Tax non-compliance: Solving IR35

There has been much activity in recent years concerning off-payroll working rules, also known as IR35 – most notably a number of high-profile court cases involving television presenters.

However, the dust may have finally started to settle in this space. After the initial disruption experienced in both the public and private sectors following the reforms, more businesses are getting to grips with the changes.

“Many firms are now in a position to make fair and well-informed IR35 status determinations which allow genuine contractors to operate outside IR35,” says Seb Maley, CEO of IR35 specialist Qdos.

What is IR35?

IR35 aims to ensure that individuals who work ‘like employees’ pay generally the same employment taxation as employees, even if they work through an intermediary such as another individual, partnership, unincorporated association or a company.

The rules place the responsibility upon the client entity receiving the individual’s services to determine whether the individual would have been regarded as an employee for income tax and national insurance contributions (NICs) if they had been engaged directly.

Typically, the client is responsible for accounting for and paying the relevant employment taxes – these responsibilities previously rested with the individual’s company. These new rules have applied to private sector organisations and charities since April 2021 and public sector entities since April 2017.

‘Notoriously complex’

The IR35 legislation is “notoriously complex, with many different factors to consider” when assessing status, Maley says. HMRC’s Check Employment Status for Tax (CEST) tool makes things even more difficult, he adds.

“Put bluntly, it isn’t fit for purpose – it’s resulted in many genuine contractors wrongly being placed inside IR35.”

Additionally, there’s the risk-averse nature of some businesses. Concerned about being hit with an IR35 bill, Maley says far too many organisations “chose the path of least resistance”, which was to insist contractors worked via umbrella companies – a financially costly tactic that made it difficult to attract flexible talent.

“This approach should be avoided at all costs,” Maley advises.

RSM employment tax partner Susan Ball notes employment status determination is often undertaken within organisations by somebody without a clear understanding of the contract and the working relationship, shown by the number of public sector organisations that settled with HMRC “for considerable sums” by incorrectly applying the rules.

Additionally, CEST is not always able to give a definitive answer.

“In a fifth of cases, it is undetermined – meaning organisations using the tool need to have a mechanism for accurately assessing status themselves,” Ball says.

Impact of 2017 and 2021 changes

Since the rule changes, HMRC has issued ‘nudge letters’, firstly to public sector organisations and, lately, businesses in the private sector, explains John Chaplin, BDO employment tax partner. The letters aim to collect data to understand how businesses are coping with the legislation changes.

“When understanding why private sector businesses should be worried, you only need to look at the success HMRC has had in challenging public sector decisions,” Chaplin notes. “HMRC has recovered around £300m from public sector organisations deemed non-compliant – it won’t be long before we start to see even larger settlements in the private sector.”

Chaplin says the biggest winner from the changes, most notably in April 2021, is the rise of the statement of work (SOW) for the provision of a service and not labour.

“Any business looking to protect themselves by engaging contingent workers via SOWs is likely to find themselves with a liability if they don’t ensure that a SOW is truly a supply of a service, and not just outsourced labour masquerading as an SOW,” he warns.

Going forward

One solution to the IR35 problem, Ball believes, would be a legislative test for determining employment tax status, rather than a case law test. This would “provide certainty” for those engagers who must make assessments under the IR35 off-payroll working rules, and when engaging a contractor or freelancer directly under the employed versus self-employed rules, she says.

While it wouldn’t solve all difficulties, she believes it would be “a major step forward”.

“If a status test could be devised to cover both employment tax and legal rights, it would be a significant improvement,” Ball says.

The government recently launched a further consultation to address the issue of tax non-compliance among umbrella companies. Ball notes the issue “has long been on HMRC’s radar and we could see changes implemented as soon as April 2024”.

Complying with IR35

BDO’s Chaplin says there is no one-size-fits-all approach – every business should ask itself:

• What is the business’s attitude to risk?

• What is the current volume of contingent workers engaged? How might that change in future?

• What budgets/cost limitations is the business operating under? How might this impact decisions around contingent workers?

• How does the business ideally wish to engage with contingent workers?

• Who are the decision-makers around contingent worker engagement, and their current processes and plans?

Businesses can then understand their choices, the costs of each choice, and the administration involved in remaining compliant.