What are the proposed changes to IR35 and how can you prepare for them?
The government, as part of the controversial ‘mini-budget’ last week, announced to some surprise that it intends to repeal the 2017 and 2021 legislative reforms to IR35, also known as the off-payroll working reforms, from 6 April 2023.
Whilst the new Prime Minister had promised in her campaigning prior to her election that she expected to review the IR35 arrangements once in office, even the most optimistic of opponents to the regime was not expecting such a rapid abandonment to be announced by the Chancellor last week.
The previous reforms to the IR35 rules were introduced with the aim of helping to determine whether a self-employed contractor is genuinely self-employed or merely seeking to avoid paying income tax and National Insurance contributions (i.e. whether the contractor is a “deemed employee”). IR35 is therefore often classified as an anti-tax avoidance measure.
What is the current position around IR35?
The IR35 reforms currently set out that the liability for determining the tax status of a self-employed contractor providing their services through an intermediary personal service company (“PSC”) to an end-user rests with the end-user. These reforms were first introduced in the public sector in 2017, and then in the private sector in 2021.
End-users must therefore assess whether IR35 applies when engaging a contractor. This will involve the consideration of a number of factors such as:
- The level of control that the end-user has over the contractor;
- Whether there is a mutual requirement to offer work and to do work;
- The nature of any substitution rights;
- The extent to which the contractor is integrated into the end-user’s business; and
- Other factors consistent with employment.
If IR35 does apply, and the contractor is a “deemed employee”, the end-user must deduct income tax and NI contributions from the fees it pays to the PSC (or elect to employ the contractor as a PAYE employee instead). If it fails to do so, or incorrectly classifies the contractor’s status, it can be liable for significant financial penalties.
The government encourages businesses to use HMRC’s Check Employment Status for Tax (“CEST”) tool to determine whether IR35 applies. Although information that is correctly entered into the CEST tool leads to HMRC being bound by the result produced, the tool is (unfortunately) inherently flawed in its assessment and often produces incorrect results (more on this below).
How is IR35 changing from 6 April 2023?
It is important to note that the announced changes to IR35 are currently only proposed changes; they will still need to be approved and passed as legislation first. Businesses in any event also need to continue to comply with the current off-payroll working rules until any such changes come into effect on 6 April 2023.
However, assuming the changes are passed into law, the rules around off-payroll working will revert to how they were before 2017. This does not mean that IR35 will be repealed in its entirety. But it does mean that liability for determining the tax status of contractors will pass back to the contractors themselves. The end-user businesses who engage contractors through a PSC will no longer be absolutely liable and will be entitled to take the contractors’ assessment of their status at face value.
It is fundamental to realise however that just because end-user businesses will be entitled to rely on their contractors’ reasonable assessments for tax purposes, this does not mean that they can actively encourage or be involved with attempted or actual tax evasion by contractors and therefore should not ignore contractors whose own assessments are patently unreasonable.
Which businesses will be affected by these changes?
The IR35 reforms to the private sector only applied to businesses classed as “medium” or “large”. A business will be a medium or large one if it meets two or more of the following:
- Annual turnover of more than £10.2 million;
- Total assets of more than £5.1 million;
- More than 50 employees.
As such, only businesses meeting this definition will be affected by the proposed changes (as well as the individual contractors acting through PSCs). The position for businesses classed as “small” has been (and indeed will continue to be) that the contractor remains liable for determining their status for tax, though that business must still satisfy themselves that they are not aiding and abetting tax evasion.
What should businesses do to ready themselves for April 2023?
As mentioned above, end-user businesses must continue to comply with the current off-payroll working rules until the proposed repeals to IR35 have been formally introduced. That said, these businesses should also be considering the following issues in advance of these changes:
- Whether they will need to update their onboarding and engagement processes for contractors. Some businesses simply imposed blanket bans on engaging contractors through PSCs in response to the pressure and liability imposed on them through the previous IR35 reforms;
- How they will evaluate (if at all) their contractors’ assessments of their tax status to ensure they are not aiding and abetting tax evasion. HMRC will still expect businesses to subject someone who is clearly an employee to the PAYE regime;
- Whether their current policies, procedures, and contractual documentation will be appropriate. It may be that business’ current policies and procedures on engaging contractors will be too severe and inflexible for them to use post-6 April 2023; and
- Whether pricing models should be revisited. A number of businesses have seen increased costs as a result of the need to properly determine status and have passed these costs onto customers. With less red-tape, these pricing models may need further consideration.
Given the level of historical changes to IR35, and those which are now being proposed, businesses would also be well advised to remain flexible in case of further change!
Why are the rules changing?
Whilst the government has not been explicit in its reasoning for wanting to change the rules on IR35, it is perhaps not difficult to see why the changes have been announced.
Over the last few years, there have been a number of high-profile cases involving government departments incorrectly classifying the status of contractors and being given significant fines as a result. The Department for Work and Pensions was fined £89.7 million by HMRC after failing to properly determine status. (This was despite the DWP using HMRC’s CEST tool!) The DWP was not alone though, with the National Audit Office reporting that government departments had been fined a total of £263 million for failing to comply with IR35 (as of February 2022).
It may be that the government did not want to risk further embarrassment in respect of its departments’ failures to comply with the off-payroll working rules, or it may be that it was concerned around the results which would soon come to light in the media following the applicability of the changes to the private sector in 2021. I suppose we may never know….
There is no doubt that the repeal of the more onerous aspects of the IR35 regime will appeal to many businesses and contractors. Here at Leathes Prior we would still end with an analogy that serves as a note of caution:
If speeding cameras were abolished by government tomorrow, it would not mean that speeding suddenly became legitimate. It would remain an offence to speed, though undoubtedly far fewer drivers would be caught and prosecuted.
If you are a business that engages contractors and need advice on the contents of this article, please do get in touch with our Employment Team by phone on 01603 281153 or by emailing firstname.lastname@example.org.
Note: The contents of this article are for general information only and do not constitute legal advice. Specific legal advice should be taken in any particular circumstance.