IR35 And The Private Sector – A Look Ahead

Lee Sharpe looks at the government’s proposed extension of the IR35 regime to private sector workers. 

 

The Autumn Budget 2018 confirmed that the off-payroll working regime was to be applied to the private sector, following what the government seems to think was a successful trial run in 2017 involving public sector bodies (PSBs).  

 

Many small businesses working in the private sector are likely to be caught up in the new regime, which will apply from April 2020. 

 

IR35 is the nickname for anti-avoidance legislation originally effected from April 2000, to capture ‘disguised employees’ – i.e. those engaged through an intermediary to disguise the fact that, had they been engaged directly, the relationship would have been one of employment. That intermediary is typically the contractor’s own limited company, (a ‘personal service company’, or PSC), although other bodies, such as partnerships, may also be in scope.  

 

IR35 thus essentially follows the all-too-familiar battleground of whether the relationship between engager and contractor is essentially one of self-employment or employment. Simply put, if the relationship between the parties at both ends of the chain can be characterised as one of employment, IR35 applies. If the relationship bears the hallmarks of self-employment, IR35 should not apply.  

 

If caught by the original IR35 regime, the contractor is basically obliged to account for all the tax and National Insurance contributions (NICs) – including employers’ NICs – that would have been due if he or she had been on the engager’s payroll and received broadly the same gross income. This imposes a very substantial additional tax cost on the contractor. 

 

The new version of IR35 places the obligation on the engager to work out whether the relationship is one of employment and, if it does, to apply payroll taxes and NICs just as if the contractor were engaged directly. The effect is a similar hike in tax cost to the contractor, although the engager will theoretically now bear the employers’ NIC cost (assuming this has not already been factored in by the engager when fixing the pay rate).  

 

It might be more straightforward to list what was ‘right’ with IR35! Key criticisms include: 

Around 2010/11, criticism of IR35 was so bad that it seemed likely it would be abolished. It is quite remarkable to see that it has instead flourished, under HMRC’s wing.  

 

HMRC clearly perceives that asking contractors to regulate themselves through the original IR35 format is problematic. In its consultation document issued in May 2018, it estimated that only 10% of those companies caught by the legislation actually complied. But given how frequently HMRC loses IR35 cases at the tax tribunals, its estimates must surely be considered adventurous at best.  

 

A good example is Jensal Software Ltd [2018] UKFTT 271 (TC), wherein HMRC contended that the taxpayer should have applied the IR35 legislation when engaged by the Department for Work and Pensions. This was the second time that HMRC took this particular company to the tribunal over IR35 – and the second time it lost! 

 

The solution is to transfer the responsibility to the payer or engager, rather than for HMRC to engage directly with individual PSC cases, which it considers too time-consuming and costly to undertake itself. HMRC says it will use the time between now and April 2020 to ensure that support and guidance are made available to engagers so that they are better equipped to judge if their contractors are caught within the regime. But again, HMRC’s track record with IR35 cases suggests that this guidance may not be reliable.  

 

HMRC has promised that it will listen to concerns raised over its online tool for determining if an engagement is within the disguised remuneration regime. It remains to be seen whether or not the tool is improved sufficiently to be reliable – one IR35 specialist has found that HMRC’s online tool gave flawed assessments in 42% of sample cases. 

 

Perhaps the biggest problem with the new approach is that engagers will be encouraged to apply blanket assessments – i.e. to deem all of its contractors as falling within the new disguised employee regime, without analysing each engagement on a case-by-case basis. The engager may reason that there is far less chance of incurring HMRC’s wrath by deeming its contractors as ‘caught’, and it may well be able to re-negotiate with individual contractors to reduce or negate the implicit cost of employers’ NICs.  

 

There is good evidence that PSBs have applied such blanket assessments since the new regime was introduced in that sector, and it is worrying that HMRC seems to have used the corresponding uptick in PAYE/NICs receipts as evidence that the new regime is working as intended – in accordance with the law – when it could easily mean exactly the opposite. 

 

In a press release issued alongside Budget 2018, the government advised:  

HMRC will not carry out targeted campaigns into previous years when individuals start paying employment taxes under IR35 for the first time following the reform, and businesses’ decisions about whether their workers are within the rules will not automatically trigger an enquiry into earlier years. 

The new rules will mean that HMRC would have less responsibility for deciding if PAYE, etc., should be applied to a contractor’s engagement. That burden will now fall more to those large and medium-sized businesses that are engaging those contractors. There are widespread concerns among the tax profession and beyond that the ‘trial run’ with PSBs is far from the glowing success that the government seems to think it is. Engagers, contractors, and their advisers will want to keep a keen eye on these changes as they develop between now and April 2020.