The repeal of the new IR35 regime: how will the market and HMRC react?
Published on 7th Oct 2022
The staffing supply chain will need to address a range of questions in a new world that may be more complex and risky
The announcement that the new IR35 regime will be repealed from April 2023 has predictably led to many contractors assuming they can return to the good old days of worry-free contracting via a personal service company (PSC) on a tax efficient basis.
But there are other, not so predictable, implications for all involved in the staffing supply chain and, in many ways, the new world of contract staffing may be more complicated and risky than the old.
The detail of the obvious implications of the announcement were set out in our initial Insight on the day of the announcement. But there are other issues to address, including HMRC's use of regimes other than IR35 to counter tax avoidance, the ease for contractors of a volume move to PSC contract models, the future of "umbrellas" and the impact of the move to PSCs on staffing companies' cashflow funding costs , what will happen in the longer term and responses to take in the meantime.
How will HMRC use regimes other than IR35 to counter tax avoidance?
The repeal will affect HMRC's ability to enforce IR35. It may decide that IR35, after the repeal, is not worth trying to enforce on a case-by-case basis for individually small sums against individual contractors. That hassle is why HMRC told the then chancellor eight years ago that the original IR35 was not working, which led to the (soon-to-be-repealed) 2017 and 2021 reforms that allowed HMRC to go after deeper-pocketed staffing companies and end users.
If it again becomes uneconomic from April 2023 for HMRC to enforce IR35, that may make HMRC turn to other tax legislation to tackle the increase in tax avoidance that seems likely to happen. The Criminal Finances Act (CFA) is a likely first choice. HMRC already routinely raises CFA compliance in large client annual review meetings and flags staffing supply chains as a key risk area.
How could HMRC use CFA after April in PSC contracting situations? The obvious target will be any roles that the end client has determined (pre April) to be inside IR35, or blanket-banned PSCs from filling, but which the end client and staffing company or supplier consultancy allow to be performed by a PSC on a self-employed basis after April.
This might be deemed to be turning a blind eye to tax evasion by the contractor such as where the contractor and staffing company knew full well that the contractor was inside IR35 and the end user knew full well that by using a PSC model the contractor was treating him/herself as outside IR35 (otherwise why would they bother using a PSC model?). Unless the end client and others in the supply chain can show that they took reasonable steps to prevent the facilitation of that tax evasion in the supply chain they will have committed a corporate criminal offence under the CFA and be liable for an unlimited fine.
The "reasonable steps" that might be needed to avoid this liability will depend on various circumstances, but all in the supply chain would be wise to continue to have some sort of process – in relation to roles that had, perhaps cautiously, been determined as being inside IR35 – of establishing and recording that in fact there were decent grounds for believing they are outside IR35.
This may well look very similar to the current processes in place for assessing the status of PSC contractors and generating a status determination. In many cases, changes may be required to the roles and the way in which clients and staffing companies engage with PSC contractors to render the roles more obviously self-employed if PSC contractors are to be allowed to perform them.
Will a volume move to PSC contract models be made easy for contractors?
Specialist accountancy service companies that offer to help contractors set up as PSCs are likely to get heavily involved in helping contractors move back to PSC contracting. Many will be expecting their client books to grow aggressively in the next months and, may well have to get involved in substantial referral arrangements with some staffing suppliers even where contractors move from an umbrella company to being advised by an accountancy service provider within the same umbrella group.
We also expect to see new accountancy services providers appear on the scene ready to make the most of the rapid growth in the need for PSCs and ready to pay substantial referral fees to get the business. It seems inevitable, for example, that some umbrella company providers will feel under pressure to help umbrella workers and sole traders back into PSC contracting arrangements.
The trouble is that HMRC is currently attacking some of the arrangements operated by these specialist accounting businesses. HMRC is using the 2007 managed service company (MSC) legislation set out in Chapter 9 of Part 2 of the Income Tax (Earnings and Pensions) Act to make all contractors – who (in its view) have used a specialist service provider to facilitate their use of PSC arrangements – liable for employment taxes.
HMRC can use this MSC regime even if the contractors are, for the purposes of normal employment status tests, genuinely self-employed. HMRC can do this because the MSC regime focusses on whether the contractor has been helped with the setting up and running of their PSC company rather than whether they pass or fail employment status tests like the IR35 tests.
