The Perfect Storm
Dave Chaplin, CEO of IR35 compliance solution IR35 Shield and author of IR35 & Off-Payroll Explained on the future of Off-Payroll compliance.
With the UK hoping to return to some sort of normality by summer 2021, the private sector implementation of the long-awaited off-payroll rules in April 2021 should ensure it is anything but business as usual for recruiters, their clients, and contractors – for the time being, anyway.
A combination of poor preparation, confusion over legislation, non-compliance, and possible unknown legal ramifications will make for an intriguing transition into the new rules and numerous potential plot twists for some of those involved. However, once the dust has settled, there is a chance that the controversial legislation could generate a better way of working.
It is likely to take a couple of years for the market to adjust, but those who are quick to demonstrate compliance and fairness and overcome the initial disruption caused by the Off-Payroll rules will march ahead of their competitors.
Non-compliant firms risk immediate Off-Payroll chaos
Unfortunately, many recruiters and end-clients are leaving the matter too late and look destined for short-term disruption as a result. Those who have failed to prepare by either conducting status assessments or agreeing alternate engagement models in advance are set to be without valuable contracting talent once the Off-Payroll rules are introduced, threatening considerable damage to ongoing projects.
Meanwhile, those who have imposed blanket bans on limited company contractors to negate their compliance obligations and tax risk could find themselves similarly devoid of contingent labour – 65 per cent of contractors told a recent IR35 Shield survey of over 3,000 respondents that they would not work ‘inside IR35’.
But non-compliant firms are not the only potential victims of this approach. With many firms and agencies looking to the unregulated umbrella market to process payrolls for their contingent workforces, thousands of contractors risk being unwittingly roped into non-compliant tax avoidance schemes.
Contract sector backlash
Non-compliant parties will also suffer backlash from contractors and industry stakeholders. Some websites are naming and shaming firms for non-compliant practices, and others are preparing to bring group litigation for unlawful tax deductions from contractor income.
Disgruntled contractors seeking compensation for ‘inside IR35’ determinations by way of workers’ rights will also be buoyed by Employment Tribunal (ET) claims such as that brought against HMRC in 2018 by Susan Winchester, a contractor who secured a £4,200 holiday pay entitlement to accompany an ‘inside IR35’ engagement with the taxman under the Agency Workers Regulations (AWR). The recent Supreme Court Decision on Uber also highlights that hiring ‘inside IR35’ using a deemed model is now potentially untenable because workers’ rights may still be claimed.
Who is set to benefit from Off-Payroll?
It’s not all doom and gloom, though. For every ill-prepared or non-compliant organisation, there will be another firm ready to capitalise. Those that adopt fair and accurate compliance processes stand to gain newfound popularity among the most sought-after contractors almost overnight.
Agencies partnering with compliant firms should, therefore, find placements easier to come by. With many small hiring firms perceivably less tempted to impose blanket bans than larger companies due to the associated heightened cost of engagement, it could be that the small agencies tied to these companies benefit.
Small consultancies providing contracted out services are also outside of scope, due to the small company exemption, so can expect to experience growth, as contractors seek engagements with these companies to secure fair treatment whilst still taking care of their own tax affairs under the original rules.
The changes are also expected to benefit overseas opportunities at the expense of HMRC. Contractors based outside of the UK will be viewed more favourably by firms who can rely on fully remote workers while UK contractors may increasingly look to overseas consultancies who are not subject to the Off-Payroll rules.
The struggle for supply chain compliance
Though it may not happen immediately, supply chain compliance will come under greater scrutiny. This has been made a necessity by the Off-Payroll rules’ debt transfer provisions, which permit HMRC to pursue agencies and hiring firms for unpaid tax liabilities resulting from non-compliance elsewhere within the supply chain.
Despite continued calls for regulation of the umbrella market to tackle non-compliance, government has offered nothing in the way of assistance. The taxman’s policing of the matter has proven so farcical that a Commons report recently exposed HMRC for itself engaging contractors via such schemes as recently as July 2020.
