Ensuring your IR35 Compliance

As a firm with an IR35 assessment regime in place, you may be seeking more confidence that your compliance practices are sharp, to reduce the risk of an unfavourable outcome after HMRC review your firm.

This guide focuses on helping you to identify any weaknesses and tighten gaps, helping to reduce your risk.

Key points in this guide

• IR35 is two separate pieces of legislation. Don’t mix them up.
• Tax liability is likely to always end up with the client. It cannot be buried.
• Contractors don’t have tax risk under the Off-payroll rules.
• HMRC’s Check Employment Status for Tax Tool (CEST) – heed the warnings.
• Make sure your contractual paperwork is robust.
• Always conduct robust status assessments and keep an audit trail.
• Monitor your contractors during engagements and gather solid evidence.
• Always use proven experts to assist you when HMRC review your compliance.

Background & terminology refresher

The original IR35 began in April 2000 under the Intermediaries Legislation, which sits in Chapter 8 of the Income Tax (Earnings and Pensions Act) 2003 (“ITEPA”).

The Off-payroll working legislation, Chapter 10 of ITEPA, referred to by Government as “IR35 reform” was introduced in the public sector in April 2017 and rolled into the private sector in April 2021 for medium and large firms.

The key point is that there are two co-existing legislation that deal with so-called “deemed employment” via an intermediary.

To ascertain whether a worker is a deemed employee, we must consider the common law (or case law), because there is no statutory test.

After making the status determination a conclusion is reached on the “IR35 Status”, and if the legislation applies the colloquial phrase used is that the engagement is “Inside IR35.” If the engagement is not deemed employment it is “Outside IR35.”

Key Off-payroll terms

The off-payroll legislation contains some key terms:

• Chain: This is the supply chain, with the work being personally performed for a “client”, to use the definition in the statute.
• Worker: This is the contractor, who works via their “intermediary”, typically a limited company.
• Fee-payer: This is the party above the intermediary usually responsible for deducting the tax if the engagement is Inside IR35. This can often be an agency, and if there is no agency, the client is also the fee-payer.

Where does the tax risk sit?

The entire HMRC investigation will be focused on the “client”, and if there are agencies in the chain, they are unlikely to be involved – because they did not make the status decision.

Poor process, which may include a pattern of many incorrect determinations, is likely to be considered a failure to take reasonable care, which means an agency is unlikely to get a tax bill for a decision they didn’t make. It's unrealistic for clients to think they could just give up, thinking an agency will settle their tax bill.

Where tax bills are issued, most large clients will seek negotiated settlements with HMRC, rather than appeal to tax tribunal.

Debt Transfer Provisions

Debt transfer provisions were introduced in April 2021, and designed to counter mischief by some fee-payers who sought to engineer schemes whereby the “Inside IR35” determinations could be ignored, and the tax risk could be buried by an unscrupulous fee-payer.

These provisions are designed to encourage clients to police their supply chains. However, they also mean that even where the tax risk theoretically sits with the agency, if HMRC consider that the agency cannot pay the debt in a reasonable time (12 months), then HMRC can simply pass the debt back up to the client.

Given the long time litigation takes, any indication of defence by an agency may provide sufficient reason to trigger the transfer provisions immediately.

Notably, the debt transfer provisions do not contain provisions to pass the tax debt down to the contractor.

For clients, who make the status determinations, the tax debt is likely to end up with them, and cannot be buried elsewhere.

Assessing Status – the law

To the layman, one would expect assessing employment status to be simple, but the reality is that the case law is vastly complex and not something that can be learnt quickly. HMRC take 3 to 5 years to train their own inspectors. If you do not already have an intimate knowledge of status, you need to bring in expertise.

A proper assessment, in law, must look at all the relevant factors, build a picture and then take a “standing back” approach. A status determination should not be formed based on any isolated factor.

The initial three factors are personal service (substitution), mutuality of obligation, and control. The presence of personal service, payment and some control are pre-conditions only, and not conclusive on their own. Other Factors must be considered, before a full multi-factorial evaluation is conducted. That evaluation must consider the “sufficiency” of mutuality and “extent” of control.

Historically, HMRC’s “Policy View” took a more narrow approach, but that approach was dismissed by the Court of Appeal in the Atholl House case in April 2022.

Control splits into four factors: How, what, where and when. Some elements of control are used when creating the hypothetical contract, and others are used in the third stage of evaluation where weights are applied to factors.

When you conduct your multi-factorial determination, you should document your results in a Status Determination Statement (“SDS”).

The Status Determination Statement (SDS)

There are two reasons to document your determination results:

1. to demonstrate you have taken reasonable care in reaching your status conclusion,
2. to produce a Status Determination Statement, or “SDS”.

The words “Inside IR35” or “Outside IR35” are just words, and are not a Status Determination Statement.

To create a document which is a valid SDS, it needs to contain the result and reasons for the determination, and the conclusion must have been reached by taking reasonable care.

The background reason for the SDS, is that it contains enough information about how the assessment was reached, so that it can be evaluated by a third party, like the contractor, and potentially disputed.

IR35 Shield will create an SDS document for you, within seconds of the last status question being answered.

Once you have the SDS, you should then give that to the worker, and others in the supply chain. It’s not mandatory to give the SDS to another party, but if the determination is an “Inside IR35” assessment, then it should be passed to the worker, otherwise the agency has no legal right to make any tax deductions.

