After being delayed for a year because of the coronavirus pandemic, from April the government’s much-discussed tax reforms to off-payroll working (IR35) will finally come into force.
The changes have caused plenty of debate and concern for businesses that rely heavily on outsourcing work to third-parties (70% of UK organisations outsource in some capacity). Questions have been asked about whether companies will need to rethink the role of outsourcing in their labour strategy in the wake of the changes.
But much of this consternation is unnecessary. The majority of firms have little or nothing to worry about from the IR35 reforms. The aims of IR35 have never been to clampdown on external contracting en masse – indeed, doing so would be an act of economic self-harm the UK can ill afford at the moment.
The problem is, like many areas of UK tax administration, IR35 isn’t exactly the most straightforward thing in the world to understand. So with the new rules coming into force, we thought it was time to set the record straight on exactly what the IR35 reforms mean for businesses, contractors and for the future of outsourcing work.
20 Years in the Making
First of all, it is worth reminding ourselves that IR35 is nothing new. The rules were passed into law as part of the Finance Act 2000 and are properly known as Intermediaries Legislation (IR35 refers to the number of the Inland Revenue press release in which the rules were announced).
IR35 was introduced to close what the government saw as a tax loophole. The name ‘Intermediaries Legislation’ refers to the practice of contractors and consultants using their own limited companies to effectively act as agencies mediating between hiring firms and the contractor.
There is, of course, nothing wrong with this for what we might call ‘genuine’ contracting purposes. But what the government took issue with was what has come to be known as ‘disguised employment’ – contractors working for an organisation on what to all intents and purposes looks like an employed basis, but doing so through their limited company, and therefore avoiding Income Tax and National Insurance liabilities.
However, over the past 20 years, the intentions of the IR35 regulations have been hamstrung by difficulties in defining ‘disguised employment’ as opposed to legitimate contract-based working. A succession of long-winded and expensive legal wrangles have been fought, bringing enforcement of IR35 in its original form all but to a halt.
There is nothing new in the intents and purposes of the latest IR35 reforms. The biggest difference is that the revised rules pass responsibility for deciding whether an off-payroll worker qualifies as a proxy employee for taxation purposes to the hiring organisation. Previously, it was up to the contractor/intermediary to make this decision.
What counts as ‘disguised employment’?
The extra administrative burden this places on organisations has been a major source of concern surrounding the new IR35 regime. Many businesses have been asking whether, with the extra work involved and potentially higher tax burdens, outsourcing will continue to represent good value. Could IR35 reforms trigger a significant cooling off in the contracting out of professional services?
It would be to the detriment of the UK economy if that were to be the case. Increases in outsourcing have been linked to significant productivity gains, for reasons including greater flexibility, better access to relevant expertise and the cost efficiencies of time-limited, project-based expenditure. That’s why close to three-quarters of all UK businesses outsource work in one form or another.
To be fair to the government, its intention has never been to try to shut down this kind of ‘genuine’ outsourcing of labour. The problem is again one of definitions. The government offers an online tool for checking employment status for tax, but the broad guidance falls short of the kind of clarity most businesses would like.
What the employment status checker does help us do, however, is pull out the main working definitions the government is using for ‘disguised employment’, which are not explicitly published anywhere. In our view, the key questions to ask yourself are:
- How much autonomy does the contractor or consultant have to do the job as they see fit (e.g. can they pick and choose their hours)? How much direct oversight do you have of their day-to-day work?
- Do you make your external hires sign exclusivity agreements?
- Is a contractor free to decline work and/or substitute another person to complete the work for them?
- Is their any expectation on the part of either party of further work being provided?
On this basis, contractors and consultants who work exclusively for one client at a time, who are closely ‘managed’ in terms of working arrangement, and who are obliged to complete work themselves within clearly defined parameters are more likely to be classified as employees for tax purposes.
Changing your thinking on outsourcing
There is clear guidance for when IR35 definitely does not apply. If a self-employed contractor or small trader is not operating via a limited company or partnership, for example, or if your company is classified as an SME, you don’t have to worry about IR35 and can carry on as before.
Another very clear exception is that IR35 does not apply to outsourcing to firms. Indeed, it’s clear that IR35 has always been about labour practices and personal taxation, and nothing to do with business relationships between one company and another.
In light of this, perhaps what is really needed to get to grips with IR35 is a redrawing of the lines between hiring and outsourcing. If you think about it, this is exactly the issue the government was trying to resolve when it first introduced its Intermediaries Legislation all those years ago.
It recognised that the use of limited companies as intermediaries in contracting was blurring the lines between hiring and outsourcing, and it didn’t like the tax consequences. It’s a shame that this pretty straightforward core message has become so lost in a fog of confusion in the intervening years.
A business can clarify its own understanding of the distinction between hiring and outsourcing by looking at what its actual goals are:
- If your primary need is to bring in new people, to add new talent with specific skills and expertise, then you are thinking in terms of hiring. Whatever the actual mechanics of bringing that person you need in are, there is a high probability that IR35 will apply.
- If your main focus is task-oriented rather than people-oriented, whether you have a specific project that needs completing or you want to push certain business functions out to an external provider, then you are thinking in terms of outsourcing. Whether you hire a freelancer on a retained or piecework basis, or look to another company to become a supplier, you have a high chance of avoiding any complications with IR35. There are greater risks with hiring individual freelancers or sole traders, but as long as your arrangement is based on tasks rather than time, there is no exclusivity and they are free to take on work as they please, there should be no issue.
Of course, these are pretty broad guidelines and certainly with existing working arrangements, there will be grey areas between the two. If you are a qualifying business and currently have external contractors working for you (including through an agency), you will have to go through the formal process of completing a Status Determination Statement (SDS).
But moving forward, the critical thing is not whether businesses should bring in people from outside their business anymore – as stated, that would be a disaster for the economy. What matters is that the thinking around how external services are provisioned has to be clarified – if you need people and skills, you hire, if you need to offload tasks or have projects completed, you outsource.