The UK's HM Revenue & Customs (HMRC) says 90% of personal service companies (PSCs) are not complying with the IR35 off-payroll working rules. Shifting the burden to the client engager should, logically, bring much of this non-compliance to an end. But what will happen in the transition?

The changes to the UK's off-payroll working rules being introduced in April 2020 present numerous challenges for medium and large businesses. Getting it right is going to involve a large measure of resource, skill and judgment. It may also require a large measure of tact and 'after care' because these changes have the inherent propensity to give rise to disputes between client engager, agencies, the workers and their PSCs, and potentially HMRC. The draft legislation introduces (for the public sector as well) a formal process for giving status determination statements to workers. It is important to step back and recognise the human element to this - or risk further aggravating the situation.

HMRC's response to its March 2019 consultation begins by saying this: "The off-payroll working rules (commonly known as IR35) ensure that individuals who work like employees pay broadly the same income tax and national insurance contributions (NICs) as employees, regardless of the structure they work through. The rules do not affect the self-employed."

"The rules have been in place since 2000, but noncompliance is widespread. HMRC estimate that only 10% of those who should be applying the rules do so, which will cost the exchequer £1.3bn in 2023/24. This deprives vital public services of important funds and is unfair to taxpayers who are complying with the rules."

The 90%

The subtext to this statement is that the '90%', assuming HMRC's statistics are reliable, are probably carelessly or intentionally failing to apply the current rules properly. The upcoming changes essentially shift the compliance burden from the individual to the client engager, rather than changing the underlying law. Those client engagers, being better equipped, more risk averse and easier for HMRC to police, are less likely to engage in such non-compliance, thus bringing the 90% into the fold. It is likely to be a smaller percentage than 90% because small businesses are unaffected by the rule changes, but we'll keep with 90% for simplicity. Or if you want to put it another way, a lot more income is about to be put through payroll and a lot of people are not going to like it.

Back to basics

Under the new rules for medium and large businesses, the worker providing services through a PSC would be an employee had he or she been directly contracted, the arrangement falls within IR35 and the fee-payer, which in multi-layer supply chains will not be the client, must then apply payroll taxes on the fees paid to the PSC. There will also be provision for this liability to pass back up the chain, ultimately to the client, in certain circumstances where the liability has not been met.

Collins Jason

Jason Collins

Partner, Head of Litigation, Regulatory & Tax

This overall process is going to be hard enough for medium and large businesses to manage at the best of times. The 'client', and we await HMRC's draft guidance to see how this term will be applied in practice in complicated supply chains, has to find a proportionate way of scoping all instances where the business engages with a PSC, ideally by a method falling short of manually reviewing all accounts payable.

This overall process is going to be hard enough for medium and large businesses to manage at the best of times. The 'client', and we await HMRC's draft guidance to see how this term will be applied in practice in complicated supply chains, has to find a proportionate way of scoping all instances where the business engages with a PSC, ideally by a method falling short of manually reviewing all accounts payable. Having identified these entry points they are going to have to consider the extent to which formal status determinations, on a singular or group basis, now need to be carried out on many thousands of pre-existing relationships, as well as introduce new controls and procedures to deal with new engagements.

Pre-existing relationships and buses

Let's look at this process from the perspective of pre-existing relationships. The client won't necessarily know whether the PSC has previously considered itself to be outside IR35 because the worker would be self-employed, but there must be a high probability, assuming HMRC's figures are reliable, that the client is dealing with one of the 90% who are getting in wrong. Leaving aside how difficult it may be in practice to determine status, let's assume that the client determines that IR35 applies.
There are a number of potential options available to the client and worker at this time. The client, or agency if applicable, could:

  • make substantive changes to the legal and practical relationship with the worker so as to satisfy itself that, absent the PSC, the worker would be self-employed - although this is likely to be difficult in practice to achieve;

  • seek to terminate the current contractual arrangements and directly employ the worker instead, applying payroll and granting the worker various employment rights; or

  • continue with the existing contractual arrangements, in which case payroll taxes, including employers' NICs, would apply to the fee paid to the PSC, but the worker would not strictly obtain any employment rights.

