Off Payroll in the Private Sector – Will It Affect Me?
Monday’s Budget confirmed that the new Off Payroll IR35 rules will soon be rolled-out to the private sector – but what exactly are the Off Payroll rules and who will be affected?
The government introduced IR35 in April 2000 to considerable controversy, due mainly to the additional administrative burden heaped onto contractors: under IR35 as originally published, the onus was on the individual contractor to assess their IR35 status on a contract-by-contract basis. There was little guidance given on to how to do this however, and at the time most contractors simply didn’t have a clue how it worked. When asked if they were working on a self-employed basis, nearly every single contractor would have said “yes”, given the nature of their engagement and the lack of statutory employment benefits such as sick pay and holidays.
HMRC had little incentive to educate contractors on the legal difference between employment and self-employment, because, in their view, the more contractors understood the distinction, the easier it would be for them to structure their engagement in such a way as to be unequivocally self-employed, meaning HMRC would receive less tax and National Insurance. They did launch an online IR35 assessment tool called the Employment Status Indicator (ESI), which was woefully inadequate, inaccurate, and gave an obvious bias towards returning “inside IR35” results.
So most contractors continued paying self-employed tax as usual, and over the years HMRC began to challenge contractors’ tax returns, arguing that the contracts worked had actually been “inside IR35” and additional tax and NI was due. Some contractors just paid up, fearing the cost and time involved in a lengthy battle with HMRC. Others, who were more sure of their IR35 status, did challenge HMRC and some cases ended up in court.
HMRC lost a fair amount of these cases, exonerating the contractors involved but also, significantly, implying that either they also didn’t understand the IR35 criteria, or had been “trying it on”, and attempting to knowingly overcharge taxpayers, capitalising on the confusion surrounding IR35. Neither of these outcomes paints a particularly flattering picture of the taxman, and IR35 remains incredibly unpopular.
The criteria used to determine an IR35 status are the same used at the Employment Tribunal to prove that a worker is employed and thus should receive employment benefits. In IR35 cases, the taxpayer is generally trying to prove self-employment rather than employment, but the actual criteria are the same. Unfortunately, this is not a statutory test – there is no official regulation that defines it – the criteria are instead derived from the historical decisions of the Tribunal (and more recently from IR35 Tax Tribunal decisions). So to understand this test, you would need to read all previous relevant decisions and make an assessment accordingly, and this is not straightforward even with legal training.
Fast forward to 2016 and avoidance using limited companies was still commonplace. IR35 had had some effect, but its complexity and a lack of confidence in HMRC led many contractors to continue drawing dividends and hope to just “slip under the radar” and never have it questioned. HMRC have limited resources so they can’t look into every single potential IR35 case, and they were losing a proportion of those cases that they did enquire into. The Panama Papers had not long been leaked and there was a huge political will to curtail tax avoidance. The government needed to reduce tax avoidance using limited companies effectively. IR35 had to be reviewed.
Their response was the Off Payroll rules, which essentially switch the onus of IR35 assessment from the individual worker to the end-client (or agency) that they are providing services at. The logic is simple: a large organisation with say 250 contractors should be in a better position to carry out IR35 assessments than the individual contractors themselves.
Curiously, the government has opted to implement the rules in two phases: the rules were rolled-out to the public sector in April 2017, and were due to be extended to the private sector in 2019, although this has since been delayed for another year in the 2018 Autumn Budget. The rush to implement the rules in the public sector may well have been due to the increasing political pressure to clamp down on tax avoidance – its not a great look for the government to be hiring tax dodgers.
One would think contractors would be cheering the decision to take IR35 off of their hands, but the announcement that end-clients would now be in control of IR35 status was met with concern. Contractors know first-hand just how complicated IR35 is, and the fear is that end-clients won’t have the skills in-house to properly make IR35 assessments, instead simply defaulting to an “inside IR35” position for all contractors (unless they kick up a stink), which could lead to legitimately self-employed contractors being forced to pay full PAYE employment tax and NI – and still not receive employment benefits such as sick pay, etc. This “worst of both worlds” situation is a doomsday scenario for many contractors who may feel its then time to give up and go perm.
Clients are being asked to make an assessment, of which they may not be 100% certain. Should they choose self-employment, there is always a risk that they made the wrong decision, and in that case they could be liable for unpaid PAYE. If they just pay PAYE in the first place, the contractor receives less but the client eliminates any risk of future tax bills, whilst avoiding the cost of making an IR35 assessment. It’s hard to fathom a situation in which a client would want to pay a contractor “outside IR35”.
And indeed, thanks to the early public sector roll-out of the rules, we have been able to get a preview of how clients react to them, and we have seen exactly this policy being enacted again and again by Public Sector Bodies (PSBs), confused to hell by this new IR35 nightmare and terrified of non-compliance with the new rules. HMRC have launched a new online assessment tool alongside the new legislation called Check Employment Status for Tax (CEST), which has also been criticised for over-simplifying what is a very complicated assessment, and for giving false “inside IR35” results for contractors who are clearly “outside IR35”.
Private Sector Roll-out
The roll-out of the rules in the public sector has been problematic to say the least, and Public Sector Bodies are typically fairly large organisations with a penchant for bureaucracy. The extension of the rules to the private sector is expected to be an even rougher ride, and private firms are likely to be less keen than their PSB counterparts to expend resources doing proper IR35 checks for every single one of their contractors.
The additional year’s delay to the private sector roll-out is welcome news, therefore, although how useful it will be in preparing business for the rules remains to be seen. Some contractors are viewing it as another year to lobby for the abolishment of the private sector extension, but there seems to be considerable political will in reducing avoidance via limited companies. Also of note is the new announcement that there will be an exemption for small firms – although we still don’t know exactly how small.
It is likely that the new rules will affect the recruitment process for contractors – we may find that contractors start to negotiate for a deliberate self-employed structuring of any engagements before accepting them, should they have the necessary leverage. If they don’t, they are likely to get pushed onto payroll as a matter of course.
The HMRC guidance for the Off Payroll rules can be found here<link https://www.gov.uk/guidance/off-payroll-working-in-the-public-sector-reform-of-intermediaries-legislation >