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Negotiating Private Sector IR35 reforms: what the Tech Sector should be doing to prepare?

Tech companies need to consider how they will be impacted by the IR35 reforms in April 2020. The draft legislation for the proposed IR35 reforms has now been published and broadly looks to shift responsibility for determining the tax status of off-payroll individuals from that individual to the recipient of the contractors’ service i.e. the tech business.  The tech and digital sector is considered to be at risk of being one of the worst hit industries given the reliance that businesses place on engaging the very best IT talent through freelance contractor arrangements.

In this article, we will look to explore the current position and proposed changes; the impact this may have on tech businesses and individual contractors in the sector and what can be done to prepare for these challenges.

The current position

IR35 (or the “off-payroll rules”) is the name given to the tax legislation which was introduced in 1999 in an attempt to ensure that contractors who supply their services to businesses via a Personal Service Company (PSC) paid the correct tax. Currently, when a tech business engages with a PSC, the PSC is responsible for considering whether the individual would be deemed to be an employee of the tech business if there was no PSC. If the determination is that the individual works “inside IR35”, the PSC must account for National Insurance Contributions (NICs) and Income Tax through PAYE.   If they fall outside IR35, they are considered to be operating a self-employed business and the PSC will pay corporation tax rates.

However, whilst HMRC estimates that around 1/3 of individuals working through PSCs should fall inside IR35 and be taxed as deemed employees,  it believes that only about 10% actually do so under the current rules.

To address this perceived large scale non-compliance, the law was initially changed in 2017 for the public sector, and now, similar changes are proposed to be applied in the private sector from April 2020.

The proposed position post April 2020

1. The tech business will be required to make a determination of the individual contractor’s IR35 status (taking ‘reasonable care’ in doing so) rather than the PSC.

2. The tech business will be responsible for issuing their determination and reasoning for the IR35 status and notifying that determination to various parties in the chain (e.g. the PSC and any employment agency).

3. If the determination is that the individual is within IR35, the “fee payer” will be responsible for deducting Income Tax and employee NICs as well as bearing responsibility for employer NICs and any apprenticeship levy. The fee payer will either be the tech business (if it pays the PSC directly), or another intermediary such as an agency.

4. If the tech business fails to comply with its obligations in connection with status determination under the reformed IR35 rules, then the liability for the tax will be for the tech business, even if it is not the fee payer.

Small business exemption

A notable and welcome exemption is that the legislation will not apply if the tech business is a “small business”. A company will be classified as a small business if it meets two or more of the following criteria – an annual turnover of no more than £10.2m; a balance sheet total not above £5.1m; or no more than 50 employees. Small businesses will not need to determine IR35 status of contractors, with this responsibility remaining with the PSC. (Note that there are specific restrictions which apply to joint ventures, groups and connected parties).

What does this mean for the tech sector

When the public sector reforms came in, the burden of dealing with the administrative requirements of ensuring compliance, and the uncertainty over who qualified for IR35 status, led to many organisations simply applying blanket decisions for all contractors. This saw contractors facing a reduction in take home pay, paying significantly more tax, whilst not receiving any additional employment rights. As a result, a number of contractors turned to the private sector, with the knowledge that they could determine their own status.

Whilst a large number of IT projects have been postponed awaiting the outcome of Brexit, this is surpassed by the constantly increasing demand for IT and technology skills in the UK. In a climate of skills shortages, highly skilled IT contractors offer businesses a solution.

However, private sector tech businesses must work together with contractors to carefully manage the impact of IR35 to avoid contractors being put off altogether and resorting to entering permanent employment, thus reducing the niche skills marketplace further.

So what should businesses be doing

The key message is that businesses likely to be affected by the reforms must start preparing now. This will take a concerted approach, with communication between tech business, contractor and any further intermediaries being key.

Review your current and future engagements

You will need to take steps to identify the contractors you engage; what they do; what their current IR35 status is and how crucial they are to delivery of your key business aims.

Then comes the difficult part of determining each of those contractors’ IR35 status. Consider how you will do this – do you have the necessary expertise and resource in-house to commit to this exercise, or do you need to consider enlisting external specialist advice?

Whilst HMRC has an on-line CEST tool which is intended to assist businesses in carrying out this assessment, it has been widely criticised as not fit for purpose, producing arbitrary and unreliable results. An independent IR35 review is likely to produce a far more reliable and informative outcome.

Lessons have been learned from the public sector reforms, and it is to be hoped that most private sector businesses will avoid the blanket assessment approach and will instead involve contractors and intermediaries in discussions. Many consider that the figures estimated by HMRC are overinflated, and with accurate and thorough assessments, many contractors will remain outside of IR35. However, early discussions with your contractors are key - for example, other work carried out by contractors for other clients will be relevant to the IR35 assessment and without open discussions at an early stage, you may not be privy to such key information.

A comprehensive and joined-up process should be developed for incorporating this assessment into your onboarding system, to ensure that contractors do not commence work until they have received and accepted their IR35 determination.

Communication is key

Contractors are likely to be wary of these reforms, so you will want to reassure them early on that you are taking all the right steps to address the IR35 reform and will carry out accurate assessments, avoiding them inappropriately being classified as inside IR35.

A process should be put in place for communicating the status determination, along with rationale, down the supply chain to the individual. Whilst the draft legislation also requires businesses to implement a process for dealing with status determination disagreements, giving a voice to the contractors who may feel impotent in the face of these reforms. However, as the legislation goes no further than a requirement to “consider” any representations made and then communicate the business’ conclusion, it is not clear how much bite this “appeal” process will have in practice.

Working practices override written contracts

It has long been accepted that terms of a written contract will be ignored in the face of conflicting working practices, so tech businesses will need to educate their hiring managers about ensuring that the working environment is not inconsistent with the IR35 status determination, by, for example, putting a higher level of control or supervision on a contractor who is deemed to be outside IR35.

Consider drawing up appropriate Statements of Work to reflect those genuine working practices. This should set out what services are to be delivered against what timescales or targets and at what fixed price, creating an outcome based contract which is followed in practice.

At what cost?

As part of the initial assessment, you will need to identify those business critical contractors who will be crucial to the business meeting its key targets, and, if necessary, consider allocating budget so that fees can be grossed up (to cover the excess tax) where they fall inside the IR35 test, to ensure retention of those vital skills.

When it comes to pricing re-negotiations following IR35 assessments, you will need to factor in the additional costs of employer’s national insurance contributions when determining the appropriate fee structure, and don’t ignore hidden costs such as review of payroll software and systems to ensure that they are fit for purpose in this new and more onerous landscape.

In light of the potentially significant impact that these reforms will have on businesses and contractors it is vital to move swiftly to take advantage of the time available prior to 6 April 2020 to fully prepare for the reforms.  Preparation will be key to ensure that you are in the best position to attract and retain the most talented contractors in the tech and digital marketplace.

We are well placed at Ashfords to assist tech businesses with all aspects of carrying out IR35 assessments and putting necessary processes in place.  If you require any advice on this topic then please contact  Su Apps, Andy Braithwaite or Nicola Manclark.

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