After a delay in 2020, the IR35 legislative requirements finally arrived on 6 April 2021 for medium and large-sized employers. This is also known as the off-payroll working legislation.
Make no mistake, this is an earthquake change for the organisations it affects and the contractors who work for them.
There may be a tendency to see the new IR35 requirements as something limited to payroll.
That certainly isn’t the case, and payroll is simply the endpoint of a long and involved process undertaken by HR and People teams, working alongside all departments within the organisation.
A survey in January 2021 by IR35 Shield reported that the majority of in-work contractors (52%) have yet to be assessed for IR35.
Meanwhile, 86% of contractors have not been provided with vital documentation (such as a Key Information Document, or KID).
Does your organisation tick either of these boxes? If so, where do you begin to communicate IR35, create engagement with the message, and ensure compliance?
Here’s what we cover in this article:
What is IR35?
We examine the IR35 requirements in our comprehensive companion blog. However, here’s a brief crash course:
- What is IR35?: IR35 is tax anti-avoidance legislation. The goal is to legally define what a contractor is in terms of employment characteristics. It aims to identify ‘disguised employees’, also referred to as ‘deemed employees’.
- What’s changed with IR35?: The requirement to identify and correctly pay the relevant taxes on disguised employee contractors expanded to medium/large-sized private businesses from 6 April 2021.
- Why has IR35 changed?: Contractors who are actually deemed employees previously avoided certain tax and National Insurance payments. Additionally, they weren’t afforded benefits and rights given to actual employees, such as mandatory sick pay and holidays.
What do HR teams in medium and larger businesses have to do for IR35?
For those organisations affected (see later in this blog for details), the IR35 requirements as of 6 April 2021 create a need to take significant care when taking on contractors, and to re-evaluate all existing contracts that necessitate payments to a personal service company (PSC) or similar.
In other words, IR35 ceases to be a matter just for contractors, as has historically been the case in the private sector.
It’s now the responsibility of organisations and HR teams to ensure they evaluate contractors in light of IR35’s requirements.
If anybody in the organisation makes a mistake with an IR35 determination for a contractor then HMRC may request from the business any tax and National Insurance that should have been paid.
Additionally, there may be penalties from HMRC for the fact you submitted inaccurate data (although not for the first 12 months – see “What’s the IR35 ‘soft landing’ period?” below).
Here’s what HR and People teams in organisations affected by IR35 should do immediately.
Note that, in the language of IR35, the business that benefits from the contractor’s services is known as the client.
1. Revisit how you manage contractors
A process of reviewing your contractor lists needs to be central to any plan around implementing IR35, and will form the heart of your strategy moving forward.
More than this, however, is that you need to redefine talent management, acquisition and reward.
Traditionally, those in high-skill in-demand roles have often moved from full-time employment to contract roles, knowing they can make more money – and organisations have paid accordingly to access this talent.
IR35 can change this if a contractor is found to be a deemed employee. This creates the need for a radical rethink about how organisations attract and retain this top talent.
Some companies are simply moving all their former contractors on to the payroll for the hours worked, albeit maintaining the higher contractor wages.
This strategy effectively removes the need for the following five steps and is certainly an easier option for organisations, especially at this late stage in the process.
And salaries are certainly a key consideration. But benefits such as flexible and remote working, wellbeing, as well as company brand and culture, also feature heavily in prospective employees considerations for employment.
Companies that do not miss out on top talent build employee experiences that make highly skilled candidates want to join their organisation, and stay.
2. Update your systems
Are all your HR and People teams/systems updated for IR35’s requirements?
Have you set aside the administrative resource to review contracts, create status determinations, create fresh procedures around hiring contractors (and switching existing ones to payroll), and to update payroll IT systems?
There are lots of little tasks that add up to a significant new and ongoing administrative requirement.
For example, you may need to update your new starter checklist and processes. Record keeping is also likely to be more extensive too.
3. Refine processes
Now’s the time to take a look at your existing contractor hiring processes, including any agencies that might be involved in the chain.
Your processes will almost certainly need to be edited in light of IR35, but this is also the perfect opportunity to refine and enhance your existing processes around hiring contractors.
What can be done better?
How can you be more efficient?
In short, is it still the case that hiring a contractor is less expensive than paid employees in a given role – especially in light of the additional administrative burden and risk attached to IR35 status determinations?
Notably, and as mentioned, some organisations are simply switching all their contractors to standard employment contracts (that is, paying them via PAYE rather than paying PSCs).
As tempting as it might sound from an administrative point of view, you should look into the feasibility for your organisation, because it’s also been reported that such a blanket approach has caused key contractors to simply move on to opportunities elsewhere.
Can you afford to train full-time employees to fill the gap?
4. Communicate with stakeholders and provide training
Every business function that uses contractors has to be aware of the new IR35 requirements, and the gravity of the situation.
Some will be impacted significantly more than others, and this needs to be part of your planning (e.g. the IT world has traditionally made significant use of contractors, as has construction).
If you use agencies then you need to communicate with them their potential IR35 requirements if they are classed as the fee payer (see “What are the new IR35 requirements if agencies are involved?” below).
Remember that IR35 evaluation is rarely a one-off occurrence, and this too should be communicated.
For example, the extension of a contractor’s working hours or a seemingly negligible change in working requirements or placement may tip the balance to them being considered ‘inside’ rather than ‘outside’ the payroll.
