HMRC IR35 enquiries are becoming more prevalent, and an Status Determination Statement (SDS) won’t be enough for companies to successfully defend themselves.
Here’s a fascinating statistic to share: On the numerous occasions I’ve been engaged to review contracts for assignments that the automated ‘tools’ (CEST or otherwise) have determined fall outside IR35, only 5% would pass the scrutiny of an HMRC enquiry. Yes, just 1 in 20.
It’s not that the tools were inaccurate with their assessment (though don’t get me started on CEST), they are useful for guidance purposes and some of the better ones are built on case law.
The issue is that the automated tools work on the basis of honest input, they also have to make significant assumptions that the contract documents and working practices exist to back up the answers given. In reality it’s rarely the case, as my experiences show. If you put rubbish in, you’ll get rubbish out, as the saying goes.
HMRC are wise to it
Across my 17 years of legal specialism on IR35, I’ve reviewed over 6,000 contracts and represented clients over 100 at HMRC IR35 enquiries, all with successful outcomes. I have first hand experience of exactly what HMRC focus on in their enquiries, their approach, the level of rigour and the process.
HMRC are very aware that assessment tools can be ‘gamed’, the answers easily contrived to suit the preferred outcome (usually outside IR35). There’s no better example of this then the recent decision to penalise Defra £15m for using HMRC’s own CEST tool with their IR35 management, they failed to satisfy reasonable care and suffered a huge volume of overturned assessments.
To put it bluntly, an SDS assessment is no protection or defence against HMRC.
What really happens in a HMRC IR35 enquiry
An HMRC IR35 enquiry will focus on two primary areas, the contract and the working practices.
It doesn’t matter how correct your SDS assessment is, if the contract and the working practices in reality don’t back this up, you’ll have no protection. The same can be said for any tax loss insurance product that a client or contractor may have been persuaded to purchase.
There is no magic bullet for IR35, no shortcuts, any insurance will be conditional on the existence of robust, defendable contracts, just search for the ‘prospect of success’ clause in the terms of their small print.
HMRC will focus on ‘the terms upon which the services are provided’. There is, however, hidden complexity here as, assuming the client is using a recruiter, it’s the lower-level contract (recruiter to contractor) that takes centre stage, not the upper-level (client to recruiter) contract. It doesn’t matter how robust and diligent the client is with their management of the contract drafting, if it’s not mirrored and flowing down the supply chain to the lower-level contract, all that good work can be undone.
HMRC will target the weakest link in the chain to exploit, and given the recent additional £161m funding for compliance enforcement, you can be sure they will be armed to do so.
Don’t forget about the delivery
Assuming that your contract does pass the HMRC stress test, their secondary area of focus will be the Work Schedule.
Any mention of role titles, contractor names, generic job descriptions is going to leave you exposed, with little defence. This needs to be cleverly drafted, preferably by IR35 legal specialists, and structured as a deliverable and outcome-based service. Anything less won’t pass muster.
If you’ve managed to tick all those boxes, can you finally rest easy? No. Invariably a contractor assignment will change through its duration with the client, often with additional deliverables and scope creep if performance is strong. Failure to document these changes and you’re staring at an assignment that started outside IR35 and has now fallen inside. Just look at the case of Northern Light Solutions Limited v The Commissioners for HM Revenue and Customs [2021] UKUT 0134 (TCC) for a classic example of this.
Will you pass an HMRC IR35 enquiry?
Take our 5 minute online IR35 risk assessment to find out
HMRC’s soft landing period has ended and IR35 enquiries will soon begin in the private sector. Make sure you identify any risk areas and ensure you’re managing it correctly.
Ways of working are key
Lest we forget, there are the all-important working practices to be addressed.
I’ve observed a worrying trend, hiring managers that have inherited SDS assessments (outside IR35) that they themselves didn’t participate in. Far too often there is a central admin person performing the assessment with little or no consultation with the hiring manager. I’ve even seen recruiters performing these assessments on behalf of their clients, under the illusion it’s helpful.
How can a hiring manager be expected to behave compliantly with the contractor if they weren’t aware of the working practices agreed to in the SDS assessment?
Don’t run for the hills, there is hope
It’s not all bad news, IR35 is very solvable, it’s also a big opportunity. Adapt and you will attract a higher calibre of contractor, retain them for project continuity, and spend considerably less for the privilege.
The cost benefit of engaging a £500/day contractor outside IR35 is a saving of c.£25,000 per year vs inside IR35, difficult for any prosperous company to ignore.
IR35 reform requires companies to adapt, but if they do so then it will provide them with a real competitive advantage in attracting the cream of the freelancer talent.
There’s only really one way to manage IR35 (properly)
Don’t underestimate the rigour needed for IR35 compliance, it’ll come back to bite you.
Cut corners and expect consequences. Reliance on inexperienced internal staff with no IR35 specialism is inviting trouble. IR35 is a complex tax law, influenced by 22 years of case history, there is no substitute for subject matter expertise if you are to avoid risk.
The benefits of adapting to IR35 reform are enormous, but compliance needs to be respected.
