Lee Sharpe looks at how several government departments have mishandled the ‘IR35’ regime, (arguably including HMRC itself) and what it means for contractor companies.
The rules for ‘IR35’, encompassing so-called ‘false self-employment’, the ‘intermediaries legislation’ and ‘off-payroll working’ are long and convoluted; the principles are relatively straightforward, but their application can be very challenging. Many one-man companies that have been ‘caught’ by the rules will consider them quite unfair.
Original rules: IR35 – The ‘intermediaries legislation’
The original IR35 regime stems from Inland Revenue press release IR35, published in March 1999. Legislation was introduced in 2000 primarily to counter scenarios where an employee might resign his or her long-term position, then be re-engaged on essentially similar terms but through their personal company (usually) so the ‘employer’ no longer had to apply PAYE or National Insurance contributions (NICs) to payments (NB: the scope of the rules covers almost any ‘engagement’ through a third party, not just one-man companies, and nobody actually needs to be ‘rehired’ for them to apply).
Essentially, the ‘intermediaries legislation’ requires the worker or worker’s own company to consider the individual’s relationship with the engager (deliberately overlooking the worker’s company in between) and determine if it is effectively an employment relationship. If it is, the payment(s) made are adjusted, and PAYE income tax and NICs are applied to them; the worker’s personal company must fund the tax and all NICs that HMRC effectively says it would have received if the worker were a direct employee (in what is now ITEPA 2003, ss 48-61, plus SI 2000/727 dealing with the NICs aspects).
These original rules still technically apply, but have been largely overtaken by a new regime aimed at the employer or engager, rather than at the individual worker and company.
New regime(s): ‘Son of IR35’ – off-payroll working
This regime places the burden primarily on the engager to determine if the relationship between them and the worker is essentially one of employment and, if so, to apply PAYE and NICs to the payment(s) made.
The regime was introduced initially to oblige public sector bodies (including the NHS) from April 2017, but since April 2021 (after a year’s delay due to the pandemic), it now also applies to engagers that are large and medium-sized entities operating in the private sector (ITEPA 2003, ss 61K–61X).
Notably:
- The engager is primarily liable for the PAYE/NICs if HMRC later finds the relationship is basically employee versus employer (although the obligation moves down the ‘chain’ to, e.g., an agency provider, in some circumstances).
- Outside the specifics of a particular contract, nothing prevents an engager from determining a worker is really an employee, accounting for NICs and PAYE on the payment and paying across only the net amount (i.e., the engager can ensure it still pays no more overall, than it would have previously paid wholly to the worker’s intermediary or company).
- A worker cannot meaningfully appeal against an engager’s determination that he or she is ‘caught’ as an employee (there is supposedly an appeals process, but it is essentially worthless as it involves only engager and worker – not a tribunal or HMRC). The most an individual worker can do is prepare their personal tax return on the basis that they disagree and should be taxed as (for example) director or shareholder, and to try and get some of their tax back that way.
The wonder of CEST
In March 2017, HMRC introduced an online check employment status tool (CEST) (to replace its employment status indicator tool); workers and employers can use CEST to answer a series of questions that apply rules derived from numerous tax cases to determine if the relationship is ‘effectively’ employed or self-employed (of course, the tool also helps HMRC avoid being drawn into countless status disputes).
In theory, it is useful that HMRC has said it will be bound by CEST’s status determinations. However, it says it will do so ‘provided the information is accurate and it is used in accordance with our guidance’ (see HMRC’s Employment Status manual at ESM11170; notably CEST itself merely requires that the information given must ‘remain accurate’).
But if HMRC disagrees with a CEST ruling, it may simply argue that the engager did not follow HMRC guidance correctly, to get the determination it did (or, to put it another way, HMRC may stand by CEST only when it gives an answer that HMRC likes).
CEST wrongfoots the government
It has recently been reported that the Department for Work and Pensions’ (DWP’s) 2020/21 accounts disclosed it had paid £87.9 million in tax and interest, following HMRC’s 2020 review of the DWP’s contractors’ status from 2017 onwards. The DWP confirmed it had used CEST, but clearly, HMRC disagreed with many of the determinations.
However, the DWP is not alone:
- The NHS’ 2018/19 accounts revealed it had to pay £4.3 million over contactors’ status even after using CEST.
- HM Courts and Tribunals Service’s 2020/21 annual report included provision for £12.5 million covering 2017 to 2020.
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The Home Office’s 2020/21 accounts disclosed that it likewise incurred £29.5 million in taxes and interest, and incurred a £4million penalty (albeit suspended) for carelessness.
On the one hand, it is encouraging that HMRC seems to be scrutinising other government departments ‘without fear or favour’; on the other, it is worrying that even large government departments can get employment status wrong so often – even using CEST.
Computer says ‘don’t know’
There are numerous complaints that CEST is not up to the job of providing reliable results. CEST was supposed to have been substantively overhauled in November 2019, in preparation for the move to include large and medium-sized ‘employers’ (strictly, ‘end clients’ or engagers). Its test results from then to 31 August 2021 have just been published by HMRC, covering roughly 2 million tests during that time, as follows:
While it may, initially, be reassuring that CEST is returning ‘outside IR35/self-employed’ in at least half of the cases, this becomes less so in light of the above problems encountered by government agencies (and presumably others) actually relying on those negative test results. Furthermore, it is alarming that, despite the 2019 update, the tool is still returning ‘don’t know’ in around 20% of cases.
There are also specific concerns that the CEST tool has not been updated correctly to reflect the rulings in earlier IR35 leading cases; in particular, with regard to:
Right of substitution – Basically, a contract cannot be a contract of (personally-provided) service (i.e., employment) if the worker can readily offer (and the employer will genuinely accept) a similarly qualified person to undertake the project. For example, “I cannot dig that trench for you next week because I’m already booked with someone else, but my friend Kylie, who is also a whizz with a mini-digger, can do it instead, if that’s OK?”
Mutuality of obligations (MOO) – Very simply, where the engager is obliged to provide work and pay the worker, and the worker is obliged to turn up to do the work to get paid. This is quite a hot topic at the moment, with the Court of Appeal having recently set the cat amongst the pigeons with a, frankly, quite unsatisfactory ruling in HMRC v PGMOL [2021] EWCA Civ 1370, which clearly needs further exposition, if necessary at the Supreme Court (we now know practically all the things that MOO is not, but what we really need to know is what MOO actually is).
Conclusion
While the engager is supposed to consider each individual’s particular circumstances, there is extensive anecdotal evidence that many larger employers have decided simply to treat all contractor engagements as employed from April 2021 – and this probably suits HMRC quite nicely. Indeed, I am aware of an entity (not a client!) that had made a blanket decision covering well over a hundred contractors – without even using CEST. Engagers have very little incentive to treat workers as self-employed, and individuals unfairly treated as employees have little redress under the new regime; meanwhile, the original IR35 regime is still there to catch out contractor companies that are not engaged by public sector bodies, or large or medium-sized clients in the private sector.
