Be wary of the repeal of the off-payroll rules

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Update: This policy area has been subject to frequent change in recent weeks - as a result, the information in this article is out of date. For the latest on IR35, visit our IR35 hub.

Now that Paul Mason of Markel Tax has picked himself up off the floor following the incredible U-turn to repeal the off-payroll working legislation in April 2023 (and Kwasi Kwarteng confirmed the decision at the recent Conservative Party Conference), he considers some of the practical considerations.

By the time, you read this, my colleague Danny Batey and I will have joined Andy Chamberlain, IPSE’s Director of Policy, on a morning webinar to IPSE members to discuss the changes and answer questions raised from members.

This article will look to provide answers to some of these, but before reading on, we need to make three things clear: the mini-budget will need to survive a vote; IR35 remains a major issue for contractors; and we don’t have the detail. It is far too early for contractors to assume that they are returning to the ‘sunny uplands’ (not that there is anything ‘sunny’ about IR35) and so a good place to start is to view matters from HMRC’s perspective.

Why change?

We suspect that this will have been HMRC’s initial reaction. In order to understand why everyone is scratching their heads, we need to wind the clock back to the introduction of the Intermediaries Legislation (IR35) in April 2000. This put the burden upon contractors engaged through their own limited or personal service companies (PSCs) to determine their employment status on each and every engagement.

In the early years, there was sufficient IR35 enquiry activity for contractors to be genuinely concerned about the risks of getting their IR35 decision-making wrong. HMRC also had some notable successes such as the Dragonfly case (Dragonfly Consultancy Ltd v HMRC Commissioners [2008] EWHC 2113) with its newsworthy £99K assessment.

However, the tables turned: the contractor population increased, yet the number of enquiries fell dramatically from over 1,000 in the earliest years to around 250 on average 10 years later and even reaching a low point of only 12 in 2010/11!

HMRC were also losing too many enquiries (albeit in recent years they have achieved some success prosecuting cases in the media). The complacency that existed in the contractor market about IR35 was recognised by a Government discussion document in 2015, which was noted in March 2021, by a House of Commons Research briefing that “in 2011/12 around 10,000 people paid tax under IR35, an estimated 10% of those who should have paid tax on at least part of the income their PSC receives under the legislation.”

From HMRC’s perspective, introducing a system whereby initially public sector bodies (from April 2017) and private sector end clients (from April 2021) determined the status of each engagement made sense. It narrowed HMRC’s target pool from an estimated 500,000+ contractors to about 60,000 end clients (because small companies as defined by the Companies Act were exempted) and 20,000 recruitment agencies.

In HMRC’s consultations leading up to the planned introduction of the private sector off-payroll working changes, HMRC indicated an expectation that a third of all contractors would be deemed to be “inside IR35” once the legislation came into effect. As Markel Tax’s own experience of contract reviews suggested that the ratio of inside to outside engagements was probably closer to 50%, the one third target didn’t necessarily seem to be that ambitious.

Whether HMRC had planned for this or it was an unintended (but fortuitous) consequence, the reaction of end clients effectively banning the engagement of limited company contractors, and the effects of Covid, not only resulted in many engagements to become PAYE, it also had a dramatic effect of contractor numbers generally.  Seemingly a win for HMRC.

One clue to the change can be found in The Growth Plan 2022, the document released immediately after the Budget by the Treasury:

 “The Growth Plan sets out first steps in taking complexity out of the tax system. The 2017 and 2021 reforms to the off-payroll working rules (also known as IR35) will be repealed from 6 April 2023. From this date, workers providing their services via an intermediary will once again be responsible for determining their employment status and paying the appropriate amount oftax and National Insurance contributions. This will free up time and money for businesses that engage contractors, that could be put towards other priorities. The reform also minimises the risk that genuinely self-employed workers are impacted by the underlying off-payroll rules.”

One assumes that medium and large-sized businesses lobbied hard on the grounds that the off-payroll working reforms created unnecessary red tape. Nevertheless, the final sentence suggests that concerns from contractor representatives such as IPSE have also been noted. Blanket bans in terms of PSC engagement and over-cautious assessments of the IR35 status of assignments did surely contribute to genuinely self-employed workers being taxed incorrectly.

One wonders if there was also pressure from the public sector. It is well documented that the collective tax bill for the various government departments has exceeded a quarter of a billion pounds. Money paid out to HMRC, therefore unavailable to provide front line services.

Yet, in the private sector, HMRC compliance visits would have resulted in “real” money coming into the Treasury and one assumes that the government would rather see those potential tax bills being used to fund growth in the economy.

On the face of it, all this time and effort expended by both the public and private sectors appears to have all been in vain. We are returning to what everyone is describing as the “old” Chapter 8 (Part 2 ITEPA 2003) position of the contractor being responsible for IR35. Contractors will be pleased as they are no longer at the mercy of end clients unwilling or unable to properly engaged with the (Chapter 10) legislation and can determine their own destiny.

