IR35 four years on: How to manage key emerging risks and protect your business

Off-payroll working arrangements, including IR35, can quickly accumulate potentially substantial tax liabilities for businesses as well as other commercial and reputational risks. Many businesses experience both operational pressures, to secure resources at a reasonable cost, and pressures from specialists who insist on working via personal service companies. As a result, business need can often override control processes and risk reviews, both of which are important tools to scope and manage what can be an evolving and potentially significant financial exposure.

This article, while not a substitute for advice, provides a checklist of key IR35 risks which professionals working in Legal, HR, and Procurement can use to be aware of, check, and if need be, mitigate IR35 related risks in their business.

Quick summary

The key risk areas at this point include:

• Slips in contractual discipline related to (1) the identity of the end-client in services that involve labour supply, as well as in (2) agency, and (3) contractor agreements - which may be of particular interest to Procurement functions within businesses.
• Inadequate record keeping and compliance procedures; as HMRC are starting to enforce the rules in compliance checks and enquiries, Fieldfisher’s insight from that process is that tax inspectors focus more than perhaps expected on (1) IR35 population data, as well as (2) compliance policies, processes, manuals, and training materials – which may be of particular interest to HR and Tax functions.
• Changes to contractor status due to (1) legal developments arising from court decisions, (2) patterns of contract extensions, and (3) employment law risks arising from changing contractor status, which may be of interest to Legal and HR functions.

We explain those points in more detail below. For more information and for advice, please feel free to contact Fieldfisher's interdisciplinary IR35 team which is comprised of lawyers specialising in tax, tax disputes and employment and which brings a wealth of expertise to IR35 and off-payroll workforce arrangements, enquiries and disputes.

 I. Risk 1: Slips in contractual discipline

Area 1: End-client risk

Why does this risk matter?

The identity of the end-client determines who is responsible for compliance, and therefore who carries liability if it goes wrong.

The method of identifying the end-client is not clearly defined in legislation. It simply says that the end-client is the person who receives, or is entitled to receive, personal services from the contractor. Unless that is clear cut, the answer will likely lie both in the wording of supplier contracts, and the facts of the actual circumstances of the supply.

Example

A supplier contract may be outsourcing the creation of a new IT system to a specialist provider, but a statement of work may name individual resources, their day-rate, and require them to work with client personnel, which would, in combination, create uncertainty over the identity of the end-client in that particular arrangement. 

In reality, this means:

• the clearer it is that a payment by a person further down the supply chain is reasonably linked to personal service by a contractor, the more likely it is that the payor at the very top of the chain is the end-client;
• the pragmatic context to this is that if HMRC enquire into a particular business, it is difficult to shift them away from the assumption that that business is the end-client, unless the matter is clear cut;

HMRC also provide some additional guidance on the factors they consider in their Internal Manual ESM10010.

Ultimately, the analysis involves a mix of law and facts which inevitably involves uncertainty, and there may also be changes over time as projects evolve, so this area is rife with unidentified risks. 

For legal and procurement functions in particular, it is important to review supplier contracts (especially those with a labour-supply element) to ensure the identity of the end-client is clearly understood and all commercial and tax risks are dealt with accordingly. Contractual clauses, and specifically warranties and indemnities, can form an important part of working with these risks commercially.

What are they key points to look out for?

Areas of risk include:

• contracts with an element of labour supply, or services contracts, especially those which are contractor-resource heavy;
• contracts where the assumption has been made that the highest person in the chain is not the end-client;
• agreements which name particular contractors the supplier is using, and / or setting out roles or names and of those contractors and their price on a time basis;
• projects which involve an element of control by the outsourcing business of personnel provided by a supplier, or which involve supplier personnel working e.g. on client premises.

You can find more Fieldfisher resources and detail on this here.

Area 2: Agency contracts

Why does it matter?

Where an IR35 worker is supplied by an agency, and the end-client uses reasonable care in making a status determination, liability for any tax should generally pass to the agency.

