Having a thorough understanding of IR35 legislation is essential for any business, but for contractors and agencies in particular lack of knowledge with regards to IR35 puts them at significant risk of non-compliance. Below we will explore IR35 legislation in detail to ensure contractors and agencies alike can ensure they are compliant for each and every contract undertaken.
The background on IR35
Prior to IR35 legislation being introduced, the majority of contractors were operating as self-employed, however new regulations introduced by HMRC (then Inland Revenue) put the liability of any missing tax that had not been deducted as PAYE prior to payment, on the shoulders of recruitment agencies. Consequently, many recruiters chose not to work with self-employed contractors, which led many contractors to establish their own limited companies, taking the liability away from agencies.
For contractors, the benefits and opportunities that having a limited company presented was a great step forward for their career. HMRC, on the other hand, found that tax payments reduced significantly, due to the fact that PSCs were operating more tax efficiently. However, it was also found that some were operating in a way that was very difficult to differentiate between employee and contractor.
As a result, IR35 legislation was introduced in April 2000, to establish those that were ‘true’ contractors and those operating under ‘disguised employment’. From that point on, contractors that had been deemed within IR35 were liable to follow PAYE regulations, alongside employees.
Changes to IR35
For 17 years the decision-making process as to whether or not a PSC was within or outside of IR35, fell to the contractor themselves with little to no input from agencies. However, reforms to the legislation introduced in April 2017, meant that PSCs working in the public sector, were no longer able to determine their own status, liability for this now resided with the recruitment agency. Subsequently, agencies are now responsible for deducting the correct tax and NI when applicable, in order to remain compliant.
A recent consultation into extending IR35 reforms into the private sector took place in August 2018, and the autumn budget confirmed these changes would take place in April 2020, which will ultimately impact a significant majority of agencies across the UK. For many agencies IR35 legislation is not something that impacted their business prior to these reforms, however with public sector reforms already in place and private sector changes coming next year, now is the time for agencies to become accustomed with IR35.
The tests of employment
When changes to IR35 came into force in April 2017, HMRC also released its Check Employment Status for Tax (CEST) tool, which aimed to help make the decision-making process much easier. The tool has, however, been questioned on its accuracy, due to the fact that it doesn’t consider one of the three tests of employment that are essential factors to making an IR35 status decision.
Placing a contractor in the wrong status, can bring a number of repercussions. Contractors wrongly placed outside of IR35 will mean that the agency is liable for missing tax should HMRC investigate, and those wrongly placed inside of IR35 may choose to take the agency to tribunal further down the line. It is vital, therefore, that agencies fully understand how to correctly identify the IR35 status of the PSCs they work with.
With August’s consultation covering the effectiveness of the CEST tool, it may be that a newer and more effective tool will be released. Until this happens, for agencies that don’t feel confident in relying on CEST, assessing contractors against the three tests of employment (below) is the best way forward.
Mutuality of obligation (MOO)
This area involves two sectors one ongoing mutuality and two mutuality within the engagement. Ongoing mutuality of obligations looks at whether there is an obligation for the client to offer work and the individual to accept work on an ongoing basis after the particular assignment is complete. The second looks at whether there is a mutuality of obligations during the engagement. If no notice period to terminate the engagement by either party exists for the assignment this would indicate a lack of mutuality of obligations as neither party has an obligation for the assignment to be seen through to the end. HMRC only consider the second point and their view is a mutuality of obligations does exist in the engagement as the contract provides that services are provided in exchange for payment. Most legal experts feel that all factors need to be considered not simply a contract agreement.
Where a client has the right of control over an individual this is an indication of a contract of service i.e. an employment contract. If the client has no right of control then an employment cannot exist. Control in this context is where the client controls the manner in which the tasks are performed. To do this in practice the individual must be suitably qualified to carry out the assignment tasks without advice from the client.
Where an individual is required to provide services personally this is an indication of employment. If however, a substitute can be sent in to carry out the work this is an indicator that a contract of service does not exist. The right of substitution should not be overly fettered. The client should only be able to refuse the substitute if the individual is not suitably qualified to carry out the work. To be considered relevant by a court the clause in a contract must be able to be exercised in practice.
Assessment of IR35 should be done on a contractor by contractor basis, agencies should not carry out ‘blanket assessments’ of all contractors and this is likely to result in incorrect statuses.
How can Sterling support agencies?
The expert team at Sterling are supporting recruitment agencies across the UK in ensuring that they remain compliant with IR35 at all times. Offering telephone support and guidance, as well as contract reviews. Contact our team today to discuss your IR35 requirements.