Compliant practices

Implementing robust processes will help to ensure your IR35 compliance. Here are seven fundamentals:

1. Contracts: Problems often occur due to poorly drafted or generic off-the-shelf general employment type contracts being used. Repurposed agency contracts are not unsuitable. Always use commercial contracts “for Services” if the position is Outside IR35.
2. Accurate information: If the assessment information is wrong, it can materially infect the status evaluation. Include the right people during the assessment process. Be consistent to reduce errors.
3. Approval process: Include an approval process and oversight, when you are building up your Q&A base for specific terms or roles.
4. Consistency: Use a consistent, unbiased process, for case-by-case determinations, to avoid contradictory evaluations which clearly lack reasonable care.
5. Training: It is prudent for your firm to have some training and insight into IR35, on how to engage contractors who are providing Services, as opposed to just being “of service”, like an employee.
6. Monitoring: Conduct key monthly checks to ensure all your contractors are staying outside IR35 and gather key evidence, vital when HMRC conduct a compliance check. See IR35 Shield Monitoring – which achieves this for you via automation.
7. Stay aligned to the law: Whilst the case law is largely settled down, learning from tribunal decisions and understanding emerging case law is useful.

You can achieve this by following IR35 Shield, and signing up to our newsletters.

HMRC Check Employment Status for Tax (CEST) tool

HMRC’s Check Employment Status for Tax Tool was released in 2017, and updated it in November 2019. Since then the underlying decision engine has not been changed.

IR35 Shield conducted a comprehensive analysis of CEST, the findings of which are contained in a 34 page report – which you can download for free.

The report contains references to independent verifiable sources, including the CEST programming code, the case law, and what HMRC has told Parliament.

The main findings are:

1. Outdated: Despite the Head of HMRC promising to Parliament that CEST would be updated inline with court decisions, it’s not been updated since November 2019 – since then, there have been over 20 court decisions published.
2. Legally misaligned: In April 2022, HMRC’s view on status, upon which CEST was built, was exposed as flawed by the Court of Appeal.
3. Reasonable care: CEST’s “Outside IR35” determinations arguably do not adhere to reasonable care, because a single-factor determination has been made and the output does not contain sufficient reasons to meet the statutory definition of a valid SDS.
4. CEST is not mandatory: CEST is not mandatory, as HMRC has stated to Parliament on six separate occasions.
5. Government bills: There are over £250m pounds worth of tax bills in the public sector, issued by HMRC to their own Government departments, who all used CEST and followed HMRC guidance. The DWP was issued with a tax bill for over £80m, and recent accounts indicate they put 97% of contractors Inside IR35, using CEST. It appears that HMRC will only “stand by” CEST if it says “Inside IR35”.
6. SINGLE-FACTOR DETERMINATIONS: As the Court of Appeal confirmed, a status assessment must be multi-factorial one. CEST does not always do that.

CEST asks all the questions, but, for most “Outside IR35” assessments, it does not conduct a full balanced assessment for Outside IR35 decisions, and instead focuses on one single factor, ignoring all the other answers. If CEST cannot pick out the extreme cases, it just says “Indeterminate” or “Inside IR35”.

CEST Checker Service - free

Because of the single-factor exposure risk for firms who use CEST, IR35 Shield published a free tool to detect when they occurred.

Go to the IR35 Shield CEST Checker. Then drag and drop your CEST PDF output on our tool, and it instantly tells you if you have a problem.

Managing HMRC Compliance Checks

IR35 Shield estimates that the chance of a firm being investigated in any one year, is 1 in 20. With at least a four year window available, the probability moves to 1 in 5, or 20%.

HMRC are not the only risk though. Company owners, when selling companies, will normally have to sign a personal warranty covering any tax liabilities incurred prior to a sale.

When HMRC investigates you, they will ask for lots of information, and form an opinion. If HMRC form an opinion that you owe them money, you will need to appeal to a tax tribunal – which is time consuming and very costly.

The best way to win a status fight, is not have a long one in the first place. If your compliance is water-tight, you should not end up on the expensive tax tribunal merry-go-round.

If HMRC open an enquiry, it’s imperative that you seek expert help from status specialists with experience of tax tribunals.

How to choose an IR35 supplier

If you do not have experience with status tax matters then do not make the mistake of thinking you can easily defend any IR35 or Off-payroll investigation on your own.

These are unique tripartite investigations, and it is not a simple tax or accounting matter.

Defending a status investigation requires:

• Considerable knowledge of the case law
• A fundamental understanding of contractual interpretation
• Legal knowledge of contractual construction of the hypothetical contract, for IR35 status cases.
• An understanding of HMRCs emerging legal arguments, which are not in the public domain.
• Ability and experience of forensically building high quality corroborated fact-patterns.
• Experience in tax tribunals on status matters.

You will need professional help, from proven experts, which IR35 Shield can provide.

Summary of Best Practices to ensure compliance

IR35 best practice consists of the following:

1. Be educated – train your staff.
2. Know your responsibilities.
3. Implement a solid compliance regime.
4. Generate detailed and robust determinations (SDS).
5. Always rely on the law.
6. Rely on expert help when you need it.

If you need help, then please get in touch.