On 6 April 2021, the rules regarding IR35 are changing. Whether IR35 applies to a particular engagement has not, until now, been a matter of concern for employment businesses, who have usually addressed any commercial risk through appropriate tax indemnities in their contracts.
However, from 6 April, the landscape is changing and many employment businesses are finding that not only do they have to deal with the impact of IR35 head on, but they are also being squeezed commercially by their clients at one end, and their contractors at the other.
What are the new rules?
IR35 applies whenever a contractor is providing their services through a personal service company (‘PSC’). This method of service delivery has been particularly popular in the IT, construction and financial services sectors.
IR35 applies an income tax and national insurance charge to fees earned by the PSC where the relationship between the contractor and the end client would otherwise be one of employment. This is known as ‘deemed employment’. Historically, it has been the responsibility of the contractor to declare whether any of their engagements fall within IR35 at the end of each tax year. However, from 6 April 2021, this responsibility will shift to the end client. End clients will be required to make a ‘Status Determination Statement’ (‘SDS’) at the beginning of each assignment, and provide a copy of this to the employment business and the contractor.
If the determination is that the engagement falls inside of IR35, then the employment business will be required to deduct income tax and national insurance payments from the consultant’s fees before these are paid to the consultant.
What are the particular challenges faced by employment businesses?
1. Knowing your client
The new rules only apply to medium or large companies. Employment businesses will need to understand the criteria for determining client size, and have processes in place for identifying whether particular clients are likely to be caught.
In addition, some employment businesses, particularly in the IT sector, also operate as consultancies. The new IR35 rules do not apply to contracted-out services. Employment businesses operating as consultancies will have to ask themselves whether the engagement with the client is a fully contracted out service (and therefore outside the scope of the new rules) or a contract for the supply of labour (and therefore caught by the new rules). This can be difficult to identify in practice, but typically a fully contracted out service will involve the provision of goods and material as well as labour. A service provider will have an opportunity for profit beyond taking a percentage of the worker’s fee.
If the employment business determines that the engagement is a contracted out service, then it is the employment business that will be the client for the purposes of the new IR35 rules. The employment business will then have to decide if it meets the criteria for being a medium or large company, and if so, it will then have the responsibility for undertaking the SDS and, if relevant, accounting for income tax and national insurance due.
2. The question of whether IR35 applies to an engagement may now fall on the Employment Business
Although it is the responsibility of the end client to make the SDS, many employment businesses are finding that clients are turning to them for assistance. While this places an additional administrative burden on the employment business, it can also be an opportunity to add value. However, an SDS must be undertaken with reasonable care, and any employment businesses offering this service must make sure their staff are appropriately trained.
3. Increased cost of business
Where IR35 applies, the employment business will have to place effected contractors on their payroll and operate PAYE. In addition, employment business will be liable to pay employers national insurance payments at 13.8%, and (if applicable) any apprenticeship levy charges. These requirements will substantially increase the cost of doing business. Employment businesses will need to consider how they will absorb these costs or if they will be passed back to the client through increased fees.
4. Commercial pressure
Many clients will want to take a cautious approach, and will be tempted to find that an engagement falls inside IR35 in borderline cases. Contractors, on the other hand, will want to ensure that their engagements fall outside of IR35. This is where employment businesses could find themselves caught between a rock and a hard place, which could be particularly difficult when dealing with valuable, specialised contractors. Employment businesses may need to consider ways in which the relationship can be restructured to avoid being caught by IR35, or look at different structures such as direct engagements or umbrella companies.
In addition, contractors have the right to challenge any SDS decisions, and if challenged, the client must provide a written response within 45 days. It is likely that any challenges raised will first come to the employment business, which will then have to manage the process between the client and the contractor. Employment businesses would be well advised to take proactive steps to avoid such challenges by agreeing the status of an engagement and the terms of the SDS with the contractor before hiring.
5. Contractual terms and risk
It is not unusual for employment businesses to find themselves in the middle of a long labour supply chain, and as such they will need to act as a conduit for the information flow between the client at one end, and the contractor at the other. The changes to the IR35 rules impose financial risk and liability for failure to pass information such as the SDS or contractor complaints up and down the supply chain. In addition, any changes to the engagement will require a revised SDS to be undertaken.
While there are set processes and tight timeframes for compliance set out in the legislation, there are also gaps. For instance, there is no requirement for a contractor to make a complaint about an SDS in writing. These gaps could leave employment businesses, and their clients, exposed. The best way to deal with these gaps is to ensure there are appropriate contractual arrangements in place to deal with the flow of information, and the processes that will be in place to deal with contractor disputes and reporting any changes to the engagement.
In addition, it is crucial that any terms relating to an engagement are consistent as between the contractor, the employment business, and the client. When determining if IR35 applies, a court or tribunal will take into account all relevant contractual terms, not just those between the employment business and the contractor. For instance, it is no good relying on a right of substitution in the contract between the employment business and the contractor, if there isn’t a corresponding right in the contract between the employment business and the client.
Employment businesses should take immediate steps to review their contracts and ensure IR35 related amendments are made in good time before 4 April 2021.
6. Interaction with other regulations applying to employment businesses
Employment businesses will have to be mindful of other obligations imposed on them by law, and the potential impact of the new IR35 rules on these obligations.
For instance, the Conduct of Employment Businesses and Employment Agencies Regulations 2003 (‘the Conduct Regulations’) apply certain contractual obligations and rights governing the relationship between employment businesses and their workers. Many of these are cumbersome and undesireable in a commercial relationship.
However, the Conduct Regulations only apply where there is ‘control’ of the contractor by the end client. ‘Control’ is a factor indicative of employment status for tax purposes. Some employment businesses may have taken the view that, since the contractors are truly self-employed, there is no ‘control’, and therefore the Conduct Regulations do not apply. Employment Businesses that have taken this approach may find themselves in a difficult position if such contractors are later found to fall ‘inside’ IR35. This is a grey area of law, and employment businesses will have to think carefully about the conflict between the element of ‘control’ under the Conduct Regulations, and the desire to ensure their contractors are operating outside of IR35.
In addition, since 6 April 2020, employment businesses are now required to provide all work seekers (including contractors providing their services through a PSC) with a ‘Key Information Document’ setting out the key terms of their engagement, including how much they will be paid and any deductions. This document must be provided before the work seeker enters into terms with the employment business. However, the details in the Key Information Document cannot be confirmed until after an SDS has been undertaken, since it is only once the SDS has been provided that the employment business know whether there will be any deductions for income tax and national insurance. Given that an SDS must be undertaken on a case by case basis, and the outcome of an SDS depends, at least in part, on the circumstances of each individual contractor, this can present logistical challenges and may necessitate the provision of multiple Key Information Documents setting out different payment methods.
The particular challenges faced by employment businesses who rely heavily on contractor populations can be difficult to navigate. However, Boyes Turner have particular expertise in this area, and are currently assisting a number of clients with the following:-
Labour supply chain audits – identifying whether the rules apply, who to, and the level of risk exposure;
Contractor Engagement Reviews – for particularly valuable contractors we can provide a full IR35 assessment including a bespoke ‘traffic light’ report outlining the IR35 risks and how these can be mitigated;
SDS drafting – we can prepare and draft these on your behalf;
SDS tools and training – we can provide employment businesses with the tools and knowledge they need to undertake SDS’s with confidence through our tailor made templates and training; and
Contractor disputes – we can assist with any challenges raised by your contractors.
Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.