In recent months I’ve taken on a number of large clients that previously decided managing IR35 internally was the best course of action, following the April 2021 changes.
They’ve all recognised that the self-employed contractor workforce is an integral part of their business, that they need to adapt to work outside IR35 compliantly with them, but they were unsure just how effective this internal management really was.
So how vulnerable were they?
The short answer is that they were all exposed to a greater or lesser degree. None of this came as a surprise, I’ve specialised in providing legal IR35 services for over 16 years and it was clear that it would become an almost impossible problem for companies to self-manage robustly. Add to that the unwelcome distractions of Brexit and COVID, asking internal departments to deal effectively with IR35 whilst coping with furlough payment complexity was never going to be feasible.
What concerns me more is that this pattern is recurring, it’s very likely most companies are far more exposed than they actually realise, indeed many will assume they have IR35 completely covered, without being conversant with the onerous law that sits beneath. We are very much in the ‘calm before the storm’ phase, HMRC have recently been given an extra £161m to police compliance and in my observations there are many companies that are sitting more comfortably than they should be.
This isn’t all bad news. IR35 is actually a great opportunity for forward thinking businesses, for those that adapt it offers great rewards, most notably cost-effective delivery and attraction of the very best freelance resources in the market. Companies will be forced to adapt or they’ll be left behind by their competition, working with contractors inside IR35 is already proving to be unsustainable.
To take advantage, it’s important the management of IR35 is not underestimated, nor should your company underestimate HMRC’s expectations of you.
In this short article I’m going to explain the legal reasons working with limited company contractors outside IR35 can be 100% risk free for hiring companies, the classic mistakes that companies are making, and the specific legislation than underpins them. I’ve represented clients in 103 HMRC IR35 enquiries to date, all successfully, and I’m going to share what HMRC focus on and what they don’t, for some it may be an eye opener.
The importance of ‘reasonable care’ and why it’s not as easy to achieve as you think…
The good news first, at least from a hiring company’s perspective. If you satisfy HMRC’s requirement for ‘reasonable care’, you will pass on all the risk and liability of using contractors outside IR35, down to the ‘fee payer’. This is the company that actually pays the contractor, invariably a recruiter. So yes, you can actually eliminate the entire risk of IR35 by adopting this approach.
Great news? Yes. There is a but though. If you’re a large company managing IR35 internally, it’s unlikely you’re doing enough to satisfy reasonable care, just look to the recent multi-million pound penalties levied against Defra and the Ministry of Justice (MoJ) who assumed they had their house in order.
In both cases they managed IR35 internally, supported by the CEST software tool, and were found to fall short of the requirement for reasonable care, therefore attracting both penalties (up to 70%) and liability for underpayment of tax and National Insurance contributions.
So how does a company satisfy ‘reasonable care’ and why is it so difficult?
If you’re managing IR35 internally, it’s likely you’ll be using a combination of the resources that HMRC makes available, namely their Employment Status Manual (ESM) and the CEST determination tool. But did you know neither of them are legally binding? Essentially, HMRC will stand by them as long as it suits their agenda, which it likely won’t. It’s almost as if ESM and CEST are the wolves dressed in sheep’s clothing.
To determine what constitutes reasonable care, you have to look at a relevant judgment. 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‘.
What does this judgement mean in practical terms?
In simple terms, the level of rigour you are expected to apply to managing IR35 is proportionate to the resources you have access to. If you’re a £100m+ turnover company, your pockets should be deep enough to be expected to engage IR35 legal expertise for each and every contractor engagement.
Using any automated assessment tool for an SDS, coupled with non-specialist IR35 resources to manage the paperwork, is simply going to look like corners have been cut. Too many companies have hastily constructed internal IR35 teams, yet they don’t have the depth of IR35 legal knowledge to manage it effectively.
HMRC state in their ESM manual that ‘engaging a qualified IR35 professional’ helps to demonstrate that reasonable care has been taken. It’s not sufficient for them to review ad-hoc assessments, they must be intrinsically involved in applying their knowledge for each contractor assignment.
Failure to engage an IR35 professional with relevant legal qualifications and experience would expose a client to unnecessary risk.
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.