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A practical guide to planning for IR35 reform in the Private Sector
24 May 19 | By: Jas Jhooty
Sweeping changes in the way that medium to large Private Sector businesses are to engage with off-payroll workers were announced in Budget 2018. From April 2020, these firms will have the onerous responsibility of taking reasonable care in ascertaining the true employment status for any Personal Service Companies (PSC) they have engaged with. If the engagement is found to be that of deemed employment (i.e. the individual would have been classified as an employee if it wasn’t for the veil of incorporation) then the Private Sector business will be mandated to deduct payroll taxes from the net amount of any invoices presented to them by the PSC.
This legislative change requires substantial planning by affected Private Sector businesses. This article offers practical advice and best-practice solutions on how to manage Private Sector IR35 reform.
Setting up an IR35 reform project team
If you haven’t already done so, now would be a good time to set up an IR35 reform project team. Representatives from your HR, Finance, Payroll and Legal departments should be invited to be members of this team. Amongst the first items that should be discussed is the issue of how you will be able to identify any PSCs that you have on your supplier list, as this is not always obvious.
The best practice methodology would be to assign a task within the Finance Department to work through due diligence supplier check list to identify any PSCs. emTax consultants have devised such a checklist that incorporates 4 key employment status questions. If the assessor can answer at least two of these questions positively, (by doing a little bit of online research), then you will be safe to classify that supplier as not being a PSC so will not be affected by the IR35 reforms. A copy of the completed checklist should be retained in the supplier file to prove to HMRC that you have taken reasonable care in identifying any PSCs that you may have engaged with.
Contact us if you want more details about our IR35 due diligence supplier checklist.
IR35 testing methodology
The next stage is to select a robust system for performing the required IR35 employment status tests. Lessons should be learned to avoid what happened within the Public Sector when IR35 reforms were introduced in April 2017. Most Public Sector Bodies were instructed to use HMRC’s flawed Check of Employer Status Tool (CEST) to assess common contractor roles under blanket IR35 determinations. Unsurprisingly this methodology resulted in nearly all contractors supplying services into the Public Sector being caught within IR35, thus requiring PAYE tax & Class 1 NIC to be deducted from their presented invoices.
We advocate that the Private Sector should avoid making blanket determinations as they are invariably inaccurate and will either lead to too many contractors being labelled as employees thus affecting your bottom line. Conversely if you decide that whole groups of contractors fall outside IR35, you run the risk of miscategorisation for certain individuals within that group and thus will be liable for backdated tax & Class 1 NIC.
The only safe way to demonstrate that you have taken reasonable care, is to undertake individual assessments preferably undertaken by the off-payroll worker themselves, as only they know the answers to certain key employment status factors; e.g. how many other clients do they provide services to?
So, you have decided to undertake individual IR35 tests but how will you go about making accurate employment status determinations? You need to choose a system that takes no shortcuts when considering which employment status factors require consideration. HMRC’s CEST tool misses out at least 2 key employment status factors and only asks a maximum of 20 questions. To make an accurate employment status determination, adequate information on every single employment status indicator needs to be gathered. Questions need to be asked of not just what the contractual position is, but also what occurs in reality. We estimate that at least 100 questions need to be asked to arrive at a reliable employment status determination.
Ideally the information capture should occur online. The last thing you will want to try to do is to attempt to undertake assessing all of the information captured to make employment status determinations manually. Even if you were to seek professional assistance there are only so many assessments that a tax consultant can undertake in a day. It will be next to impossible timewise (and extremely expensive) if you decided to engage tax consultants to conduct these IR35 assessments, especially if you have a large volume of contractors on your supplier list. Mistakes are bound to arise and the penalties for making such mistakes will be severe.
The only safe way is to choose a system that will automatically make accurate and reliable determinations using advanced algorithms. Behind the scenes these algorithms should apply an individual weighting to every answer provided and then balance which side of the employment status scales, your contractors’ status fall into.
Evidence of this process in the form of a due diligence IR35 status report should go into the specific detail of which answers have been provided and what the relevance of those answers are to the overall employment status determination.
By taking these steps you will be able to prove to HMRC that you have taken reasonable care in arriving at the true IR35 employment status of your off-payroll workers.
Initial IR35 audit
Your identified PSCs should be invited to complete the online IR35 assessments in a stipulated timeframe. Pressure can be put onto them by stating that their invoices will not be paid after a cut-off date unless the information required for the assessments has been submitted. Once all of the test results are in, your chosen system should be able to provide you with a breakdown of:
• Total number of contractors in each assessment status i.e. fail, borderline, pass etc
• Financial impact for contractors inside IR35
• Tax savings for contractors assessed as outside IR35
• Case law and common issues across the organisation
• Possible solutions and positive impact on the bottom line
The advice gathered after the initial audit should be acted upon to try to change the contractual and working terms and conditions with a view to change as many borderline cases into passes as possible, the next time an IR35 test is taken.
All of the above requires early planning and implementation, especially if you wish to take remedial action to maximise the number of IR35 passes to minimise your additional tax & NIC payroll costs. The above process typically takes a minimum of 6 months and with only 10 months left until April 2020, IR35 systems should be getting selected and implemented within the next 3 months.
Unfortunately, the requirements for IR35 assessments will not be a one-off. Whatever system you use will need to baked into new workflow procedures to assess any new contractors’ employment status, post April 2020. There will also be occasions when an existing contractor’s employment status will need to be revisited because their circumstances may have changed; e.g. an initial 3 month contract has turned into a 9 month engagement.