Employer guide to contractors under IR35 reform from April 2021

From April 6th 2021, the off payroll ‘IR35’ rules that have applied to public authorities since April 6th 2017 will be extended to the private sector.

This means from that date, the assessment of a contractor’s deemed employment status, the obligation to account to HMRC and the risk of non-compliance with IR35 will transfer from the contractor to the ‘employer’ client, and others in the contractual supply chain, writes Adrian Marlowe, managing director of Lawspeed.

Who’s affected by the IR35 changes, and where

This is a new tax burden on all client-businesses engaging contract workers in the private sector, with the exception of small companies. The obligation to assess status applies wherever the individual performing the work operates through a third party, usually a Personal Service Company (PSC), in which the individual has a material interest.

The client, being the party that receives the work, must decide whether, if the PSC did not exist and taking all intervening parties out of the equation, the individual providing the actual work would be an employee of the client. This is not a straightforward task and in most cases involves complex legal ‘employment status’ considerations, many of which clients may not be that familiar with.

Next steps if you're an engager, or fee-payer

The proposal from HMRC is that, from April 2021, the decision must be made before work starts and, that once the decision is made, it must be passed to the contractor if the hire is direct, or to the next in line in the supply chain where one or more agencies are involved.

A tax obligation on the ‘fee-payer’ -- the party that is contractually responsible for paying the PSC, arises where the decision is that the arrangement involves a deemed employment status. In that event, the fee-payer must charge PAYE and NICs as payroll on the gross amount of the PSC’s invoice for work done, and account to the PSC only for the net amount, thereby significantly reducing the amount of money that the PSC has available to pay the individual.

How to pay HMRC under the IR35 reforms

Next, because the invoice sum is to be treated as payroll, the fee-payer must pay Employer NICs to HMRC, in addition to the NICs and PAYE deducted from the contractor’s invoice. As with normal employee payroll, the Employer NICs and Apprenticeship Levy amounts must come from the client’s own resources. In the case of chain supply, this means that the Employer NICs and levy sums will now have to be factored into the agency charge, as will the impact of lower income on the individual.

Where HMRC disagrees with the client’s ‘outside IR35’ decision, the Revenue may serve a demand for unpaid PAYE and NICs. The demand is for payment from the ‘fee-payer. If that is a third-party, i.e. an agency not the client, a defence available is that the client’s decision was not made 'reasonably,' so pitting agency against client, potentially damaging the relationship. Alternatively the fee-payer can appeal, perhaps ultimately involving a tribunal claim.

The IR35 status decision (cont.)

Decision-making of the kind required here is not an exact science. In favour of deciding that arrangements are not caught is that contractor arrangements can continue, paying the contractor’s invoice as before. Against will be the risk of an HMRC investigation for up to six years after the event, and in some cases this can be extended. Therefore many clients will only want to take this route for those contractors that are business-critical and working on arrangements that are confidently outside IR35. A financial director will want to consider balance sheet contingencies.

The primary reason for making the decision that IR35 rules apply is the avoidance of any tax risk. Against it is that business-critical contractors may refuse to take the work on an IR35-applying basis. In all such cases, there will have to be a balance met between additional cost of the Employer NICs and Apprenticeship Levy versus the lower sums that the contracting individual will receive. A supplying agency should be able to negotiate this.

Other risks and repercussions

Additional risks arise where a client decides that the rules apply but a fee-payer lower in the chain of contractor supply decides not to account for the taxes. In these cases, as with decisions that the rules do not apply, HMRC may well investigate as tax and NICs will not have been accounted for. HMRC proposes that liability should ultimately pass up the supply chain to the client if payment cannot be recovered from the fee-payer or a party lower in the chain. The proposal means that an engager must always check compliance in these cases.

Some hiring arrangements will clearly be caught by the status rules, and others clearly not -- for example where there is a defined project. It is the grey area in between that will be the most challenging, and as soon as there is temptation to consider technical legal arguments such as supervision, direction, control and substitution, warning signs should be apparent. There are other options, for example employment or engaging individuals on a different basis that avoid the rules altogether, but care should be taken over advice issued by self-interested parties. Weighing up the pros and cons will be a hard choice for employers.

If in doubt...

If you’re interested in a cold hard look at the options available, a professional and independent recruitment law specialist with 22 years of sector expertise such as us can help make that hard choice easier. Going down this path totally alone could be a solitary and challenging experience.