Welcome to Contractor Corner, the series written specifically by Qdos Contractor for accountants with clients who are contractors.
IR35: an end of year update
IR35 reform was originally set for implementation in April 2020, after a long period of upheaval within the industry and immense pushbacks to no avail, any delay of IR35 reform in the private sector seemed impossible.
Contractors accepted what seemed like the inevitable and settled in for the changes to take place on 6 April 2020. Announced a mere two weeks before the implementation date, the year-long delay to the IR35 reform came as welcome news to contractors as they faced the challenges brought by the Covid-19 pandemic.
Earlier this year, MPs voted against a proposed further postponement to 2023/2024. This decision meant that the reform to the private sector, once expected in April 2020, would for sure be introduced on 6 April 2021.
After facing this year-long delay, and with the effects of the Coronavirus pandemic to consider, it has certainly been an unusual year for the industry.
As we begin the descent towards the end of 2020, it is time once again to consider the coming private sector reform and the changes that can be expected.
What to expect from IR35 reform
From 6 April 2021, the responsibility for determining IR35 status will no longer lie with the contractor for any engagements they undertake with medium and large-sized private sector businesses. Instead, the responsibility will lie with the businesses themselves.
Any workers who fall inside of IR35 will have PAYE and National Insurance Contributions deducted at source from their income by the fee-payer in their engagement or offered alternative arrangements such as through umbrella companies or PAYE as is often the case.
In addition, the reform brings with it some additional requirements and refinements:
Small clients exemption: Contractors engaged with a small client company will be required to assess their own IR35 status. You can find the requirements for a small company within the Companies Act 2006.
Status determination statements (SDS): An SDS includes the decision made upon IR35 status and the reasoning for that decision. The hiring organisation needs to pass this document along the contractual chain to both the contractor and the next party in the chain.
Client-led disagreement process: This process allows a contractor to provide evidence as to why the initial IR35 determination made may be inaccurate. Part of this process means that the client must respond to the dispute with both a decision and their reasons for this decision within 45 days of receiving the dispute.
Obligation-based liability: In essence, the liability of performing the role of the fee-payer in the engagement is dependent upon the client meeting their obligations. The client will be deemed the fee-payer if they do not meet their obligation of providing an appropriate SDS.
Despite the challenges businesses are in a much better position than the first time around, with HMRC having increased their education and support for businesses, an improved (but still lacking) CEST iteration, and the final IR35 legislation now available.
We can expect to see some changes over the coming months to how some businesses treat their IR35 strategies – with many turning to independent specialists as opposed to using HMRC’s CEST, and re-evaluating decisions on how contractors are engaged.
How to prepare for IR35 reform
There is plenty that can be done to ease the private sector towards the coming reform. One of these steps can be as simple as encouraging open lines of communication between organisations or between those involved in engagements affected by IR35 reform. By starting the conversation about IR35, it can be an easy way to ensure that each party understands what they are responsible for, thus giving them time to prepare themselves for their new responsibilities and put the necessary processes in place. Unfortunately, there are still a number of businesses who are not yet adequately prepared for the challenges that April will bring.
One thing to consider is the possibility that we may be entering a time in which HMRC’s compliance activities begin to increase. With resources being drained by a second lockdown, it would not be a far cry to imagine tax compliance activities increasing in order to compensate for these losses.
As such, contractors should prepare by keeping up-to-date with the legislation and HMRC compliance activity.
At Qdos, we are seeing an increase in end users picking back up their IR35 preparations. While a little later than we saw in 2019, many businesses have been working hard against the challenges of the Coronavirus pandemic and are now beginning to turn attentions to their compliance strategies.
Before the delays to IR35 reform, many organisations were set to use entirely automated assessment methods such as HMRC’s very own CEST tool. In our experience here at Qdos, we have since seen quite a number of these organisations reconsider their stance and opt for a more balanced approach this time around. It appears as though receiving a fair assessment of IR35 is, thankfully, becoming a priority for businesses as we move towards April 2021.