Whichever way you look at it, though, if the client engager determines that the arrangement falls within IR35, this creates a problem for the PSC if it hasn't already been applying payroll taxes. The client is, through no fault of its own, effectively throwing the PSC 'under the bus' for the past - because if the conclusion is that the PSC fails the IR35 test now, why would the conclusion be different for any earlier period when the current arrangements have been in place? It is this trickiness in the relationship between client and worker which needs to be handled carefully.
HMRC has said that it is not going to wage a campaign to recover past taxes from PSCs, but that it will deal with cases as they present themselves. I find this difficult to accept; HMRC is duty bound to collect the right tax and institutionally geared up to invite people to voluntarily disclose past issues to save HMRC much of the legwork. But, in any event, in many cases HMRC will be alerted to the identity of a given PSC and an investigation into the past is likely to follow.

Dispute resolution

The draft legislation does provide a mechanism for a worker and certain others to challenge a status determination and the mechanism will also apply to the public sector. It is only draft and is no doubt liable to change as the draft legislation becomes law.
First, the client must provide the worker with a 'status determination statement' with reasons for the conclusions reached. The worker has the right to make representations to the client that the conclusion is wrong, and there appears to be no time limit for doing so. The client must respond within 45 days either to provide a new statement with its fresh conclusions or uphold the conclusions in the original statement and provide reasons.
To aid compliance, if the client makes a status determination without taking reasonable care, or it does not respond to a representation within the 45 days, any payroll liability will sit with the client, even when, absent this provision, it would have sat with an agency between the client and PSC.
What happens after the worker has made representations? If the worker accepts the client's position going forward, ought the worker to contact HMRC to correct the past as well? What if it does not accept the client's position? Some might say they have nothing to disclose because they believe themselves to be self-employed - and perhaps that the client has failed to take reasonable care, so hasn't given a valid statement. Others might decide to face up to HMRC and put the argument out on the table both for the past and present. The correct status under IR35 is a question of fact and law, so the client's conclusions aren't binding and HMRC will have to form its own view. But, crucially, for the same given facts, HMRC clearly isn't going to agree a different treatment for the past and present. If a dispute between worker and HMRC ensues, the client engager might find itself sucked into it, having to justify and maintain its own conclusions (although happy if the worker wins the day), putting strain on its relationship with the worker if it has continued.

Contractor care

Client engagers and the agencies they use need to consider these issues carefully. They may want to consider a few measures such as:

  • providing some kind of support to workers including explanations about the ramifications for the worker and PSC and recommending they take independent advice; and

  • prioritising 'critical' workers to provide the best aftercare possible if there is going to be an adverse status determination.

Such aftercare might even extend to helping the workers to find an adviser if they don't already have one and recommending that workers check whether they have insurance which might cover professional fees incurred in dealing with any fallout with HMRC.
However, against this approach the client has to balance not being seen to be accepting any duty of care and/or liability for the past. The BBC has faced claims that it 'made' freelancers contract as self-employed rather than employees. Indeed, there are myriad claims management companies out there looking for work, especially as the PPI claims limitation window hits later this year, and former tax planning boutiques looking for something new to turn their hand to.

Evasion and facilitation

Finally, the other factor to bear in mind is that HMRC's figures suggest that there has been a very large amount of non-compliance for many years in the supply chains leading from and to large and small businesses and those businesses and the agencies which support them will have to be mindful of the extent to which their representatives (e.g. employees) have been aware of it. A worker knowingly and deliberately flouting the rules is engaged in tax evasion, any representative knowingly and deliberately assisting tax evasion (potentially even by turning a 'blind eye') will themselves commit an offence of facilitation.
For conduct taking place after 30 September 2017, that representative's criminal liability may also be imputed under the Criminal Finances Act 2017 to the client or agency in question on a strict liability basis, with the only defence being that the client or agency had reasonable procedures in place to try to prevent such facilitation from having taken place. Realistically, as IR35 compliance has, until now, been the responsibility of the worker and PSC, there is perhaps no reason for any representative of the client or agency to have any knowledge of whether the PSC should be and has been applying payroll taxes. But, equally, given the significant saving of employers' NICs available, one can see why representatives might have been tempted to put pressure on workers to hold themselves out as self-employed and turned a blind eye to the non-compliance.
The draft guidance is eagerly awaited. In the meantime, those responsible for their organisation's change programme should make sure they give adequate consideration to managing the risk of disputes with their current contractors and, although much less likely in practice, the Criminal Finances Act 2017 applying.

This article was first published in Tax Journal on 26 July 2019 and is reproduced with permission.