Employment Status: Checking Whether You’re Inside or Outside IR35

Who is responsible for determining employment status?

 

The responsibility for working out the employment status of an individual depends on the size of the business.

 

For companies in the public sector and those meeting two or more of the following criteria – an annual turnover of no more than £10.2 million, a balance sheet total of no more than £5.1 million, or no more than 50 employees – it’s the responsibility of the company to work out the IR35 status of their contractors. The company is also responsible for deducting tax and National Insurance for anyone falling inside the IR35 rules.

 

For smaller private companies that do not meet at least two of the criteria listed above, it’s the responsibility of the individual contractor to work out their employment status. If they fall inside IR35, it will also be the contractor’s responsibility to ensure they pay the appropriate tax and National Insurance.

Determining whether you are inside or outside IR35

 

Working out whether an arrangement is inside or outside of IR35 can be complex. HMRC’s CEST tool can be very useful but should always be used alongside professional advice. Getting it wrong can be hugely expensive, potentially leading to steep bills for additional income tax, National Insurance, interest and penalties.

 

A number of factors can be used to help ascertain employment status: three of these play a particularly important role:

 

1. Control

Control is one of the key tests of employment used by HMRC to determine whether a contractor is a disguised employee. Where does ultimate control lie? Contractors found by HMRC to be under the control of the company engaging them are likely to be found to be inside IR35. Determining where control lies will include answering questions such as, who controls the location where work is completed? Does the company dictate to the contractor when tasks must be completed? And does the company set out detailed instructions to the contractor about how they’re expected to complete the work?

 

2. Substitution

Whether or not an individual can be substituted is another key test of employment status. A contractor providing a service should be able to be replaced by another contractor who can provide the same service. If an individual cannot be substituted, HMRC is likely to deem them to be providing personal service and therefore class them as an employee.

 

3. Mutuality of obligation

If a company is obliged to provide paid work and the contractor is obliged to accept the work, there is mutuality of obligation. It is typically present in most employer-employee relationships where the employee receives regular payment from the employer and may occasionally be asked to undertake tasks outside of their core job description.

 

While control, substitution and mutuality of obligation are generally accepted to be the most important criteria, they are by no means the only considerations to be taken into account when deciding if an individual is self-employed or employed.  Other factors include:

 

• The method and regularity of remuneration.
• Whether any employee-type benefits are made available.
• Whether there is the option of alternative work.
• Which party provides equipment and work premises.
• Whether an individual is involved in the corporate structure of the organisation.
• Whether an individual has any personal financial involvement in the organisation.

Using the CEST tool

 

As you can see from this highly simplified overview, determining employment status is a very complex area. Although HMRC’s CEST tool cannot be relied on wholly to provide a definitive answer, it can be a useful indicator of whether you, or a worker on a specific engagement, should be classed as employed or self-employed for tax purposes.

 

Before using CEST, you’ll need to know the details of the contract, the responsibilities of the worker, who in the relationship decides what work needs to be done, when, where and how the work is to be carried out, how the worker is going to be remunerated and whether any benefits or reimbursements are included in the engagement.

What updates has HMRC made to CEST?

 

In October 2023, HMRC made changes to CEST to improve the user experience; these include:

 

• Allowing users to review their answers after each section – rather than at the end of the process. By giving users the opportunity to reflect on answers as they go along, HMRC hopes to reduce users receiving an ‘unable to determine’ result.
• Guidance information on employment status has been embedded into the tool, so users are quickly directed to answers without having to visit external websites and run the risk of being timed out.

Along with the result returned, CEST will provide the user with information to help them understand how the outcome has been reached.

