Waqar Shah assesses the complexities of IR35s
Tax rules introduced in the previous century still rarely cause taxpayers and tax advisers issues in identifying the boundaries of what is meant to be captured. IR35 was introduced by HMRC (at that point, the Inland Revenue) in 1999 and to this day, it is still an area which challenges the minds of lawyers and accountants (among others) across the UK.
Despite hopes that the March 2023 Budget would be a good opportunity for the government to either ‘ditch it or fix it’, these were dashed when the Chancellor chose to ignore IR35 altogether. However, this is not entirely surprising as the Chancellor in charge of the most recent reform in this area was the current Prime Minister, Rishi Sunak.
To that end, at least for the short-term, IR35 in its current form is here to stay and so lawyers need to be able to spot issues for clients as their trusted legal advisers.
Back to basics
‘IR35’ is the name given to the ‘Inland Revenue 35’ press release of 1999 which announced the new tax rules applicable to off-payroll working. Broadly, these apply to contractors who supply services through their own company – namely a Personal Services Company (PSC), or individuals treated as ‘self-employed’ and engaged directly.
The use of such PSCs to shield individual workers being taxed as such ie being subject to income tax and National Insurance Contributions (NICs) was the issue that was intended to be resolved.
Similarly, the effective ‘employers’ who opted to save on NICs by using consultants. This has been common practice by those in the financial, IT, healthcare and professional services industries among others for a while.
But the question has always been: where does one draw the line? An apparent scenario that would be caught by the guidelines is HMRC's worry of someone quitting as an employee on a Friday and continuing to supply the same services via a PSC on the following Monday. However, as recent caselaw has demonstrated, sometimes HMRC’s consideration of the factual position can be arbitrary at best and illogical at worst.
There might be many reasons why Liz Truss’ 49 days as Prime Minister will always be remembered; high up on the list will always be her and Kwasi Kwarteng’s mini-budget. One of the many things it promised was a reform of the IR35 rules whereby it would be up to individual contractors to decide if they were in or out of IR35; with no input from their clients. Of course, the plan didn’t last a month and so the status quo remained and is unchanged in the March 2023 budget.
Depending on whether the engaging entity is in the public or private sector and its size, in most cases the engaging entity will be responsible for determining the employment status of the worker not the worker him or herself.
If applicable, both income tax and NICs must be deducted from the monies due to be paid to the contractor by the engaging entity. The engaging entity would then need to account to HMRC for the income tax and NICs in the usual way.
Therefore, there is a need for clients to exercise ‘reasonable care’ in determining the tax status of their contractors (ie act in a way that would be expected of a reasonable person in the client’s position). HMRC has issued its guidance on what it considers that to mean.
There is an acceptance that ‘reasonable care’ will vary depending on the client. Importantly, failure to take ‘reasonable care’ in carrying out a status determination may result in the client being treated as the contractor’s deemed employer for tax purposes.
Despite facing challenges like being under-resourced, HMRC is in the process of contacting more organisations with respect to their IR35 compliance. The fear with any such contact is that without proper management, these may extend to far-reaching enquiries costing businesses time and money. HMRC’s powers are such that not only can they claim backdated income tax and NICs, but they can also assess for interest and issue penalties.
Indeed, such is the current state of the rules that there are situations where recruitment companies can be left holding the bag with regards to the tax liability; this is despite the recruitment company not being the one to determine the status of the relevant contractor.
The fact that double taxation is incorporated in the present reading of the rules — both the contracting organisation and the contractor paying tax on the same monies — may be the most alarming. This understanding has existed for a long time. Even if one ignores the advantages and flexibility that contractors have over other real employees, the double taxation viewpoint cannot be supported.
It is generally accepted that there are 3 key areas to look out for when determining status for IR35 purposes:
1) Degree of Control: does the contractor have genuine independence when it comes to how and when to work?
2) Mutuality of Obligation: is there an obligation on the contractor to carry out work and on the engaging entity to provide regular work?
3) Right of Substitution: can the contractor provide a replacement to carry out the contracted service to the engaging entity?
There has been plenty of case law touching upon all of these facets. The extreme examples are easy to spot but there are plenty of grey areas across a number of industries. All the circumstances need to be considered as no factor is more important than another on the determination of the position.
Depending on the size of the engaging entity, HMRC’s Check Employment Status for Tax (CEST) tool is a useful starting point to consider status of the contractor.
Regardless of the outcome, engagers should keep copies of Status Determination Statements and have these to hand if HMRC come knocking. This, along with demonstration that sufficient internal procedures were in place, will help to prove reasonable care has been taken.
Helping your clients
IR35 is such a wide-ranging regime that it could impact a fair number of clients. Knowing the powers HMRC have in this area and the lack of clarity embedded within the rules is important to be able to spot potential issues. Many believe that the best lawyers always know what they don’t know and this might be a perfect example of a situation where it is in a client’s best interest that a practitioner defers to a specialist tax lawyer with expertise in this area.
Waqar Shah is a tax disputes partner at Kingsley Napley LLP kingsleynapley.co.ukTags:
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