In the government’s ‘mini budget’, Chancellor Kwasi Kwarteng announced that the widely criticised IR35 reforms, introduced into the public sector in 2017 and the private sector in 2021, will now be repealed. This means the liability for determining employment status will once again fall on the contractor in April 2023.
James Bridgland, Managing Partner for Consultancy+, explains:
Q: What is IR35 and why was it introduced?
A: Originally introduced in April 2000, IR35 seeks to broadly tackle the issue of disguised employment and ensure that, where an employment relationship exists, the same amount of tax and national insurance contributions (NICs) are paid, regardless of how the individual is engaged. It follows the view that if you're doing the same job, you should pay the same tax, fundamentally.
From HMRC’s point of view, the challenge was that this became a very expensive and time-consuming tax to collect. The reason for this being that the determination is based on a lot of moving parts and the outcome is relatively nuanced. Add to this that there were hundreds of thousands of freelancers to track down, each engagement could potentially only last a few weeks at a time, and you can see why HMRC might spend more time and money recouping the tax than was the value of the tax itself.
Therefore, in 2017 and 2021, reforms were brought in to put the responsibility on the employer or end client to make the determination, putting greater liability on businesses. This led to many companies deciding on a blanket ban on working with personal services companies (PSCs) and many contractors moving to a PAYE engagement model.
Now, the chancellor has announced that these reforms will be repealed. The law itself is not changing, other than who is responsible for deciding whether the worker, or the engagement, is inside or outside IR35.
Q: How does HMRC define a contractor versus a temporary employee?
A: To be honest, a lot of the challenge is around that exact question. In 2017, they launched an online test called the CEST tool (check employment status for tax).
The three main criteria the CEST tool uses are:
Substitution – can they delegate tasks to someone else thus suggesting it is not a ‘personal’ service?
Financial risk – is there a level of financial risk or burden taken on by the contractor when undertaking the engagement?
Direction and control – does the employer have the right to tell the worker when/where/how to do their work?
There has been a lot of debate about some of the areas that are not covered in this assessment or placed at a seemingly lower level of importance. These include mutuality of obligation – i.e. the legal duty an employer has to give employees work, and the one an employee has to do that work, the length of assignment, and payment structure (e.g. “outcome based” commercials).
There are other tools online that cover some of these areas and engage the contractor to undertake some of the assessment, but they are usually not free and are not endorsed in the same way by HMRC.
Although no one is required to necessarily use these tools, if the responsible party doesn’t take due care to find out the worker’s employment status for each engagement – and they get it wrong – they have nothing to fall back on. If they’ve used the CEST tool, HMRC has stated that it will stand by the determination, providing the inputs are accurate.
Q: Why have the reforms been so controversial?
A: It’s controversial for a number of reasons, but a fundamental element is that people don’t agree with the determinations that the CEST tool makes.
HMRC has tried to put in place rigid, fixed rules for something that is actually really nuanced. Some determinations are easy and obvious, but others blur the line, and this causes confusion and disagreements. The CEST tool isn’t built on a particularly complex algorithm either, so there’s opportunity for gaming the tool, putting in certain answers to get the desired result.
After using the tool and answering questions, the result should either be that an engagement was ‘inside IR35’ or ‘outside IR35’. However, a fair number of results (circa 40% according to some reports) come back ‘undetermined’ leaving people a little stuck as to what to do. The common approach to this is to assume the ‘low risk option’, to determine the engagement as inside IR35, even though that may be incorrect and unfair on the contractor.
Q: What is changing in April 2023?
A: The only changes really are that contractors are again liable for determining their own employment status, and PSCs have liability for deducting tax and NIC, rather than the end company. We can assume the system will largely return to what it was pre-2017, but there are a lot of questions that will need to be answered before April:
What if a role had always been deemed inside IR35 by the end client but a contractor now deems themselves outside IR35?
What if multiple contractors make different inside/outside decisions based on the same role?
What if the client fundamentally disagrees with the contractor’s decision, in something they have decision making capability in – for example, right of substitution?
How will organisations and contractors react – will those that had a blanket ban on PSCs feel that undoing this not worth the effort or will there be a gradual creep?
What if a PSC was deemed inside IR35 before the repeals and then outside afterwards – are they open to risk?
What if projects straddle the change period?
How will organisations accommodate the changes and still protect themselves for the period “in between”?
I think it’s fair to assume that, over time at least, a number of employers will likely lift their blanket bans and restart engaging with contract workers again. In addition, we will likely see more people offering services through this route again as a result.
However, both employers and contractors should remember that IR35 is not going away. There are still other bits of legislation to stop employers from facilitating tax evasion, and for contractors, although there is potentially more opportunity and flexibility, they now hold more responsibility.
If you’re looking for a new role, or a talented professional, for an engagement that’s inside IR35, contact your nearest Reed office.