With these schemes often difficult to identify, some hirers have decided to insist that their recruitment partners only operate their own internal payroll. Some umbrella company providers are now offering a payroll bureau service as a result.
Particularly cautious hirers are likely to request agencies indemnify them against any risk caused by events further down the supply chain. And to gain the confidence of clients and supply chain partners, the documenting of audit trails may soon become common practice among agencies and umbrellas.
HMRC enquiries no concern for compliant companies
It may be a surprise to some, but we do not expect HMRC enforcement to be particularly problematic for agencies, although agencies who are promoting tax loss insurance must be careful not to fall foul of the Managed Service Company Legislation, which is akin to all their contractors being found ‘inside IR35’, irrespective of the actual status in law.
Remember that, under Off-Payroll, the end-client only offloads the tax liability risk onto the agency having assessed the contractor’s IR35 status and provided a Status Determination Statement (SDS) that demonstrates ‘reasonable care’ and contains reasons for the conclusion.
At this point it becomes extremely difficult for HMRC to overturn an ‘outside IR35’ determination at a tax tribunal. This would require the taxman to gather evidence persuasive enough to convince the judge that the original determination was wrong, despite the contractual paperwork and all parties providing evidence supporting the position.
This is why HMRC enforcement activity is far more likely to focus on inspecting engagements and simply encouraging businesses to place their contractors on a payroll where the contractors are ‘inside IR35’.
Given the huge cost of litigating cases, which must still be done on a case-by-case basis, the taxman will likely only intervene where firms are clearly cutting corners with their compliance efforts. Chief among them will be firms that are overly reliant on insurance products and may appear to be insuring against deliberate non-payment of tax. Agencies are reminded that insurance offerings should underpin rigid compliance.
Evolving case law should provide clarity
Another impediment to any tax collecting efforts applied by HMRC is its reliance upon the Check Employment Status for Tax (CEST) tool. The use of CEST is encouraged by HMRC despite accusations that the tool is misaligned with employment status case law, which could pose further problems for the taxman.
We are currently awaiting the outcome of the Court of Appeal case between HMRC and Professional Game Match Officials Limited (PGMOL). Ruling in favour of PGMOL, last year’s Upper Tribunal (UT) judgment exposed various flaws in the taxman’s interpretation of case law, particularly in relation to mutuality of obligation (MOO).
HMRC infamously omitted MOO from consideration by CEST due to the taxman’s assertion that MOO is inherent in any contractual engagement. However, the same arguments used to justify MOO’s omission from CEST were roundly rejected at UT, which found that the referees engaged by PGMOL weren’t within scope of IR35 largely due to an absence of MOO.
Should the Court of Appeal uphold this decision, it will further expose HMRC’s limited view of case law and prove CEST’s assessments to be fundamentally incorrect.
There are also other tribunal cases on the horizon and outcomes pending which will further evolve case law while bringing some much-needed clarity and certainty to the market.
The end of ‘outside IR35’ engagements?
With the legislation so heavily geared towards pushing contractors onto payrolls, it’s easy to forget that operating ‘outside IR35’ is still a possibility – but the number of contractors operating this way has severely diminished. Admittedly, many of these individuals will not have been assessing their tax position correctly to begin with, and HMRC’s estimate of a third of the market is probably about right.
While many hiring firms and agencies understandably remain risk-averse, the dust will settle and businesses will soon recognise the Off-Payroll bogeyman for what it is. Once some begin to test the water by engaging limited company contractors, others will undoubtedly follow suit, not least because of the unsustainability of an alternate labour market where one-person businesses are banned. Placing all contractors on payroll is like pouring glue on the UK’s flexible workforce.
Limited company contractors are the bedrock of UK Plc, providing the ad-hoc access to key skills and expertise needed for businesses to complete projects in an efficient and affordable manner. Once businesses overcome the initial fear factor of Off-Payroll, they will once again embrace the practical and commercial benefits of engaging limited company contractors.