Off-payroll and the rise of the small consultancy
While much has been made of IR35’s negative impacts on certain markets, IR35 compliance solution IR35 Shield’s CEO Dave Chaplin believes it has handed small consultancies who have mastered the legislative nuances and differences between the IR35 and off-payroll legislation a significant competitive advantage over larger competitors. However, the author of IR35 & Off-Payroll Explained added that benefits seen by consultancies and clients requires careful navigation to avoid later risks.
The original purpose of the new Off-payroll legislation (Chapter 10 of ITEPA 2003), which rolled out to the private sector in April 2021, was to be a wholesale replacement of the longstanding Intermediaries Legislation (Chapter 8 of ITEPA 2003) from 2000, commonly referred to as "IR35".
However, following consultations, Parliament felt the onus on small companies (as defined by the Companies Act) would be too much, so it introduced a "small companies exemption". Whilst designed to ease the burden on small businesses; it has added considerable complexity because the original legislation remains but only applies to contractors working for those small companies. The newer version of Off-payroll applies to the public sector and private sector companies that are medium or large. Both are somewhat confusingly referred to as "IR35", and firms need to understand the differences to avoid accidental exposure.
The common element is assessing whether the relationship between the contractor and hiring firm may be "deemed employment", colloquially referred to as their "IR35 status". But the other differences are striking, which is where the advantage appears.
The contractor must assess their status in the original legislation, and their company bears the entire tax risk. Their client has hired them clean, with no longer-term potential balance sheet tax risk. The risk for the contractor is minimal too. Savvy contractors are prudent, HMRC rarely investigates, and it loses more cases than it wins when it does. And if HMRC wins, the contractor can offset the taxes already paid.
The new Off-payroll legislation is a different beast. If HMRC issues a determination to the client, multiple contractors can be simultaneously targeted, leading to potential contagion. The total tax risk is two lots of national insurance contributions and Income tax, equally roughly 50% of the gross payments made. At the time of writing, there is no clear path to reverse any offsets of tax the contractor has already paid. It's no wonder that many of these firms have blanket banned the use of limited company based contractors.
Therefore, medium and large clients prefer to outsource work to a consultancy that can leverage the small companies exemption. Contractors would also rather work for small consultancies to keep them within the original IR35 regime and receive fair tax treatment.
Where are the dangers?
Firstly, just because small companies can leverage the exemption doesn't mean they can ignore the IR35 legislation, nor can the contractors. Whilst the contractors are legally liable for the tax and self-assessments, procurement departments expect these consultancies to conduct assessments still, protect all parties, and be squeaky clean.
If the parties somehow conspired to avoid paying taxes that were due, then hefty fines and potentially criminal sanctions could apply. No one recommends tax evasion.
The larger hiring firm's other concern is related to a fault-line in the Off-payroll legislation. If the hiring firm did not consider that the consultancy provides a fully contracted out service, not just warm bodies, then the new legislation could come into play. In that instance, because the hiring firm hasn't conducted assessments and passed the Status Determination Statement ("SDS") to the worker, they are liable for the unpaid tax and not the consultancy. The belt-and-braces approach to protect against this is to conduct assessments for all contractors, which isn't expensive.
There is much discussion about the reasonable care requirements in the new legislation, but, alas, there is no statutory reasonable care provision that protects the hiring firm who reasonably decided the consultancy was the client and not them.
That said, providing firms have the proper contractual paperwork in place that demonstrates the provision of services, not people, is the reality, then courts will support that position.
The complexity of assessments
Assessments can be a daunting challenge for firms, particularly when assessing large numbers of contractors quickly, effectively, and consistently. An incorrect evaluation could result in a significant tax hit for companies that get the determination wrong.
Because of the complexity of the underlying case law, which relies on considering the contractual paperwork and conduct of the engagement, the status evaluation can potentially be arduous and time-consuming. Resolving this burden requires a blend of human expertise and automation.
Where is the proof?
The other hurdle to overcome is collating enough material evidence during the contract to combat any future investigation by HMRC. After all, turning up in court with your voice but no evidence makes it near on impossible to discharge your burden of proof. Quality evidence is everything when defending cases and stopping them reach the tax tribunal. Oddly, it's a piece of the puzzle missing from many firms compliance processes.
Firms really should gather evidence during the contract to help shore up the original status. Then, if a dispute arises many years later, the firm isn't scrambling around to locate corroborating evidence to back the initial determination.
The full compliance life-cycle
Successfully implementing a robust Off-payroll regime is ultimately about accurate status determinations and collating the evidence to support them. And for small niche consulting companies and contractors working with them, they now have an excellent advantage to grab some land.
