Hiring contractors has never been easy. From unreliable partners to legal issues, we’ve got ourselves a bit of a minefield to traverse.
And now, thanks to a change to an already existing bit of HMRC legislation, it’s about to get a whole lot more complicated.
Hiring managers: these are the IR35 changes you need to know about if you’re going to be hiring contractors anytime soon.
What is IR35?
IR35 is a set of tax laws designed to figure out whether a self-employed worker is genuine or cheating the tax system by working as a ‘disguised employee’.
IR35 has been active since HMRC first realised there was a loophole in how contractors were paying things like holiday pay, national insurance and PAYE.
That was 2000 and Gordon Brown was Chancellor of the Exchequer. Major throwback.
Since then, public sector contractors have been responsible for self-assessing their IR35 status and National Insurance Contributions. This arrangement has, according to HMRC, been less than satisfactory and the HMRC estimates that, under current rules, the cost of non-compliance in the private sector would escalate to £1.3bn by 2023/24.
A big problem for HMRC.
An even bigger problem for HMRC was the scale of the contractor market. There are an estimated 1.77 million contractors in the UK. That’s a lot for a reportedly understaffed department to keep in check.
Wouldn’t it be a lot easier to police the one commonality between all these contractors: the person hiring them?
So in 2020, that’s exactly what they decided to start doing with a new wave of IR35 legislation.
That legislation will be applied to the private sector and it will shift responsibility for paying these taxes and fees away from the contractor and towards the fee-payers. (The sweeping term for the person responsible for paying the contractor).
It may all seem like doom and gloom but the silver lining here is that HMRC “seem” to have a pretty stable standard for what IR35 compliance looks like and that’s unlikely to change.
So if you’re IR35 compliant now – you’ll be IR35 compliant come April 2020.
With that in mind, it’s a good idea to do all the hard work now while there’s still time. So here are the major IR35 changes:
1. Hiring Managers are now responsible for determining the IR35 status of contractors
The new IR35 legislation to be introduced in April 2020 shifts responsibility for assessing IR35 obligations from the contractor or PSC to the end-user, that is the company that uses contractors.
That’s hiring managers and people in recruiting positions.
To do that effectively you’ll want to be able to distinguish between being ‘inside’ IR35 and ‘outside’ IR35.
How to determine the IR35 status of a contractor
HMRC aren’t messing around. Their recent aggressive pursuit of GSK gives us an insight into their stance come April 2020.
Because of this, a lot of hiring managers might resort to knee jerk reactions where they list every contractor of theirs as being inside IR35 just to avoid the threatening glare of HMRC.
But then you’d be paying unnecessary tax, and more importantly, be potentially meddling with the livelihood of contractors who rely on the work you provide them.
Because there is no occupation that would be automatically outside IR35, the borders between the two determinations are grey and always changing. Take the time now to study the signals that determine whether a contractor is ‘inside’ or ‘outside’ so you can make the correct determination.
HMRC’s determination of a contractor relies heavily on a number of different ‘signals’ which may mean different things to different companies:
- Control – Does the contractor have control of how he carries out his work? As a client, you’d want to prove that you don’t have direct control over how the contractor meets the agreed deliverables of the project. Easy for IT contracting, less so for Construction, where management may be essential.
- Access – Does the contractor work on site? Does the contractor use company tools like a laptop or a power drill? If a contractor is using all of your tools and has access to all of your facilities, the contractor may fail their IR35 inquiry because their access is indistinguishable from that of a full-time employee.
- Payment – Is the contractor receiving a day rate? Or by the job? The more regular it is, the closer a contractor is to an employer-employee relationship.
- Work Perks – Does the contractor go to all your parties? Do they receive staff perks? Sounds silly but it’s these fine margins that can make or break an investigation.
- Exclusivity – Does the contractor only work for you? Or do they have a long list of clients they’re contracting with? If they’re exclusive to you, you’re going to have a harder time explaining why they aren’t full-time staff.
You can probably spot a theme here.
The difference between being inside and outside IR35 is the difference between being a full member of staff and being a truly independent party that operates for, but apart from your company.
Okay, I know whether my contractor is inside or outside IR35 but what does that mean?
Figuring out which of your limited companies or contractors are inside or outside of IR35 is the most important thing to do right now.
But what do you do once you know that information?