It should also be communicated that this scrutiny and need for understanding applies not just to new contractors but to existing contracts, no matter how old.
These have to be re-evaluated in light of IR35 and the requirements it places upon organisations, such as providing a status determination statement (SDS).
This represents a significant administrative burden.
Of course, there’s also the need to communicate individually with the contractors too. For example, using the Check Employment Status for Tax (CEST) tool is best done with the contractor present because there may be questions you’re unable to answer about their working patterns.
5. Keep on top of developments
It’s going to take time to uncover the impact of IR35 in the context of medium and larger-sized organisations.
You need to stay on top of developments to watch for any particular gotchas that weren’t obvious in the wording of the legislation.
These may be announced by HMRC as a matter of clarification, or they may be the results of unavoidable legislation and tribunals that iron out the finer points of IR35.
Professional bodies you belong to may track these as a matter of course.
6. Prepare for contingencies
You may find that, despite your best efforts, it’s later found you didn’t get an IR35 determination correct. This may especially be the case if the real-world roll out or tribunals provide new insights.
You may need to ensure the additional budget is available for such a contingency should HMRC come knocking for unpaid PAYE (plus additional administrative costs, of course).
Methods need to created and mentioned within contracts to allow recovery of this money from the contractor(s) concerned.
Does IR35 apply to my organisation?
This is the million-dollar question, of course.
Although the new IR35 legislation applies to medium and large-sized companies, it’s necessary to define exactly what this means.
Unfortunately, this can be a very difficult determination to make. You should consult expert opinion if in any doubt.
But generally speaking, the rules for identifying the size of an organisation follow that set out in the Companies Act 2006, section 382.
This means a limited company is probably considered medium or large-sized if two or more of the following apply in a given financial period and also applied for the prior period:
- Annual turnover is more than £10.2m
- The balance sheet total is more than £5.1m
- The average number of employees is more than 50.
You can also use a ‘simplified test‘ if your organisation is any of the types listed below – in which case you must apply the rules if you have an annual turnover of more than £10.2m.
You can use the simplified test provided your organisation is not:
- A company
- A limited liability partnership
- An unregistered company
- An overseas company.
If your organisation didn’t meet the criteria as of 6 April 2021, but does subsequently, then you’ll need to apply the legislation from the beginning of the tax year after the end of the second consecutive financial year in which you meet the criteria.
If you use the simplified test to determine your organisation’s size, the legislation should be applied from the beginning of the tax year following the calendar year that you meet the turnover threshold.
What are the new IR35 requirements if agencies are involved?
IR35 requirements placed on the client become a little more complicated if they don’t directly pay the PSC (and therefore the contractor).
Should a contractor be identified as a deemed employee, IR35 legislation identifies a fee payer for the contract.
In the simplest situation, the fee payer is the same organisation contracting the individual, and for whom the contractor provides work – that is, the client.
But often it’s an agency. Sometimes there are several agencies.
This matters because the fee payer has legal requirements when it comes to payroll.
The organisation for which the contractor provides work should pass the SDS they create on to the agency, as well as to the worker.
Should there be more than one agency then the SDS should continue to be passed on down the chain until it reaches the party that pays the PSC. This is the fee-payer.
But there are some very important notes:
- The liability for deducting tax and NICs sits with the business until they pass on the SDS to the next party in the chain.
- If any party in the chain receives an SDS but fails to pass it on, they become the fee payer. A party is not liable for deducting tax and NI until they receive the SDS.
- If no other party in the supply chain meets the above conditions, the client becomes responsible.
What’s the IR35 ‘soft landing’ period?
In February 2021, HMRC declared that there won’t be any penalties for the first 12 months of the new IR35 rules (unless there’s evidence of deliberate non-compliance).
This is detailed in HMRC’s policy paper about IR35.
People refer to this as the soft landing period and, notably, it affects only client and fee-payer organisations.
It doesn’t affect the contractors themselves or their intermediaries because HMRC considers the clients and fee-payers to be the ones who are primarily burdened with additional responsibilities.
Additional key points announced in HMRC’s policy paper about the soft landing period are:
- HMRC has committed to not using information acquired as a result of the changes to new IR35 rules to open a new compliance enquiry into returns for tax years before 2021 to 2022 – unless there is again reason to suspect fraud or criminal behaviour.
- HMRC may contact organisations to discuss how they are applying the changes with the aim of helping them meet their obligations.
Preparing for the new IR35 requirements in HR and People teams
If your organisation hasn’t yet got processes in place for the new IR35 requirements then work should happen immediately.
There are few departments or functions that IR35 doesn’t impact, in however minor a way, and the first step should be having conversations to explain this.
The HR function simply can’t complete the likes of status determinations without the full input of those within the organisation responsible for taking on contractors.
These people need not only to understand IR35, but they need to take ownership of it when it comes to what they do within the organisation.
Remember, IR35 is not just a one-off problem to be solved. Since 6 April 2021, it’s a fact of life for affected organisations that use contractors.
All of this is in itself is a challenge, although not one untypical to the HR function, where it can often be difficult to achieve the required credibility within the organisation to push large manifestos.
But efforts must be made, perhaps by illustrating the impact to both the organisation and any contractors of what happens should the process not be completed (and any agencies involved, of course).
Editor’s note: This article was first published in March 2021 and has been updated for relevance.
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