This all means that end clients and staffing and consultancy companies will effectively have to leave the contractors to find accountancy support for themselves, perhaps advising them to be careful about using any volume provider of accountancy support services. In practice, many staffing companies may find this very difficult. There are already reports that some staffing companies see this all as an opportunity to make extra profit by extracting referral fees from accountancy services companies by way of referral fees (perhaps, to replace the referral fees they currently get from umbrella companies).
This is clearly very risky behaviour but many less sophisticated staffing companies may not be aware of the risks of making these referrals and receiving referral fees. Alternatively, they may be hoping that HMRC will give up enforcing MSC as well as IR35 but we have seen nothing to suggest that HMRC won't use MSC, especially if it sees a major increase in the use of PSCs.
There's also the logistical challenge and inconvenience for staffing companies of having to process and pay large numbers of PSC contractors' invoices. Staffing companies will need to be careful about introducing any arrangement that relies on an intermediary to invoice and receive payment on behalf of multiple PSC contractors; this could in itself give rise to an MSC risk. Self-billing arrangements will also need to be set up carefully.
What will happen to umbrellas?
We consider that the umbrella model should continue: it is a useful engagement model for many types of gig worker and will help ensure those gig workers can gather holiday pay and get sick pay and various other benefits and training, and help ensure PAYE and NICs are properly dealt with. Gig platforms and the like are not well set up to do this for the workers. A sign of the future that they may have can be seen in the enormous growth in US-style employer-of-record companies worldwide, and in many ways the better-quality umbrella companies in the UK are more sophisticated than those employer-of-record companies.
However, it seems possible that in the short term there will be a big reduction in higher-paid umbrella workers. Many contractors moved to umbrella models in 2017 and 2021 when the different stages of the IR35 reforms came into force, and they seem likely to want to leave umbrella work and return to PSC contracting.
That leaves umbrella company owners with a decision about whether they want to move into or increase accountancy service provision hoping that HMRC will not attack them under the MSC regime. This is a classic dilemma in the staffing supply chain: act cautiously and lose market share, or take a risk and make hay while the sun shines.
We imagine that more sophisticated umbrella companies will, if they do offer accountancy services to PSCs, be taking urgent steps to minimise MSC risk.
Will a reduction in umbrella working put up staffing company cashflow funding costs?
Many umbrella companies have strong cash balances. Many use that (legitimately) to win business by offering generous credit terms to staffing companies. That means the staffing companies do not have to use invoice discounting which, with interest rates going up, is likely to be an expensive funding option for some time.
If workers stop working through those umbrellas and become directly engaged as PSC contractors by the staffing companies they will generally expect to be paid promptly. That will lead to some of those staffing companies having to fund cashflow via invoice discounting. We imagine that such staffing companies will need to pass on that cost to clients or more likely (via lower gross fees) contractors.
The longer term?
We think it more than likely that by the time everyone has got used to these changes the IR35 reforms will be reinstated by a future government and we will all start again. The Grand Old Duke of York would have been proud of the history of tax policy in this area.
What to do in the meantime?
- Remember that the repeal is not law yet and the expected £1-2Bn per annum loss to HM Treasury may force a rethink, especially if the markets further lose confidence in the UK government. (And the tax loss may be greater if there is a PSC surge).
- Even if the repeal becomes law it will not be in force before 6 April 2023.
- Even if HMRC relaxes enforcement now (for example, we have heard reports that it is "in shock"), remember that it has until 2026-7 to raise assessments for the current period so keep current processes for time being.
- Don't throw away your current IR35 processes and manuals – the 2017-2021 regime may return?
- Keep an eye out for guidance and announcements from HMRC about the transition to the new 2023 regime.
- If you expect a surge in new PSC contractors, work out key operational issues you will need to deal with and a timetable.
- Work out how to navigate the significant new tax risks under the MSC legislation associated with helping contractors operate via PSCs. Do not request or accept referral fees from accounting services companies and do not have referral arrangements with them.
- Develop plans to give you and your supply chain and clients reassurance about this surge not involving CFA risk, for example, to avoid your being deemed to have turned a blind eye to PSC contractors operating after April 2023 in what you know to have been thought of as inside IR35 roles. Major end clients will be concerned about this.
- Generally plan what new procedures and policies and new contract terms you will need.
- Work out how to play this if you are talking to investors. You will need to avoid due diligence issues if and when you decide to go to market to raise funds or sell up – we know investors are already looking at this.
We are advising on changes to relevant contracts and procedures to minimise risks relating to the above. Please let us know if you would like assistance with this.