End clients and public sector bodies no longer have to determine the IR35 status of each and every engagement. Recruitment agencies who found themselves as the fee payer (the entity responsible for paying the PSC) no longer have the liability for end clients who could demonstrate that they had taken reasonable care in their decision-making process, but had nevertheless made an incorrect decisions – a classic example of tax logic trumping common sense.

It feels like HMRC must be holding their collective head in their hands. Before the private sector reforms last year, finding contractors who were inside IR35 resembled looking for the proverbial needle in a haystack. There may not be half a million contractors now, but already contractors are re-forming companies and you can expect that to increase rapidly. We wait to see if HMRC recruits additional inspectors as it has done to combat the rising number of spurious R& D tax claims.  

Does HMRC have any remedies available?

There are various pieces of legislation which HMRC has at its disposal and these should be of concern to contractors if implemented.

Managed Service Company (MSC) Legislation

IPSE members will be aware of HMRC’s current MSC activity in connection with the legislation, looking into the affairs of two accountancy service providers, arguing that the services they provide to PSCs go beyond that of an accountant and are influencing, if not controlling, the way the contractor is running their business.

If HMRC are successful in their investigation, would HMRC stop there? There are a number of contractor accounting specialists active in the market, as well as general practitioners with significant contractor portfolios.  And this pool only runs to hundreds of firms, not the 60,000 end clients which HMRC estimated were responsible for IR35 from April 2021 onwards.

Intermediaries Reporting

HMRC might also make better use of the quarterly reporting by recruitment agencies which have to inform HMRC of the PSCs they are paying gross (because the engagement falls outside IR35). An untapped opportunity, albeit HMRC will be targeting a greater number of taxpayers.

Even if HMRC don’t start enquiries, they might use their tactic of ‘nudge letters’ to provoke a response. If a contractor decides to reclassify an engagement on the basis that they have received a communication from HMRC asking if they are sure that they have complied with their responsibilities under IR35, that’s not a bad return for the cost of a 2nd class letter?

Phoenixism: PSCs rising from the ashes

As noted above, we will see an uptake in contractors incorporating again. There is the targeted anti avoidance rule (TAAR) to deal with what HMRC see as ‘phoenixing’ (i.e. closing down one PSC, extracting the profits in the most efficient manner and then starting a new PSC), which has been used by contractors as a “defence” against IR35.

HMRC may try to make the argument that it is reasonable to assume that one of the main purposes of the liquidation was to avoid or reduce the payment of income tax.

Certification/Taking reasonable care/Protecting your tax position

Could we see Status Determination Statements (SDS) created by contractors or even end clients still having to provide information to the contractor about an engagement which the contractor will incorporate into a “Contractor SDS”?

If end clients are to be completely relieved of any administrative burden, then contractors need to be aware of the importance of being able to provide evidence that they have taken reasonable care in their decision-making – particularly if HMRC challenges their IR35 status.

Whilst there might not be any form of official certification, a contractor is only going to demonstrate reasonable care by having contractual terms and working practices reviewed for ALL engagements. If you are an experienced contractor with an in-depth knowledge of IR35, then you will know the key factors that determine IR35 status and what to look for in a contract.

However, most contractors are going to want to undertake an independent and unbiased assessment: if you can demonstrate reasonable care, then the cost of a contract review will be far offset by the fact that even if HMRC are successful in arguing IR35 applies, you won’t have a 15%-30% penalty added to the tax and interest.

And for those whose engagements are deemed to be outside IR35, there is also the opportunity to insure against the tax loss.

End client reactions

From April 2023, the responsibility and liability for IR35 will rest with the contractor. However, we may find end clients which still decide that they do not wish to engage PSCs. This is a commercial decision and has nothing to do with IR35. Therefore contractors need to be aware that we may not simply be returning to the days before the 2017 and 2021 changes.

As a result, it is too soon to predict the demise of umbrella companies, although it wouldn’t be surprising if many of the contractors who have used their services return to working through a PSC. The repeal of the off-payroll working rules represents an opportunity for accountants to replace the contractors that they lost from as early as 2020 when the first end clients took their decisions; it could also benefit contractors who may see better and more innovative services being offered to support them in their accounting and tax responsibilities.

Whilst end clients and agencies will no doubt welcome the tax focus returning to the contractor, it doesn’t mean that they will turn a blind eye to how they engage with PSCs. It might actually be in the interests of end clients and agencies to have contracts that genuinely reflect outside IR35 engagements. The reputation of their businesses is often based on the quality of the contractors they engage, so they need to create the right contractual environment to attract and retain the best contractor talent.

What does the future hold?

For some contractors – those engaged by small companies or businesses based wholly overseas with no UK presence – nothing changes; but for many, the return to Chapter 8 offers genuine independence in terms of their tax affairs.

But with independence comes responsibility and what we don’t have is all the detail. Government announcements rarely provide the full picture, so treat this repeal with caution.

The new regime will undoubtedly be policed by HMRC; seeking to prove and protect your tax position after the brown envelope lands on your doormat is much too late!

Contract reviews and tax defence and tax losses cover are likely to be the cost of responsible contracting from April next year.

It’s a small price to pay for peace of mind, and as a long-term advocate of IPSE, I suggest that IPSE membership would be a great place to start that process.



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