On the 18th March 2020, the Government delayed changes to the IR35 rules for the private sector until next year as a result of the COVID-19 pandemic. The new rules are now due to come into force on the 6th April 2021.
Has this delay actually helped recruitment agencies? We explore some of the impacts that this delay has had on the sector. In a glance:
- Agencies have already spent considerable time and incurred administration costs by the time the delay was announced, which has now been wasted as the process has to start all over again
- Some contractors have already left the contractors market and become employees again
- Some contractors are now incurring additional costs because they have already started using an umbrella
- Confusion and annoyance by some contractors who are now requesting to be declared as outside IR35 again
Review of IR35 – What does it mean
The Intermediaries Legislation, or IR35, was originally introduced in 2000. It was designed to stop tax avoidance by individuals who do not fall within HMRC's definition of being self-employed and are in fact 'hidden employees'.
Following the Taylor Review in 2017, HMRC proposed changes to the private sector with regards to IR35, consistent with the changes already in place for the public sector since April 2017. The significance of the changes is that they move the employment tax responsibility on to the fee-payer from the contractor themselves.
Contractors, through the use of a Personal Service Company (PSC), currently reduce their income tax and National Insurance Contribution (NIC) liabilities by paying themselves in the form of a tax efficient salary and dividends rather than running a PAYE/NIC system. HMRC claim that too many contractors are declaring themselves outside IR35 (when in effect they are inside IR35) and follow this rule to reduce their tax liability. By 2023, this interpretation of the rules will cost the UK economy £1.3 billion per year in lost tax revenue. Once these new IR35 rules come into force, some advisors predict that contractors could lose up to 25-50% of their net income.
Under the new rules, the end-client (subject to the relevant small business test if applicable) are responsible for deciding the contractors' employment status for the purposes of IR35 and producing a Status Determination Statement (SDS). A SDS is a written document containing the status decision and the reasons for it. The end-client must pass the SDS down the supply chain and each party must pass the SDS on until it reaches the PSC. Failure to pass the determination down the chain to the fee payer and the PSC may make the failing party liable for any employment taxes rather than the fee-payer.
The appeal process of status determinations has also been criticised for lack of clarity, and while HMRC has confirmed that end-clients will have 45 days to respond to an appeal, there are no other formal requirements, so the process will undoubtedly vary between businesses. It also seems that contractors and agencies are devoid of any real influence over the decision.
All these changes of course carry significant operational and legal risks for the businesses involved. One of the major points that recruiters should be wary of is end-clients attempting to insert indemnity clauses into contracts and of contractors who may attempt to claim employment rights.
However, due to the delay the current position remains the same that contractors operating via a PSC are still responsible for determining the IR35 status of their work and paying any employment taxes due. Therefore, liability still rests with contractors if there is a HMRC investigation during this period.
Those contractors working within the public sector will not be affected by the delay and the end-client continues to determine the IR35 status of the contractor.
Impact of the Delay
While it's too early to predict the full extent of the delay, it's unlikely to have much positive effect for the recruitment industry. As the announcement came just weeks before the implementation date, many end-clients and recruitment agencies had already invested large amounts of time and money to comply with the changes, for example:
- Many contractors had switched to using umbrellas
- End-clients had already issued SDS
- Some contractors had left the market and become permanent employees
- Certain companies have introduced blanket bans or blanket assessments on contractors who operate via a PSC so resulting in contractors leaving the market
The knock on effect of the delay has been that:
- As contractors continue to be in charge of their status, many contractors who had received an inside IR35 SDS will now want to go back to classing themselves as outside IR35. Not only does this place all parties in the contractual chain in a difficult position but this has several serious legal implications
- There is a possibility that HMRC will consider this a Corporate Criminal Offence, and that all parties involved, including the agency, are knowingly participating in tax evasion. While the risk of prosecution is low, prosecution and conviction carries an unlimited financial penalty and can cause reputational damage
- Aside from criminal liability, any contractors and as a result, agencies, investigated by HMRC when the rules do come in are likely to be negatively impacted by the contradictory status assessments
- HMRC will be receiving less additional tax income than predicted so they may be more inclined to take action now and in the future against contractors and recruiters
- Next year when the changes to come into effect there could very well be no period of grace for the changes and fee payers could be prosecuted immediately for any incorrect SDS
Has the safety net for fee payers been removed?
Before the delay, HMRC had promised a 'soft landing' for the first year of the updated IR35 rules. It is unclear whether this will still be the case come April 2021.
A 'soft landing' is not a relaxation of the rules nor a time for parties to forget about their responsibility under the legislation, and HMRC has confirmed that penalties will be applied where there is deliberate non-compliance.
HMRC had attempted to reassure recruiters and end-clients that fines would only be imposed in cases of 'deliberate tax avoidance', yet many have pointed out that with or without a penalty, you may still find yourself liable for paying back significant amounts of tax and potentially face penalties in the years to come. There is also no clarity on what deliberate avoidance is, and HMRC would not know what is deliberate without conducting an investigation, which of course will be a cost to any business involved.
Finally, it is worth noting that HMRC had previously stated that the new IR35 rules would apply to services actually provided on or after 6th April 2020. Due to the delay, it is now unclear whether this change will stand, or whether in view of the 12 month 'grace period' HMRC will revert its decision, so that the new IR35 rules would apply to any services performed before 6th April 2021 but paid for form this date.
What should recruitment agencies be doing now?
We must remember that the reforms to IR35 have only been delayed not cancelled. Recruitment agencies should use the next 12 months to get ready to implement the changes and not leave it to the last minute so that they are not caught out by a HMRC investigation. We recommended that recruiters continue as they were and sooner than later;
- Liaise with end users to confirm whether they fall within the small business exemption
- Identify any potentially affected contractors
- Check that end users have a clear process for assessing IR35 status and appealing the decision
- Review SDS' for 2021, even if contractors have completed SDS' for 2020 and are still working under the same contract, as working practices can change over time. Don't forget the completed SDS' for 2020 will be useful in any future HMRC enquiry to prove that the status has been set with reasonable care
- Take steps to review existing contracts to ensure that they are not signing contracts that will cause them issues in the future
Can Lockton Help?
Recruitment agencies need to check their insurance policies to make sure that they have the correct cover that they need in light of the changes and increased risks caused by the changes to IR35. Agencies taking on more potential liability as they PAYE contractors as well as clients seeking indemnities for tax and employment liabilities will have an impact on existing insurance coverage. Another big concern we have is the potential changes to contract terms that recruitment agencies will be asked to sign following IR35 changes.
We believe that these changes to IR35 have significant potential legal and financial issues for recruitment agencies. If recruitment agencies do not seek advice then they will be exposed from contract changes and incorrect insurance cover purchased.
If we can help with the review of these contracts, review of insurance policies as well as IR35 insurances, then please do get in touch with us.