering a “hypothetical contract” based on that relationship.
The Off-Payroll rules will invert this process by forcing end-clients to make an IR35 decision before the assignment has even commenced, because a decision has to be made to payroll the contractor or not. This is counter-intuitive and unrealistic. Companies that make an “outside IR35” decision will be exposed to the risk that at some point during the duration of the assignment the contractor’s level of autonomy may diminish, negating the initial status decision and creating a PAYE liability. Although a defence of “reasonable care” is provided for in the legislation, such a level of risk would arguably be unacceptable to most businesses.
The Chartered Institution of Taxation said in their response to the Off-Payroll consultation:
“What happens if on a reassessment of the facts (i.e. based on day-to-day practice) … a contract is found to be outside the scope of the new rules. Would HMRC accept that the client took reasonable care? Will clients face penalties for being prudent?
“Section 61NA provides that a status determination statement issued by the client to state the client’s decision as to whether an engagement falls within the off-payroll working rules and to also include the reasons for reaching that decision. The legislation also requires the client to take reasonable care in reaching its decision. However, what is the position where a client has taken reasonable care but unfortunately come to the wrong conclusion? Where, for example, the client considers that IR35 does not apply, so that no PAYE/NIC is accounted for, is the comeback to the client, or does the worker/PSC also have a responsibility to consider whether IR35 applies?”
Those are what we consider to be the top five issues that the industry has with the Off-Payroll rules. We will consider additional complaints in the next instalment of this series.
17th January 2020.
