Philip Hammond has spoken ... and the changes to the IR35 regulations and off-payroll hiring introduced to the public sector in 2017 will now also apply to "large" and "medium" sized private sector enterprises with effect from 2020.
We discussed the importance of professional business legal advice when considering the basis with which you work with different groups of people such as employees and contractors in Part 2 of our SME Roadmap.
With the recent developments in the IR35 regulation, we delve into greater detail on this vital part of running a successful business. This is a major shakeup on tax and employment law which all business owners need to be aware of. The IR35 regulations were originally intended to dissuade organisations (which at the time were largely public sector) from the practice of reducing headcount by taking staff off-payroll and engaging them as consultants and contractors on a day rate but without employee benefits. The IR35 rules were never intended to restrict arm's length arrangements between truly independent contractors and their customers, which is something the new changes may well end up doing.
Employee or Contractor? An IR35 Case Study
If you work as a contractor then your position may well be about to become somewhat more awkward. Some of the key indicators of whether or not a contractor is or is not found to be infringing IR35 regulations are divorced from the actual signs of whether or not a contractor is actually working as an employee: Taking, for example, the guidance provided in response to the Budget 2018 by HM Treasury in its publication Off-payroll working (IR35)
: Budget 2018 the following is a description of a contractor who is not caught by IR35 regulations: Alan is taken on by a manufacturing firm to design and build a new website. Alan and the firm have
agreed a price for the job and when he will deliver the new website. Alan will mainly work at home, using his own equipment to complete the task. Alan is free to work for other clients but faces a contractual penalty if he doesn’t deliver the website on time, to the agreed standard. This represents a significant financial risk to Alan if he fails to deliver the final product as agreed.
and the following is a description of a contractor who is caught by IR35 regulations: The manufacturing firm needs someone to maintain and update the new website. It hires Jemima to work for three days a week, eight hours each day. The firm provides Jemima with a laptop so she can work at its offices or at home with permission. She reports to the head of the IT department and must follow their style guide and format to update the website. The firm is responsible for providing and updating the software Jemima needs to do her work. If Jemima has to work longer than her contracted hours, she will be paid overtime. Jemima can work elsewhere on the days she is not working at the firm, with their agreement.
Potential problems and grey areas
There are numerous issues with these archetypes, which highlight the difficulty of interpreting the HMRC's application of the IR35 rules: 'Alan' first:
- The description of the contract with Alan is the description of an arm's length service agreement for the design and build of a website. This is an agreement with a 'service provider' not obviously with an individual contractor. It's therefore easy to see why it passes the assessment tests. LawBite provide a number of templates which you can use if you work as a contractor or freelance.
- The service provider could as easily be a firm of web designer/builders working from their own offices, who come into the manufacturer for progress meetings or to receive instructions only.
- As Alan works independently from home then it also serves as a very clearly delineated image of a contract which escapes IR35 regulation, but it does so because the task, and the way in which it is delivered is one typically delivered by an independent service provider, not because it is an accurate and discreet image of an individual working through a Personal Services Company ('PSC').
- Jemima is clearly an employee. She works on an on-going basis and is paid overtime if she works outside regular office hours. There is therefore mutuality of obligation and payment issues.
- She can only work for other clients when she's not obliged to work for the manufacturer and then only with the agreement of the manufacturer. The manufacturer, therefore, exercises control over her availability.
- The rest of the description of Jemima's activities might equally apply to a contractor in a way which would not be subject to IR35 regulations, because:
- Jemima works on the provision of a limited service - the maintenance and content of the manufacturer's website - if she had a one year contract and was paid a flat hourly or daily rate for this and, was perhaps also obliged to update the site by a specific date each month, then this would not be inconsistent with a role not subject to IR35;
- Jemima 'reports' to the head of IT. If the contract were given to an external business one might expect the head of IT to manage the relationship and the external web agency to 'report' at some level to the job-holder and follow corporate design guidelines in delivering its services. The extent to which the manager directs Jemima's work on a day by day basis is not clear. If she agrees a general approach to her tasks each week/month and then delivers the services, adhering to corporate web design guidelines (as may have been agreed between the head of IT and Alan) when delivering her services, this could equally well indicate that Jemima is an independent consultant;
- Jemima works from home 'with permission'. Another way of putting this would be 'by arrangement' or 'by agreement'. There is a very grey area in the middle. The company could dictate the terms of the contract to the contractor on the basis of what was important to the company. It still doesn't mean that the relationship was that of employer and employee.
How might a business deal with the changes?
There is always the option on the part of businesses engaging contractors, only to engage on the basis of a Full-Time Contract ('FTC') and pay PAYE and NIC in line with IR35. But many, if not most have thus far eschewed this course in favour of an arm's length contract with a recruitment business which pushes the risk downstream. In relation to public sector hires, recruitment consultancies have been facing the dilemma of assessing the nature of their and their client's relationship with the contractor for over a year now. As public sector on/off book hiring was at the original heart of the state's decision to introduce IR35 in 2000, recruitment consultants have had a year to get used to the change in liability introduced in 2017. What the government relies on and, what poses the greatest risk to the consultant, are two things. Firstly, recruitment businesses have no interest in accepting the risk (which is difficult to manage and assess) and look immediately for ways to move the liability on. Secondly, HMRC will find a recruitment consultancy liable if the agreement it strikes with a consultancy business doesn't accurately reflect the upstream agreement signed with the client business.
What this means for consultants
There is certainly some concern that in all this, clients become less willing to engage contractors on a day rate and consultants who continue to work this way, accept the risk of all three parties.
- The criteria on which the status of a hire is assessed by HMRC is a blunt instrument at best and, always was. There is so much latitude in the interpretation of the rules that assessments become a subjective judgment. The answers to certain questions - is the contract limited in time? does the contractor contract with a business by which they were previously employed? does the contractor carry professional indemnity, public liability and employer's liability insurance? and, does the contractor control their relationships with other parties and market themselves through various recruitment business without reliance on one client or one recruitment business? - should be sufficient to prove a level of independence;
- A consultant working in the way Alan does in the above example, typically doesn't pay tax at a PAYE level of someone who is fully employed but the latter doesn't accept the risk of regular and repeated periods of being without work as businesses' budgets and Brexit uncertainty may dictate; and
- A fully employed person doesn't accept the risks of commercial business to business contracts or the liability which may fall on them if the requirements of the businesses for which they work are found by the tax authorities to create a relationship of reliance.