Don’t leave IR35 until the last minute – five things you should be doing now
06 January 2021
With less than three months to go until significant changes to the IR35 rules take effect in April 2021, this article sets out five steps that employers should consider taking now.
As the third lockdown gets underway, it may be tempting to relegate next year’s changes to the IR35 rules to the bottom of your to-do list. Yet you should not underestimate the time it will take to prepare for the new regime.
The new rules require medium and large sized businesses in the private sector to assess the employment status of those contractors who provide their labour through their own intermediary and, if appropriate, operate PAYE and NICs. Here are five preparatory steps which you may want to consider taking without further delay:
1. Identify contractors who will be providing labour through their own intermediary
You need first to identify those contractors who will be using their own intermediary to supply labour to you after 5 April 2021 (including under any new engagements entered into between now and then). This applies even if the contractor is supplied via a third-party employment business, such as an agency or umbrella company. You should ask the employment business to confirm which contractors are not being paid subject to PAYE/NICs and assume that those contractors are using their own intermediary.
“Intermediary” is defined very widely for these purposes. The contractor may be using their own company, a partnership or another individual. The final IR35 rules confirm that a company may be an intermediary if the contractor manages and controls that company, even if the contractor (either alone or with their associates) does not hold any shares in it.
The IR35 rules only apply where there is a supply of labour rather than a supply of services, so you should disregard any contractor who is providing a fully outsourced service. You can also disregard any contractor who is not UK tax resident and is providing all of their labour outside the UK.
2. Consider how to deal with contractors supplying labour from April 2021
If you are unlikely to have the processes and procedures in place to comply with the new IR35 rules, here are some potential alternatives you may want to consider:
- Allowing contractors to use their own intermediary but requiring them to contract via a UK employment business. You would remain responsible for making the status determination and dealing with any disputes, but the employment business would be obliged to operate PAYE and NICs. While this option reduces some of the IR35 administrative burden, it will increase your costs as the employment business will invariably seek to pass the cost of operating PAYE and NICs (and if appropriate the apprenticeship level) to you as well as charging a mark-up.
- Prohibiting the use of contractors who are using their own intermediary and instead requiring the contractors to become your employees or employees of a UK employment business. While this approach would relieve you of the burden of complying with IR35 completely, it would again increase your costs. If the contractor is engaged in the same role for a continuous period of more than 12 weeks, they will be entitled to the same basic working and employment conditions (including pay and holiday) as if they had they been recruited and engaged by you at the start of the 12-week period. Although the obligation to comply is on the employment business, the costs of compliance will invariably be passed onto you.
- Engaging the contractor as an individual self-employed contractor. This route would again relieve you of the burden of complying with IR35, but it carries both tax and employment risks. To minimise those risks, it is essential that the relationship with the contractor is genuinely self-employment.
- Requiring the contractor to engage as a genuinely self-employed contractor with a UK employment business. Generally, the employment business would still be required to operate PAYE and NICs because for tax purposes the individual is likely to be a deemed employee.
3. Have procedures in place to assess contractors’ employment status
The IR35 rules apply where the contractor would have been an employee of your business if they had been engaged directly. You therefore need to decide who in your organisation is responsible for making that determination and the methodology they should use.
Many businesses use HMRC’s Check Employment Status for Tax (CEST) tool as a starting point, particularly as HMRC has indicated that it will stand by the result provided that the correct information has been inputted and the CEST questions have been answered in accordance with HMRC guidance. In addition, the CEST print-out can be used as a basis for any status determination statement (see below).
Unfortunately, in several cases, CEST is unable to provide a determination so it is essential that you have a procedure in place to deal with those situations. There are various tools on the market – some backed by insurance – which may help. You need to ensure that, whichever methodology is chosen, it is applied consistently across your contractor population.
You may have assessed the employment status of some or all of your contractors prior to April 2020, when it was originally anticipated that the new IR35 rules would come into force. If those contractors will still be providing labour to your business after 5 April 2021, it may be worth revisiting those assessments to check whether they are still valid. Due changes in working practices as a result of the Covid-19 pandemic, some of those contractors may now fall outside IR35.
You must confirm your status determination together with the reasons for it in a “status determination statement” (SDS). The contractor and/or employment business has a right to challenge your determination. You should have procedures in place to ensure that you are able to respond to any such challenge in writing within 45 days, either confirming the original determination or issuing a new SDS. In both cases, you should provide reasons for your decision.
4. Get your documentation in order
As well as having a template SDS and a template dispute outcome letter, your contracts must be IR35 compliant.
If you are contracting directly with the contractor’s own intermediary, you should ensure the contract gives you the right to operate PAYE and NICs if you determine the arrangements fall within IR35, even if the contractor disputes the status determination. You may also need to extend the timeframe for payment of invoices to link in with the operation of your payroll and accounts payable systems (see below).
Contracts with employment businesses should make it clear whether the employment business can supply contractors using their own intermediary and oblige the employment business to confirm which individuals are using their own intermediary. The contract should also require the employment business to operate PAYE and NICs and make clear which party is going to bear the cost of the additional employer NICs (and, if appropriate, the apprenticeship levy).
Comprehensive tax indemnities should be included in the contracts.
5. Ensure your payroll and accounts payable systems can deal with the changes
You should make sure that your IT systems are set up for the changes. Your payroll needs to operate PAYE and NICs for the individual contractor on the gross fees excluding VAT, while your accounts payable system needs to pay the fees to the contractor’s own intermediary net of income tax and NICs together with VAT calculated on the gross fees. In addition, you must ensure that the contractor is not included in the employee processes on the payroll, such as gender pay gap reporting.
We discuss changes to IR35 in more detail in our webinar IR35: Are you ready (again) for April?’ on 14th January. Click here for more details.