Why a Statement of Work is not a workaround for IR35
With IR35 reform fast approaching, the phrase ‘Statement of Work’ (SoW) is increasing in its popularity within the industry. With many trying to find a way around the IR35 legislation, SoWs have been presented as a way to engage contractors in order to avoid the rules and guarantee an outside IR35 status.
Not only is this dangerous from a compliance standpoint, but it also entirely undermines the true use of a SoW. Contractors would be ill-advised to consider SoWs as a workaround to IR35 and the coming reform.
What is a Statement of Work used for?
A Statement of Work (SoW) is a document that forms part of a managed service agreement between two parties for fully contracted out services, it details the specifics of a piece of outsourced work.
For example, a SoW may include some of the following details:
- Details of the scope of work.
- Clear deliverables with scheduled due dates.
- Tasks set to reach those deliverables.
- Any equipment necessary for the work.
- Detailed outlining of costs and the due date for payment.
- Clear expectations set for the outcome.
- Any other necessary conditions/requirements.
As you can see, a SoW is far more detailed than a standard contract schedule and crucially, is used for project-based work where you are engaged for specific outcomes and deliverables as opposed to time and materials. In fact, the more detail that is included in a SoW, the better. A clear and exhaustive SoW lays out the expectations of each party entering into the engagement. Because of this, it tends to prevent the possibility of disputes further down the line concerning exactly what was included in the costing and what would be additional.
A SoW also provides structure for an engagement. With clear deliverables and time frames set out in writing, it means that all parties know what they are responsible for and when. Thus, helping to diminish the potential for tension between the parties during the contract.
When you hear the phrase SoW however, it is important to remember that it may be referring to either:
the actual SoW document itself which forms part of that outsourced service agreement, or
the use of a Statement of Work as a method of engaging contractors with the aim of circumventing the IR35 off-payroll rules due to come into effect on 6th April 2021
Why a SoW doesn’t eliminate IR35 obligations
The off-payroll rules state that clients who are receiving fully contracted-out services will be exempt from the legislation. A SoW is often included in fully contracted-out service agreements.
This has led to an increase in those engaging contractors through the use of a SoW structure in order to present those contractor services as an outsourced service working upon the assumption that this method automatically creates an ‘outside IR35’ status.
Engaging contractors via a SoW structure can be a cost-efficient way of managing resource for projects as engagers are hiring resource for specific outcomes as opposed to time where some of that time may end up being wasted. However, it does not remove the need to assess a contractor’s status.
It is important to remember that IR35 must always be considered where an engaged worker is the owner/director of a company which sells the services of an individual or group of individuals i.e. a personal service company (PSC). Irrespective of the contractual agreements in place for any engagement, a PSC still remains a PSC. If a contractor is being engaged, then the off-payroll legislation will need to be applied.
A SoW should therefore not be used to remove the burden of IR35 obligations. A SoW should instead be in place because of a genuine business reason to engage a contractor for specific outcomes and deliverables rather than time and materials. Its use will make clear exactly what is expected and when. Its use will not, however, grant an automatic outside IR35 status.
Things to remember when considering IR35 status
Contractors may find themselves in a situation where they are engaged via a SoW and told it is, therefore, outside of IR35. This conclusion should not be taken for granted. As shown above, having a SoW in place does not guarantee an outside IR35 status.
IR35 can be managed effectively even when engaged for time and materials. A whole host of different factors impact upon overall IR35 status. When HMRC look to determine status, they will look past the written terms of an engagement and consider the working practices first and foremost. This means that they will be looking at the everyday working of the contractor to find the reality of the engagement. Status tests such as the right of substitution, control, and mutuality of obligation are just to name a few of the factors HMRC take into account when investigating IR35.
A good rule of thumb when it comes to IR35, is to not look for a quick fix or a workaround. Instead, take some time to familiarise yourself with the legislation and work together within contractual chains to ensure compliance obligations are met.
• Qdos Contractor is a leading authority on the IR35 legislation. Visit www.qdoscontractor.com/ir35 for more information.