But, there can be issues. In our experience, agencies typically impose their own contracts. In practice, this often means terms which are meant to cover agency workers (automatically subject to PAYE) or even employees, are also used to cover contractors which are intended to be self-employed. Agency terms will inform HMRC's view of whether a contractor is deemed self-employed, so mixed language and terms create risks. Also, agency agreements are an important document in dealing commercially with the allocation of any ultimate tax liability in the context of the IR35 rules.

Where HMRC do not recover the tax debt from an agency, the debt can be transferred back to the end-client.

What are the key points to look out for?

It is worth:

• reviewing the insurance cover and financial position of any agencies on a regular basis;
• ensuring the agency-client and agency-contractor terms deal appropriately with IR35 contractors in separate provisions;
• ensuring that all agency terms, especially those which may have come onto the books since 6 April 2021, contain appropriate commercial clauses to deal with IR35 risks.

You can find more Fieldfisher resources on this here. Getting this right both from a tax, and commercial perspective, which tends not involve that much work, can make a significant difference in addressing risk.

Area 3: Contractor agreements

Why does it matter?

Contactor agreements are the starting point for determining whether a contractor was intended to be employed (or 'inside IR35') or self-employed (or 'outside IR35') for tax purposes.

Realistically, contracts can change over time and across stakeholders. Fieldfisher have found that they can end up being amended several times over the years, without being re-reviewed for tax risks. Again, established practices, change in control over the business, and operational expedience often means the tax angle gets lost over time.

 What are the key risks?

Common issues include:

• new statements of work, side letters or additions or changes to terms which materially affect the tax status of the contractor;
•  in project work, cross references to project plans and documents which can dilute the contractual intention in the main contract;
• terms which no longer reflect the type of supply a contractor is providing, with the result that this is a factor pointing towards employment for tax (i.e. the ability to move a worker across projects or tasks).

It is worth reviewing the documentation that has been put in place, and the processes for extending terms and services just to make sure these risks remain controlled across the business.

II. Risk 2: Slipped compliance processes

Area 1: Need for robust compliance practices to demonstrate reasonable care

Why does it matter?

When a client uses reasonable care in making status determinations, they will validly pass liability down the contractual chain where a contractor's intermediary / personal service company is not engaged directly by the client.

The legislation suggests that reasonable care must be used when making the status determination.

But HMRC (whether correct in this or not) appear to be taking a wider approach now, and do consider the wider compliance processes which are in place to determine whether reasonable care was used in making status determinations.

Where a client uses an agency, there might be commercial implications to the allocation of liability if doubt can be thrown over whether reasonable care was used.

What are they key points to look out for?

Risks include:

• status-determination inputs which are debatable across the documentation and facts of an engagement, or lack of evidence that those completing status determinations e.g. reviewed the written contracts, and did not just consider the facts of the expected engagement; blanket determinations without considerations of individual circumstances which differ from the norm or sub-groups, or inappropriate sub-grouping;
• absence of support and sufficient training for those who make determinations;
• training and process documentation which is incorrect, incomplete or open to (mis)‑interpretation;
• not carrying out new status determinations when contracts are changed, or significantly extended.

From our tax disputes experience, robust reviews and proper documenting of compliance processes are key elements to handling IR35 risk, and doing so in advance of any tax compliance check can save considerable cost, liabilities, and effort down the line.

A list of at least some of HMRC's expectations has now been published and can be found here.

1. Risk 3:  Changes to contractor status

Area 1: 'Control'

Why does it matter?

The test for whether something is an employment engagement considers whether (1) there is mutuality of obligations (2) sufficient control (3) other provisions consistent with employment.

The Supreme Court's decision last year in HMRC v Professional Game Match Officials Ltd (or ‘PGMOL’) could have changed the balance of risk for some engagements.

