What is IR35 and what's changing?
IR35 is a piece of tax legislation introduced in 2000 to try and prevent individuals engaged as consultants via an intermediary (usually, but not always, a personal service company) from avoiding paying income tax and National Insurance contributions (NICs) by paying themselves in dividends as shareholders of the personal service company. When IR35 was first introduced the intermediary (and so usually the consultant themselves) had responsibility for determining whether IR35 applied to their relationship with the company engaging them and for accounting for income tax and NICs where applicable. This also meant that the intermediary (and so the consultant) bore liability for any penalties imposed by HMRC where their determination was wrong. This remains the case in the private sector. However, since 6 April 2017, where the company engaging the consultant is a public authority it has been for the authority rather than the intermediary to determine whether IR35 applies and, where it does, to make payment to those consultants (via the intermediary) subject to deductions of tax and NICs in the same way as it would do if they were directly employed by the authority. Where payment is through an agency or umbrella company, the authority has the burden of telling that organisation whether it considers the IR35 public sector rules should apply so that it can make the required deduction. HMRC estimates that an additional £550 million in tax has been raised since the public sector changes in 2017.
From 6 April 2020 the public sector changes (or something similar) will come into effect in the private sector. We will have to wait for the outcome of the recent consultation and publication of the draft legislation to see exactly how the changes to IR35 will be implemented in the private sector, but, whatever the outcome, the end result will require private sector companies to bear responsibility for determining whether IR35 applies to their relationships with the consultants they engage and take on the financial liability if they get this assessment wrong.
The difficulty with determining whether IR35 applies
The IR35 rules will apply where:
- an individual personally performs services for a client;
- those services are provided under arrangements involving an intermediary; and
- the circumstances are such that, if the arrangements had been made directly between the individual and the client, the individual would have been regarded as employed by the client for the purposes of either NICs or income tax (or both).
The first two questions will usually be a clear matter of fact. Determining whether IR35 applies is usually therefore dependent on whether the individual would, were they not engaged and paid via an intermediary, have employment status for tax and NICs purposes.
It is worth noting that, just because an individual is assessed as having employment status for the purposes of HMRC, they will not necessarily be an employee for the purposes of gaining employment rights. However, they often will be an employee for the purposes of both analyses and companies would be well advised to consider whether a consultant who is not genuinely self-employed for tax purposes may be, and should be treated as, an employee for the purposes of employment law. Indeed, from the point of view of the individuals to whom IR35 applies post April 2020, if they are going to be treated as employees for tax purposes they may prefer to have employment status.
There have been a number of cases brought against HMRC by intermediaries operating in the private sector over the last 18 months which have highlighted how difficult it can be to determine employment status for tax and NICs purposes. In Christa Ackroyd Media Ltd v. Revenue and Customs Commissioners  the first tier tax tribunal (FTTT) held that a television presenter engaged by the BBC via a personal service company would have been an employee had the personal service company not existed and that IR35 therefore applied to the fees that had been paid to her company (which should have deducted income tax and NICs before making the payment to her). The decision largely turned on a contractual clause which gave the BBC first call on her services and required her to obtain the BBC's permission before providing services to other broadcasters.
However, the outcome of two more recent cases brought against HMRC in relation to television presenters has been quite different. In both Albatel Ltd v. HMRC , a case concerning Lorraine Kelly, and Atholl House Productions Ltd v. HMRC , a case concerning Kaye Adams, the FTTT found in favour of the taxpayers despite some factual similarities with the Christa Ackroyd case. In Ms Kelly's case the FTTT focused on a finding that Ms Kelly, and not ITV, controlled her "brand and personality" and so ITV did not exercise sufficient control to demonstrate that an employment relationship would have existed had it not contracted with her via an intermediary. In Atholl (which concerned Ms Adams' engagement with the BBC) the FTTT considered that, as Ms Adams had the ability to take on engagements with other broadcasters without the BBC's permission, it was clear that she was a freelancer rather than an employee and so IR35 did not apply.
What these cases demonstrate is that the determination of whether a relationship is caught by IR35 can be very difficult and will always turn on its own facts. In the Albatel and Atholl cases HMRC clearly had sufficient conviction that IR35 applied such that it issued tax and NICs bills to Ms Kelly and Ms Adams. If the application of the rules is difficult for HMRC it is clearly going to be difficult for companies too.
Preparing for changes to IR35
Companies should not take the IR35 changes lightly. Failure to get it right may lead to the imposition of penalties by HMRC and make an organisation unattractive to would-be consultants as well as bringing adverse publicity. Even more seriously, if an organisation is found to have been involved in structuring relationships or payments so as to unlawfully avoid tax, it may be subject to criminal penalties under the Criminal Finance Act 2017.
On the direct implementation of IR35 to the public sector, many organisations decided to take a blanket approach to determining whether the rules applied and deduct tax at source from all sums paid to intermediaries through which individuals were engaged to ensure they didn't fall foul of the rules. However, as the recent case law examples have made clear, the determination will always be fact specific. For this reason, a blanket approach is an imperfect solution. The blanket approach initially taken by many public sector organisations proved problematic. Genuinely self-employed contractors were deterred from engaging with those organisations that took a blanket approach and took their services elsewhere. Private sector organisations will want to avoid this – particularly as, in times of economic uncertainty, they may well be in need of the valuable temporary resource contractors can provide. Organisations should therefore start to think about other approaches they might take to dealing with changes to IR35.
A good starting point is to take heed of HMRC's recent guidance. This recommends that medium and large private sector organisations that will be affected by the changes take the following steps:
- Identify individuals currently providing their services to the organisation through intermediaries.
- Undertake a case-by-case analysis to determine whether IR35 will apply to any contracts that continue past April 2020. HMRC has an online tool which can assist with this analysis.
- Speak to contractors about whether IR35 is likely to apply to them.
- Put processes in place to ensure that the correct rules are applied to future engagements.
Other things organisations might be doing include the following:
- Canvas the views of individual consultants to understand their view of whether IR35 applies to them. Where existing contracts are in place, they may well have taken steps to undertake this analysis and have some formal professional guidance on this.
- Consider outsourcing the IR35 analysis to a third party. Some organisations that make this analysis their business are already out there – and agreements with them should require them to take on the financial liability if their analysis proves wrong.
- Take steps now to ensure that future contracts avoid significant control and mutuality of obligation between the organisation and the intermediary and that this is reflected in reality. HMRC will look at the reality of the situation and not just the contract (and the lessons from case law are clear that the FTTT will take the same approach).