What to do as full IR35 enforcement looms for the private sector
Published on 14th Jan 2022
Eight reasons for a legal review of processes before HMRC starts full enforcement in the private sector
Nearly five years since the IR35 changes in the public sector, HMRC is beginning to flex its muscles. The Ministry of Justice – which relied on the Check Employment Status for Tax, or CEST, tool but was argued to have leaned too heavily on the right of substitution – is reported to have received a tax assessment of £72.1m plus £4.5m in interest and a penalty of £15m for 2017- 2021. At least three other government departments have received multi-million-pound assessments plus penalties.
Nine months after the introduction of the reforms affecting the private sector, HMRC's "soft landing" enforcement policy for the first year following the commencement of the private sector IR35 regime will expire in April 2022. In the future, HMRC is more likely to impose sizeable penalties (in addition to the tax assessment and interest) where it finds that those making decisions about or implementing IR35 processes relating to the private sector have been "careless". HMRC is expected to enforce IR35 against the private sector at least as enthusiastically as it has against the public sector.
HMRC has shown its hand and full enforcement is coming. Consequently, many companies are reviewing their processes in advance of this development. At the same time, many other users and suppliers of contract workers have started moving away from blanket bans against engaging contract workers on an outside IR35 basis: they have not seen much IR35 enforcement to date and are keen to find new ways to attract talent in the current skills shortage crisis.
Why review your IR35 processes?
- Improve your approach to "special cases". You may feel you need to make occasional exceptions to your original IR35 approach so that you can better access top talent in the current talent crisis. How can you safely do this? Or it may be that line managers have set up their own exceptions policies. Are these safe as HMRC enforcement activity increases?
- Stress test prior to sale. If you are approaching or planning a sale or seeking investment you will need to ensure that your IR35 processes reduce IR35 risk for your and your clients' businesses. IR35 was a key due diligence issue in every workforce solutions sector deal we worked on in 2021 and investors' advisers will be even more alert to IR35 risk in 2022. Many companies who either supply or use large numbers of contract workers or consultants need to review their IR35 processes ahead of going to market in order to avoid due diligence problems and potential deal-breaker situations.
- Does your insurance solution work or does it expose you to more risk than it helps you avoid? Many clients and suppliers rely on insurance-backed IR35 checking tools. Some of these tools are regarded by many commentators as generating too many "outside IR35" determinations. Many are asking if it unwise in these circumstances to rely completely on untested insurance. And there are huge potential liabilities under the managed service company (MSC) tax debt transfer regime for users of insurance-backed arrangements, with HMRC currently looking at MSC as a way of targeting supply chains. Under the MSC regime, tax-related insurance is one of the things that can trigger tax liability in a supply chain and many users of insurance solutions have taken no steps to manage this risk.
- Umbrella risks. Organisations that adopted "no personal service company contractor" policies and moved towards reliance on "umbrella" companies are starting to worry about other staffing supply chain risks and potential liability around the use of umbrellas, some of whom operate unlawful tax avoidance and/or criminal tax evasion schemes. End users and staffing companies have become aware that they are potentially liable for some types of umbrella non-compliance and so, as per HMRC guidance, many are increasing their supply chain checks and finding that some umbrellas are using unlawful arrangements. Legal advice is needed to manage this risk.
- Concerns of end users about IR35 processes that are set up by suppliers. End users are aware that liability is likely to pass to them if the staffing supplier they hire workers through cannot cover IR35 claims. They are becoming more aware of the need to use reasonable care when issuing status determination statements (SDSs) and are starting to question whether SDS tools and processes put in place, in many cases with the help of staffing suppliers, are adequate. If they are not, they may be primarily liable for the IR35 liabilities and may face penalties for being "careless" on top of this. So many are now double-checking their IR35 processes.
- SOWs. If you have relied on statement of work (SOW) contracts to remove the need to carry out IR35 status determinations or to avoid the need to operate an IR35 process altogether then, following HMRC's recent guidance on what constitutes a "contracted out" service (that is, what they think "works" as an SOW approach), SOW may not provide the solution to IR35 you hoped it would. Many are, therefore, revisiting SOW arrangements so that they can withstand any HMRC investigation.
- Tax indemnities. Staffing suppliers are becoming more concerned and, perhaps, more discerning about blanket tax indemnities they give to end users and managed service programmes and potentially being on the hook for their clients' carelessness when issuing SDSs – especially in light of the threat of penalties (which may then pass to staffing suppliers under the indemnities). We are seeing more negotiation of what is "fair" to ask for in an indemnity.
- Legal privilege. Many reviews of IR35 compliance will reveal potential liabilities. Using a regulated law firm to carry out the review will help ensure that advice is subject to legal privilege and generally non-disclosable. Many organisations are involving advisers whose advice is not privileged and will generally be disclosable to HMRC and potentially others as part of an investigation or any subsequent litigation.
Please contact us if you would like a fixed price review of your IR35 processes.
Getting your processes and policies checked at this stage, before HMRC enforcement action becomes more widespread, will help:
- Ensure that your processes are as efficient as they can be and based on correct legal assumptions – we have reviewed many that aren't, there are major mistakes being made by many organisations based on some widespread incorrect assumptions about IR35.
- Ensure that you can evidence compliance, and lack of carelessness, should you suffer an IR35 tax investigation.
- Reassure purchasers and investors that IR35 does not present a material risk to the company which could affect value.
- Create an effective exceptions policy to help you hire outside IR35 in areas where that is viable, minimising the potential loss of talent.
We use our understanding of staffing markets and supply chains to provide pragmatic legal advice. We also represent clients on tax disputes involving staffing supplies and so know how HMRC views certain arrangements and what evidence it expects organisations to produce. Compliance with tax law is a legal issue and, ultimately, one that would be appealed to and decided in a tax tribunal. Given the potentially large size of tax and National Insurance contributions assessments linked to failure to comply with IR35, it is important to get your processes reviewed by a law firm that not only understands the law but also how off-payroll working arrangements work in practice.