• If you wanted more detail, we've published a detailed explainer on our website, but in essence it is now easier for HMRC to show 'a sufficient framework of control'.
• Our main comment is that this test is broad, implying that control does not require an employer to have the right or ability to intervene in every aspect of the worker’s duties. But it is still very much open to the tax tribunals to decide what 'sufficient' control actually is.

HMRC appear to be advancing the proposition that 'control' is not purely about direct control from the putative employer but may include rights to control under a wider 'framework' of rules or contractual obligations which operate on the worker so even if this is incorrect, it is current policy battlefield which opens up risk to end-clients. The main take way,  from our view of how these cases run in the tax tribunals in particular, unless these terms are refined by the tribunals going forward, which will likely take years, the key determining factors for, and against employment, will in many scenarios fall onto (3), that is 'other provisions consistent (or inconsistent) with employment'. 

What are they key points to look out for?

In light of HMRC's apparent policy position, industries with the following hallmarks are probably at increased risk of HMRC compliance checks and tax disputes:

• professional services where it was thought that, because contractors were largely free to choose how, when, and where they would supply their services, there could never be sufficient control;
• services which are subject to third party regulatory compliance, in regulated sectors, or otherwise subject to strict contractual provisions (e.g. as part of a wider service contract for example), or legal rules, as we have seen a particular focus by HMRC in recent years on off-payroll checks in regulated sectors.

We do not think HMRC's stance in this respect is correct, because just complying with the law should not be a relevant element of control for the employment test, but it is a focal point in terms of HMRC's compliance and investigations strategy and so is something where it is ultimately necessary to balance whether HMRC may take a more conservative view in an enquiry.

In addition, though not linked to control, there are increasing numbers of cases both in the tax tribunals and under HMRC enquiry which cover overarching agreements, which are subject to individual engagements or pieces of work.

Example

Ms Smith enters into one global agreement, and under it, will be able to pick and choose individual one-off assignments lasting one day. In those cases, HMRC and the tribunals have increasingly considered whether both whether the 'overarching' global agreement is one of employment, and / or whether each individual engagement is one of employment for tax purposes. For example, control and mutuality of obligation might be different between the global agreement, or the individual assignment.

The broad effect of PGMOL is to make it easier for HMRC to argue that there is mutuality of obligation for shorter term engagements under an overarching contract.

Area 2: Long contracts and extensions

Why does it matter?

This is not a new risk. But a common issue is that a contractor was hired for a particular project in say 2021, it overran, and now four years later they remain on the books.

Duration of engagements is not in itself a determining factor, but can speak to the personal nature of services, mutuality of obligation, business integration, and lack of financial risk.

What may have been a clear-cut case of self-employment in 2021, could have changed something that is closer to 'employment' four or more years later.   

What are the key points to look out for?

Key risk areas:

• significant reliance on one pool and source of contractors, which is particularly common where contractors are part of the business model or where specialist IT projects rely on a small pool of experts;
• projects which use contractors and have overrun;
• using contractors for core functions of your business.

Regular reviews, in which the durations of engagements are carefully measured against the business need for them, are a solid method of identifying and managing this risk.

Area 3: Employment risks involved in changing model

Why does it matter?

There is an overlap between the employment test for tax purposes and the employment law test. So, end-clients are well advised to consider the employment implications (such as back-dated claims etc), of converting self-employed contractors, or their functions, into employment roles. Employment specialist advice should be sought to address this risk.  

Want to know more?
 
Get in touch – we can help you develop a strategy to deal with the implications of IR35 effectively and efficiently. Fieldfisher's IR35 team is multi-disciplinary, and we harness the expertise of employment lawyers, tax and tax disputes experts to give wholistic advice.
 
For more information, please contact our IR35 team:  Ranjit Dhindsa, Partner, Head of Employment, Pensions, Immigration and Compliance, Christopher Kientzler, Director (Barrister), Employment Tax Lead in the Tax Team, and Charlotte Williams, Associate in the Contentious Tax team.