Well, when the changes are rolled out in April 2020, you’ll take the following action:
|You should be paying employed levels of tax||
You can pay the contractor as normal
For now, just keep contractors audited and involved with your decision making in regard to IR35 and their determination.
The reduction from the pay you’ll be giving to the contractor may cause some upset but remember that it’s you who will be liable if HMRC were to find out a contractor, who should’ve been paying employed levels of tax, is not.
2. The fee payer is now responsible for contractor tax and fees
Traditionally, the contractor themselves has always been responsible for paying their own tax and fees if they are determined to be inside IR35.
Come April 2020, it’s the responsibility of the hiring manager.
If you can’t prove that your contractor sits outside of IR35, you, as the fee-payer, will be responsible for paying PAYE, NIC and everything else.
Lawfully, however, you cannot deduct the fees from the contractor’s fee. Instead, they would have to be paid on top of that fee.
3. Recruitment agencies have a bigger role to play
Some recruitment agencies serve as the fee-payer for contractors and, in this case, that makes them responsible for paying the deductions to HMRC.
More links in the chain can be both a good thing or a bad thing and, depending on your confidence in your current IR35 preparedness, you may want to consider using recruitment agencies for contractors.
If you work with a recruitment agency, ensure that the upper-level contract is watertight. Any discrepancies between this contract and that between the agency and contractor can cause the contractor to lose an investigation into their accounts.
And after April 2020, the consequences of that will fall on hiring managers.
4. IR35 insurance is going to become very popular
Already, many recruitment agencies are building out their contractor insurance packages to include IR35 insurance which indemnifies everyone in the chain of a contractors employment.
In addition to this, the insurance also offers the following cover:
- Cover fines and legal penalties (up to £100,000)
- Covers any HMRC checks
- Ensures the fee-payer always has legal representation should they end up in an investigation
The only caveats here are that regular contract reviews have to be performed, which most recruitment agencies worth their salt will perform anyway.
5. You may see more widespread use of umbrella companies and recruitment agencies
Contractors that operate independently as either a limited company or sole trader can come under risk of falling foul of HMRC purely because there is a lot to keep up with. If investigated by HMRC and found to be illegitimately outside of IR35, they will be forced to pay back taxes on your eligible past earnings, including interest.
Read more about Limited Companies here.
Operating under IR35 status can be especially damaging to personal limited companies, who are obliged to pay income tax on their entire earnings on top of the company’s corporation tax, costing them more money than if they were simply employed.
Most contractors can become nominal employees of either a recruitment agency or umbrella company to avoid the IR35 classification in self-employment.
What can Hiring Managers do to comply with IR35?
There is no reason why a hiring manager shouldn’t start preparing for the changes due in April 2020 now. Here are a few places you can start:
- Familiarise yourself with HMRC’s Good Work Plan and keep your finger on the pulse of upcoming changes.
- Cultivate an open dialogue across your business where knowledge on changes can be shared in a healthy manner
- Audit your contracting employment, how many PSC’s do you work with?
- Set up a robust system for determining the employment status of a contractor that involves all those in the chain of employment
- HMRC also recommends that businesses should start reviewing internal systems such as payroll software, process maps, HR and on-boarding policies to see if they need to make any changes.
- Look into IR35 insurance
- Ensure your contractors’ professional indemnity insurance (which is a really good indicator of a contractors’ IR35 determination) is present and sound.
Even though the responsibility has been shifted towards hiring managers, contractors still have plenty to worry about. And, with the veracity that HMRC is pursuing some contractors, it would seem like they’re stuck between a rock and a hard place.
It’s also worth mentioning that having a contractor being ‘inside IR35’ isn’t illegal (it’s considered tax avoidance rather than evasion).
So, as a hiring manager, it’s important that you don’t scaremonger.
Keep sight of the fact that, no matter what happens or what is said, livelihoods are potentially at risk and any knee jerk reactions will put both parties at risk.
Changes are afoot
IR35 is a very confusing bit of legislation that means lots of different things for everyone involved in the chain of hiring contractors.
For that reason, it’s very hard to find a one fits all solution. Best we can do is know as much as we can about the changes and start to lay the foundation for April 2020.
For more insights about IR35 and its impact on the recruitment sector, please watch our webinar: Navigating IR35 in 2021: What the private sector can expect.