What are the changes to IR35 legislation coming in on April 6th?

Currently, the responsibility for determining whether a Private Sector, limited company contract is “Inside”, or “Outside” IR35 (& any associated liability) sits with the Contractor. From April 6th that responsibility shifts to the Client/Hirer & the liability sits with the Agency or Client/Hirer (depending on the circumstances). There is a small company exemption but if that does not apply, businesses will be responsible for deciding the IR35 status of all roles that utilise Contractors operating via a limited company.

How prepared are businesses for the IR35 changes taking place on April 6th?

Overall, the Clients that we deal with are more prepared for the changes this year than they were in April 2020. However, there are 2 types of business that seem to be somewhat behind the curve.

The first, are organisations that are on the border of qualification for a “Small Company Exemption”. There is a bit of confusion around the transition from small company to medium/large & how that works in practice. For small start-ups & large corporates, it is usually straightforward to establish if the new rules apply. But what if your number of employees suddenly rises above 50? Or you have a bumper sales period and unexpectedly exceed the financials?

The second, are businesses that have a parent company or are part of a group. Not everyone is aware that the small business test, will need to be applied to the group as a whole and will apply to the aggregate turnover and balance sheet total of all connected entities. This means that there are many small companies, that may incorrectly believe, they are exempt from the upcoming changes.

So how does the “Small Company Exemption” work?

The definition of “Small Company” is taken from the Companies Act 2006 – A company will be “Small” if it satisfies two or more of the following requirements:

• It has an annual turnover not exceeding £10.2m.
• It has a balance sheet total not more than £5.1m.
• It had an average of no more than 50 employees for the company’s financial year.

The existence of an exemption for small companies & the thresholds above, are reasonably well known in the market. However, Clients are often unaware, that to determine whether the small business exemption applies to a tax year, these requirements are applied to two consecutive financial years; the latest financial year where the filing date for the accounts ends before the beginning of the tax year and the financial year before that one.

So, if your business experiences hyper-growth & the requirements cease to be satisfied, you must apply the IR35 rules from the start of the tax year following the filing date for the second financial year. Depending on the accounting year, the amount of time a business has to adjust will vary – however, it should be at least a year.

What is the ratio of “Inside” to “Outside” determinations you are receiving?

HMRC estimate that 2 thirds of people working through a company are genuinely self-employed and not affected by these rules. Therefore, for every 100 determination, we should expect around 67 of them to be “Outside IR35”. However, that is simply not what we are seeing – in fact so far this year, the determinations we have received are 25% “Outside” & 75% “Inside IR35”.

Why have there been so many “Inside” determinations?

For many Clients, the IR35 determinations have been handled by a combination of HR, Finance, Procurement & Legal. These groups are typically risk-averse and may feel that by deeming roles to be “Inside”, they can mitigate the risk of an unexpected tax bill in the future.

Another factor is that some of the terminology and working practises can be unfamiliar. For instance, the government’s CEST tool is heavily weighted around the right to substitution. This can be an alien concept for many, and their initial response is often – “no, we need individual X for this role, we couldn’t accept a substitute”.

We also have Clients that are pro-tax reform – they believe that the UK Treasury needs the extra revenue and support the HMRC in their efforts.

How does CEST work with regards to Substitution?

There are other IR35 determination tools available but CEST is by far the one that we see used most often. Once the Hirer answers “Yes” to “Do you have the right to reject a substitute?” on the CEST assessment – an “Inside IR35” determination typically follows – unless Supervision, Direction, & Control (SDC) is not being exerted over the Contractor.

However, if you answer “No” to – “Do you have the right to reject a substitute” – you will find that when you retain all rights of Supervision, Direction & Control & even say that you will pay the contractor “Corporate Benefits” – an “Outside Determination” will follow. Effectively on CEST – if you grant the Contractor the “Right to substitute” they will very likely be deemed “Outside IR35”.

How does the right to Substitute work in practice?

Interestingly, the right to substitution is a standard clause in most limited company contracts. In fact, many of the Clients that say they could reject a substitute, have previously signed a contract to say that they could not. In practice, the substitution clause is rarely used, but if your company wants to support “Outside IR35” working practices – it is essential to have a policy on the use of substitutes. This includes documentation on how they would, for instance, gain access to buildings, systems etc.

It should be noted that, the “right” to substitution does not have to be exercised to exist. However, it could be argued that over a reasonable period – a Client would be expected to use the clause in some capacity. If your business has a policy of accepting substitutes – it would be worth keeping records of any time the right is exercised.

Contractors also ought to have a feasible method of providing a substitute. They are not expected to have a vast network of sub-contractors sat on a bench – e.g., it could be a relatively small number of Contractors with complementary skills in a WhatsApp group. However, the longer a Contractor is operating “Outside IR35”, the more likely it is that the clause could be exercised & we expect substitutions to rise because of the reform.

The main reason that Clients say that they could reject a substitute is that they are worried about the suitability of the replacement Contractor for the role. It should be noted that the same terms of the original agreement apply to the substitute. This will include all the clauses for notice period, technical unsuitability etc. So, whilst it may be the case that you could not reject a substitute, you could still terminate the contract, according to whatever terms you have agreed.

What about SDC?

The CEST tool asks 4 questions about supervision, direction & control – 3 of which are relatively straightforward they are:

Does your organisation have the right to move the worker from the task they originally agreed to do?
Does your organisation have the right to decide the worker’s working hours?
Does your organisation have the right to decide where the worker does the work?

Most Contractors we deal with are working from their home office, setting their own hours and would need a new contract to move to a new role.

The one that tends to be a bit trickier for Clients to answer is “does your organisation have the right to decide how the work is done”. The confusion often comes from the fact that the Client can stipulate what the work is, when it needs to be completed and the standards required – without deciding “how” the work is done. For instance, we deal with lots of highly skilled Contractors such as Software Developers or Data Engineers. It would be unrealistic for the Client to tell them “how” to do the work if they are bringing in a Contractor because they lack the necessary skills in house.

Is the IR35 reform the end of contracting?

When this reform was introduced in the Public Sector in 2017, there were a huge amount of “Inside” determinations issued. In parts of the Public Sector, Contractors (unhappy with their assessments) walked out “en masse” and programmes/projects were severely impacted. However, because the private sector was unaffected – they could move to a new contract with relative ease. This time around only small companies are unaffected and whilst there are lots of them, the major projects still tend to sit with medium & large businesses.

Interestingly, now that the Public Sector has had 4 years to adjust to the reform, they are increasingly offering “Outside IR35” contracts. It seems likely that a similar pattern will emerge in the Private Sector. There are many benefits of using Contractors and the IR35 reform will not negate those overnight. I expect that once the dust has settled and the initial panic subsides, organisations will be able to develop a robust & informed policy of assessing and supporting both “Inside” & “Outside” IR35 determinations.