We’ve all seen the headlines about the Department for Work and Pensions (DWP) having a tax bill for £87m, the Home Office (HO) for £29m, and the HM Courts and Tribunal Service (HMCTS) for £12m. It appears that all of these are casualties of the long-known major flaw with HMRC’s Check Employment Status for Tax (CEST) tool. But, who is going to pick up the tax bills when things go wrong?
Who foots the IR35 tax bills?
In many instances, due to a legislative unfairness, agencies could find themselves facing these massive tax bills, even though the client got the status assessment wrong. The crucial detail is in Section 61 of the Off-Payroll legislation as enacted in its original form in Chapter 10, Part 2 of the Income Tax (Earnings and Pensions) Act (ITEPA) 2017. This is the new legislation that applies and a stark reminder that considerably more has changed other than which party conducts the status assessment.
The “fee-payer” is the party who owes the tax – and they are “the person in the chain immediately above the lowest”, with the lowest being an intermediary, also referred to as personal service companies (PSC) in common parlance. This means it’s the recruitment agency.
The conditions in section 61T, part (6), can result in the client becoming the “fee-payer”, which under most circumstances would only be if they fail to take reasonable care in coming to its conclusion on the status.
It’s important to understand that this is the only reasonable care condition under Chapter 10, and it should not be confused with carelessness, which forms part of the Taxes Management Act 1970 and is the mechanism through which HMRC can charge penalties on top of taxes owed.
And here’s where the agencies are exposed – the client can take reasonable care, but still get the status wrong, thereby landing the agency with the tax bill. If HMRC agrees they have taken reasonable care, then the client could agree that they made the wrong decision, putting the agency in a very difficult situation – they will find it hard to appeal the status, particularly when the client has agreed with HMRC that they got it wrong.
The recent reporting indicates that the Home Office had penalties, indicating they were perhaps careless, which means they also didn’t take reasonable care. But, there’s been no reporting that the DWP did the same – which means the agencies may owe the money, and not the DWP. And this is where it gets rather messy.
So, what happens next?
The agency could try and clawback monies from the contractor but not without a fight – the contractor will argue they were ‘outside IR35’ and that HMRC’s view is not actually binding on them.
The agency also cannot claim back the employer’s National Insurance (NI) from the contractor, with attempting unlawful deductions under the Social Security Contributions and Benefits Act 1992. The agency has a hefty bill. Even if the DWP did not take reasonable care, the DWP may seek a refund from the agency perhaps leading to litigation.
Unwinding these positions is unmistakably messy and damaging for agencies who have not protected themselves. So, how do you do that?
How should agencies protect themselves against Off-Payroll IR35?
There are five options agencies should consider:
1. Client-agency indemnity: Agencies should obtain contractual indemnifies from clients for incorrect Status Determination Statement (SDS).
2. Do not send an ‘outside IR35’ SDS: Agencies can insist clients do not pass ‘outside IR35’ SDSs, preventing them from ever becoming the fee-payer.
3. Agency due diligence: Agencies should conduct their own due diligence for ‘outside IR35’ determinations.
4. Refuse CEST: If the client is using CEST, then convince them not to, or insist on all three of the steps above.
5. Work together to build a pre-emptive defence: Ideally, agencies and clients should work together on a joint solution – not using CEST – where they themselves actively monitor the engagements, recheck the status and gather additional evidence along the way that can then be used in a defence if HMRC decides to knock on the door.
The new legislation is considerably different to what we had before because status assessments must be done before the engagement starts. This in itself presents risk because:
a. nobody can accurately predict the future and,
b. much of the evidence used to defend an enquiry does not surface until during the conduct of the engagement.
Conducting a full compliance cycle, regularly checking status, and shoring up the original determination with valuable evidence is much more logical and reliable. That way, your firm won’t end up having its reputation blotted by a tax tribunal because any enquiry should be shut down long before it even has the chance to get to that point.