Expert Advice on IR35

 

Kalra Legal Group are an Inca strategic partner. They have been providing expert advice relating to employment law to Inca clients and IR35 legislation for many years. We invited Lakhvinder Kaur Digpal of Kalra Legal Group to bring us up to date regarding the latest changes to the IR35 rules:

 

The UK Government announced changes to off-payroll responsibilities, addressing the “double taxation” problem under IR35. A two-month consultation was launched between April 2023 and June 2023, and the formal response was published on 22^nd November 2023. If HMRC successfully challenges an “outside IR35” determination, the employer is currently responsible for paying all liable Tax and National Insurance Contributions (NICs) under PAYE regulations. The proposed offset rules, effective from April 6, 2024, will allow HMRC to collect the right amount of tax without “double taxation”.

 

This policy would only allow for a set-off to be given against the deemed employer’s liabilities for Income Tax and employee NICs deducted in respect of the worker. It would not be given against any employer NICs due by the deemed employer, or Apprenticeship Levy if applicable. The worker and their intermediary would not be required to pay any additional tax or NICs as part of this set-off.

 

The changes are minor but impact the engagement of off-payroll workers, distributing tax liabilities more fairly and reducing costs for end users. Some compliance checks are paused under specific conditions related to the new offset rules. Employers should also continue to maintain compliance with ongoing off-payroll working rules, including assessing the employment status of directly hired contractors, reviewing hiring models, performing due diligence for umbrella companies, and issuing Status Determination Statements (SDS) to contractors.

 

Adherence to new and existing regulations is crucial to avoid penalties and legal consequences. HMRC conducts compliance checks and may issue penalties based on the degree of error in determining employment status. The financial cost of penalties, legal costs, reputation damage, and potential publication of inaccurate determinations are all risks associated with non-compliance.

 

While there are ongoing compliance considerations, the new off-payroll working rules from April 2024 aim to prevent disproportionately large tax bills for organisations making IR35 determination errors.

 

Here are our tips on what we think you should include in your contract for services:

 

• Mutuality of obligation – include clauses which make it clear that the client company is not obligated to provide you with continuous work or replacement work if the project you are working on is abandoned. If possible, opt for shorter-length contracts with breaks in between contracts running in succession.

 

• Substitution – include clauses that clearly state that you can supply a different person to undertake your work if you are absent and it is your responsibility and discretion to choose to cover your absence.

 

• Control – retaining more control over your work than an employee would have is crucial. Include clauses stating that you control factors like timescales, locations, deadlines and how you will utilise your skills.

 

• Exclusivity – avoid signing any clauses which will prohibit you from undertaking any work for other customers while the contract is running.

 

• Financial risk and personal liability – include clauses stating that you have a contractual obligation to remedy any defect in your work at your own time and expense.

 

• Contractual changes – include a term stating that any changes to your role need to be agreed in writing with you first.

 

Kaye Adams, a broadcaster, successfully challenged a tax bill issued by HMRC under IR35 legislation after four hearings and 10 years of legal battles. Despite HMRC’s multiple attempts to convince judges, they ultimately failed to find an error of law in the initial decision. The net tax at stake was £70,000. HMRC, in its fourth attempt, fielded three barristers, but one day before the deadline to appeal, they withdrew, citing it would not be “proportionate.”

 

Dave Chaplin, CEO of IR35 Shield, expressed perplexity at HMRC’s claim of proportionality, considering the lengthy legal process and costs involved. Kaye Adams, while pleased with the outcome, referred to the victory as pyrrhic, expressing concern over HMRC’s power to impact individuals’ lives with no consequences.

 

The case highlighted the challenges in HMRC’s approach to IR35 cases, with the courts consistently not supporting their views. The legal precedent set by the Atholl House case emphasised factors such as mutuality, control, historical career history, and terms of engagement in determining employment status. Despite HMRC’s claim that First-tier rulings don’t set binding precedent, legal experts argue otherwise, underscoring the significance of the Atholl House case.

 

The victory prompts reflection on the broader issues surrounding IR35, with concerns raised about the impact on freelancers and the need for accountability in HMRC’s interpretation and application of the law. Several other cases lost by HMRC are under appeal awaiting a decision.