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How To Eliminate IR35 Risk when Engaging Limited Company Contractors

In this article I’m going to explain the detailed legal reasons that allow you to engage Limited company contractors (outside IR35) whilst eliminating any associated risks and liabilities for your company.

In order to achieve this, you need to satisfy two key requirements:

  1. a) Demonstrate ‘reasonable care’ with their management of IR35, which discharges the liability to the ‘Fee Payer’
  2. b) Using a 3rd party to pay the ltd company contractor as the ‘Fee Payer’, be it a recruiter or otherwise.

What constitutes reasonable care in the off-payroll legislation? (IR35)

The Income Tax (Earnings and Pensions) Act 2003 (a.k.a. the ‘off-payroll legislation’ or more commonly known as IR35) requires clients (both medium and large companies and public authorities) to take ‘reasonable care’ in undertaking status determination statements in respect of engagements involving limited company contractors. However, to determine the full extent of what is required to satisfy reasonable care, it is imperative to look beyond HMRC guidance and examine the associated case law that establishes the position.

The Employment Status Manual published by HM Revenue & Customs merely provides guidance and is not legally binding. Too many companies rely on this guidance in isolation, placing themselves at risk of failure to satisfy reasonable care. The guidance is misleading since HM Revenue & Customs’ CEST tool cannot consider the ‘terms on which the services are provided’ as explicitly required by section 61M(3) of the Income Tax (Earning and Pensions) Act 2003. HM Revenue & Customs have already demonstrated in recent cases with the MoJ and Defra they will ignore the results of the CEST tool simply because the results are influenced by a user’s expectations rather than being informed by impartial legal advice.

In Collis v The Commissioners for Her Majesty’s Revenue and Customs TC/2011/2813 Berner J defined reasonable care as ‘the standard of a prudent and reasonable taxpayer in the position of the taxpayer in question’. This extends beyond the SDS, the off-payroll legislation also involves an analysis of the ‘terms on which the services are provided’ and the working practices (collectively the ‘circumstances’ of the engagement).

Furthermore, it is essential the contractor assignment is closely monitored throughout and any material changes, be they project scope or working practices, are considered for reassessment. To illustrate this, in Northern Light Solutions Limited v The Commissioners for HM Revenue and Customs [2021] UKUT 0134, the IR35 legislation applied after the initial period because the working practices changed during the assignment with the effect that the individual could be moved from task to task like an employee.

It is axiomatic that the duty to take reasonable care for any medium or large company cannot be discharged unless the client has sought specialist legal support for each engagement, anything less would be considered negligent.

Discharging risk and liability to the fee payer

IR35-Risk-Fee-Payers

In a conventional recruitment arrangement, the lowest person in the chain is the limited company contractor, followed by the recruiter and, finally, the client at the top. As the recruiter is immediately above the limited company contractor, section 61N(2) defines the recruiter as the ‘feepayer’. Consequently, the fee payer is exposed to the risk of liability for any underpayment of PAYE income tax, National Insurance contributions and the Apprenticeship Levy if HM Revenue & Customs determines that the conditions in section 61M(1)(d) are met, i.e., that the individual would be regarded an employee of the client for tax purposes if directly engaged. 

If the client takes reasonable care as defined above, but the conclusion of the status determination statement is subsequently found to be incorrect due to a change in the working practices (section 61NA(1)(b)), the fee payer will be liable, not the end client.

In our observations, many recruiters are reticent to help clients resolve their IR35 headaches and supply limited company contractors, because in turn they assume the role of fee payer and therefore the liability if reasonable care is satisfied. HM Revenue & Customs has six years to undertake an employer compliance review so their exposure exists for some time.

Is it also possible to legally eliminate IR35 risk for recruiters?

Yes, simply by use of a payment intermediary, an approach that is becoming increasingly popular.

If a payment intermediary is inserted in the chain above the limited company contractor the recruiter is no longer the fee-payer, so it is no longer at risk regarding the off-payroll legislation. The payment intermediary would assume all risk regarding the off-payroll legislation, thereby freeing the recruiter to concentrate on recruitment. In practice, the client would pay the recruiter, who would, in turn, transfer the payment to the payment intermediary. The payment intermediary would then pay the limited company contractor. In the event that HM Revenue & Customs starts an employer compliance review, the payment intermediary would ultimately be responsible for the legal defence and the associated liabilities.

This approach doesn’t need to attract additional cost. It is commonplace for the recruiter to sacrifice a modest % of their commission to fund the payment intermediary fees, which in turn removes both their liability and cashflow headaches.

In the event a company wishes to source a limited company contractor directly, they would also simply direct all payments via the payment intermediary, thus passing across all off-payroll risk to them as the fee payer.

How does IR35 Pro help companies legally eliminate IR35 risk?

IR35 Pro provides an end-to-end managed service with specialist legal advice to determine the status of an engagement, coupled with drafting of the associated contract terms.

Crucially, IR35 Pro regularly monitors the working practices and scope changes of each engagement so that corrective action can be taken without delay, thus exceeding the standard of reasonable care and eliminating risk, as illustrated in Northern Light Solutions Limited.

In addition, uniquely we provide full HMRC IR35 inquiry defence for all assignments we manage within our fee structure, through to notice of non-determination.

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