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IR35: are you ready for HMRC enforcement changes from April?

  • United Kingdom
  • Employment law

16-02-2022

The off-payroll working rules, commonly known as IR35, are designed to ensure that individuals who provide their services via an intermediary but who work in a similar way to employees, such as some contractors, consultants and freelancers, pay broadly the same income tax and national insurance contributions as employees. Government concerns over non-compliance with the IR35 Rules resulted in a reformed IR35 regime for the public sector in 2017 and for the private sector in April 2021.

Importantly, HMRC announced that it would initially take a lenient approach to enforcement during the first year of implementation in the private sector, including a moratorium on penalties until April 2022, provided there was no deliberate or dishonest conduct. However, this is set to end and may take some organisations by surprise.

Challenges in applying IR35

HMRC’s own research confirmed that nearly half of employers surveyed found the IR35 reforms difficult to comply with when initially introduced in the public sector. More recently, a number of government departments and agencies have paid, or owe, HMRC £263 million for failing to administer IR35 reforms correctly. In all cases, HMRC found that they had not taken reasonable care to prevent errors, including when answering questions in CEST (HMRC’s Check Employment Status for Tax tool).

Our experience is that many private sector businesses have also faced challenges when implementing the IR35 reforms. As a recent National Audit Office IR35 report notes, complex supply chains are more common in the private sector, when compared to the public sector, creating a greater risk of companies making errors when determining tax status.

Another emerging risk area relates to the growing use of umbrella companies to reduce IR35 administration. While the Government recognises that well-run umbrella companies fulfil a useful function, there are concerns about rogue operators associated with tax avoidance.

With the end of the HMRC moratorium approaching, organisations should take the opportunity to review whether their processes for hiring contract and freelance labour are IR35 compliant, or risk HMRC investigation and, potentially, significant tax liabilities and penalties.

Taking action to mitigate risk

As a reminder, in broad terms IR35 applies when:

  • a worker personally performs, or is under an obligation to personally perform, services for a client

  • the client is either a public authority or a medium or large private sector entity that has a UK connection

  • the services are provided through an intermediary which meets certain conditions (e.g. a worker’s personal services company)

  • the circumstances are such that, if the contract had been made directly between the client and the worker, then the worker would be regarded as an employee of the client for income tax purposes (or the holder of an office under the client)

In summary, when IR35 applies, the client must:

  • decide whether the worker would be an employee if the business contracted directly with the worker, exercising reasonable care in reaching this decision

  • provide its decision on status, with reasons, via a status determination statement to the worker and to the party it contracts with for the supply of the worker

  • have in place a status disagreement process (a dispute resolution process)

  • if they are the fee payer, deduct and pay employment taxes to HMRC

Even if the client is not responsible directly for paying the worker’s fees, they could still potentially acquire liability for tax if the person responsible in the chain for such liabilities defaults.

As part of an IR35 compliance review employers should consider, as a minimum:

  • refresh their understanding of IR35 principles, e.g. using HMRC website information (any such steps being likely to demonstrate the exercise of reasonable care over the IR35 Rules). We provide refresher IR35 training to support compliance reviews

  • review the use of contract labour, ensuring that reasonable care has been taken in assessing the deemed employment status of contractors who supply their services via an intermediary

  • check the integrity and credibility of those within the labour supply chain and whether they are compliant with the off-payroll changes

  • ensure that IR35 administration is compliant, including: the issuing of status determination statements by trained personnel; communicating and applying a status disagreement process (should the contractor wish to challenge the determination); avoiding blanket determinations

  • audit labour supply contractual liabilities and indemnities

For further information on responding to IR35, please visit our Eversheds Sutherland resource page.