April 6th 2021 is a key date for many firms in the private sector that hire contractors, because it’s when the new Off-Payroll legislation will come into effect.  Whilst the sector has had a one year reprieve because of Covid-19, whether you’re a client,  agency or contractor, it is now vital that you take steps to prepare for the new tax rules so that all parties can continue to enjoy the mutual benefits of flexible working.

How agencies can prepare

The preparation required by recruiters is two-tiered. Firstly, agencies will be expected to engage with a client’s IR35 compliance processes and also help to manage negotiations with contractors around IR35 issues. Then, agencies will need to implement processes to calculate, pay and report taxes for contractors who are deemed caught by the legislation and put them on payroll, either their own or outsourced.

Hiring firms are tasked with assessing their contractors’ IR35 status but will rely on recruitment agencies to accommodate their chosen determinations process. Agencies are a key part of the process, and they will need to ensure their contractual paperwork for outside IR35 engagements is correct – including the “upper-level contract” between the hirer and agency and the “lower-level contract” between the agency and contractor.

Assist in addressing IR35 risk

Many hirers are now up to speed with the new legislation but will require agencies to help complete any renegotiations with contractors during the transition period in the lead up to April 2021. Whilst most aren’t IR35 experts, many recruiters will have handled previous requests from contractors to make contractual changes to arrangements so they properly align with the working practices.

All parties stand the best chance of securing a legitimately ‘outside IR35’ arrangement where there is cooperation and clarity throughout the supply chain, with the hirer, agency and contractor all involved.

Insure yourself

Though the hirer is responsible for determining a contractor’s IR35 status, agencies may face the primary tax liability risk should HMRC challenge an assessment – unless the hiring firm has failed to take ‘reasonable care’ when conducting the status assessment. It’s of course theoretically possible, but highly unlikely, that a hirer who has taken reasonable care has got the determination wrong. It’s even more unlikely that HMRC compliance officers would focus their limited resources on that unusual cohort rather then turn their attention to hirers who haven’t taken reasonable care, in which case there is no risk for the agency at all. If agencies are still concerned at the possibility of being struck by the equivalent of tax lightning, their tax investigation insurance, which most agencies already have, will help them defend their position.

The best way agencies can protect themselves from the administrative cost and reputational damage from being involved in incorrect determinations and subsequent litigation by HMRC  is to play their part in the IR35 compliance process – as the old saying goes, “prevention is better than cure.”

Renegotiate margins to accommodate employment taxes

Agencies will also have to consider the cost of employment taxes on fees paid to ‘inside IR35’ contractors and work out with the hiring firm how these are going to be accommodated.

The legislation dictates that the agency is liable for these. As a reminder, employment taxes consist of employer’s NICs (13.8%) and the Apprenticeship Levy (0.5%). This sum is due on top of the contract fee. This is a rather unreasonable cost for a recruitment agency to pay and will therefore need to be sourced elsewhere.

With the rate the agency charges being fixed, one option is to reduce the pay rate quoted to the contractor. However, by offering a lower pay rate, hirers are unlikely to attract the top talent. The alternative is to increase the rate charged to the hirer so that they contribute towards this cost but hiring firms may be reluctant to pay more for what they deem the same resource.

Ultimately, firms that wish to hire contractors and treat them like employees will need to accept there may be an additional cost burden.

Helping hiring firms to prepare

The Off-Payroll legislation requires hiring firms to determine whether thousands of contractors can continue to operate as they have for decades. The new rules require hirers to conduct a contractor’s IR35 status assessment and inherit a degree of tax risk depending on whether they have taken reasonable care in reaching their conclusion. However, the impact of the Off-Payroll legislation for hiring firms stretches far beyond this.

From April 2021, hirers will be required to pay the employment taxes due on the earnings of ‘inside IR35’ contractors because agencies simply won’t have the margin to cover these extra taxes. When you consider that roughly 80% of the additional tax now due from an ‘inside IR35’ engagement under the Off-Payroll legislation is composed of employment taxes, this is a significant cost to bear.

Inability or failure to offer contracts on an ‘outside IR35’ basis could see:

  • Contractors increasing rates to counter their own tax loss
  • Contractors possibly trying to claim employment rights if deemed ‘employed for tax purposes’
  • Struggles to attract talent as contractors seek outside IR35 contracts

Experience suggests the chances are employment rights claims are slim, and that many contractors will get rights under the Agency Workers Regulations anyway. The main threat for clients and agencies will be in trying to source and retain in-demand talent on an ‘inside IR35’ basis without paying a hefty premium.

Establish the IR35 risk

The first step is to acknowledge that Off-Payroll compliance will create an ongoing administrative overhead which the hiring firm will have to plan for, whether status assessments are outsourced or conducted in-house.

The second step is to assess contingent workers for IR35 risk.

The significant compliance challenge posed by the Off-Payroll legislation has necessitated innovation by way of automation. Firms tasked with assessing status and maintaining compliance for vast numbers of engagements need solutions that provide immediate assessments and assistance with the more trivial tasks.

When considering online solutions, bear in mind:

  1. Are the Status Determination Statements (SDS) comprehensive?
  2. Can assessments be made instantly to avoid losing talent due to delays?
  3. Does the solution continue to monitor engagements throughout the contract?
  4. Are the solution’s assessments consistent with historical IR35 tribunal outcomes?
  5. Does the provider have proven expertise in IR35 and employment status case law?
  6. Does the software team have expertise in IR35 and building secure enterprise-level systems?
  7. Is it truly independent or designed to sell something else?
  8. Is the service insurance-backed?

The importance of enlisting a quality compliance solution or service provider can’t be underestimated, so chose a provider who doesn’t present a risk to your organisation.

Mitigate IR35 risk

With the greatest risk factors threatening the ‘outside IR35’ status of your contractors evaluated, address them in the contracts and working arrangements. Mitigating these risks reduces the chances of contractors withdrawing from a proposed contract over IR35 status while minimising your risk of tax liability.

The working arrangements must reflect the written contract and reality. Past tribunal cases have exposed sham contracts and unrealistic clauses, often referred to as ‘window dressing’.

If contractors are inside IR35, then plan to deal with those accordingly, and don’t gloss over the problems.

Stay compliant

Ongoing monitoring and evidence gathering throughout the engagement are other crucial compliance processes. Although contractors have few statutory responsibilities when it comes to the Off-Payroll legislation, it is important that everyone in the supply chain – agencies, hiring firms and contractors – plays their part to ensure that contractors can continue to be hired and firms can continue to hire the talent they need, compliantly.