IR35: what is happening in the market?

The end of the summer has seen many end users, staffing companies and consultancy companies deciding how they are going to respond to the IR35 reforms scheduled for April 2020. Plans are being developed to shift everyone to PAYE or engage contractors on a statement of work, (i.e. a deliverables based supply) or push all contractor engagements via umbrellas or to use third parties to assess status. We are also helping investors and lenders work out where this will leave affected companies in terms of profitability.

This briefing picks up some of the key developments we have seen in the market, with our observations about what will and will not work, and what organisations involved in using or supplying personal service company contractors (PSCs) will need to do.

This briefing is no substitute for taking specific legal advice on your options and best response to the challenges many are now facing in this area.

Our initial and high-level view of some of the market developments is as follows:

Are banks (and others) moving everyone to PAYE models?

Various larger banks have made announcements about this. By implementing full PAYE policies now or before the new IR35 comes into effect the cautious banks are, in effect, trying to avoid IR35 altogether. And there can be no legal claims around doing arguably unreasonable "blanket" assessments if all off-payroll workers are engaged on a PAYE basis: there will be no PSCs and therefore no need to carry out any assessments with reasonable care under IR35.

This tactic can work in certain circumstances, such as where a contractor does not have transferable skills or some move is made to raise the gross sum paid to the contractor (so their take home pay is unaffected).

However history suggests that it may not work for all: this was effectively tried in the public sector in 2017, only for relevant organisations in some cases, to pull back when they started facing "strikes" and/or losing talent to other organisations who were prepared to take a more nuanced approach and allow contractors to operate "outside IR35" where appropriate. In the private sector will we see things like challenger banks and consultancies picking up IT talent from larger banks?

We suspect that some end users that have made these announcements will allow exceptions in "special cases", where there is no budget for grossing-up pay rates and the contractors are seen as essential to the relevant project. And many large end users are all likely to be receiving services from consultancies who are themselves using PSCs. In other words, there may be PSCs in the supply chain come what may, and whether the end users realise it or not.

In some cases the "all PAYE" policies may be driven by more general concerns about supply chain risks beyond IR35. Heads of tax at major corporates are known to be concerned about the Criminal Finances Act 2017 (CFA) and other liability transfer risks they face from their ever-longer supply chains and are looking to simplify arrangements to make supply chain checks easier. They also want to future-proof against further backlashes by any future government against use of gig workers and non-standard employment models. This policy is understandable and going forward, staffing companies and consultancies that wish to use PSCs and other non-employed supply chain models will increasingly need to be able to prove in a reliable way how workers are paid, and that, for example, proper tax is paid and intellectual property rights in contractors' work does pass up to the end user with full confidentiality protection.

Another factor that may be affecting some end users is that their hard-pressed legal and HR teams may just not have capacity to carry out status determination exercises or deal with inevitable challenges under the new IR35 regime. CFOs are faced with all sorts of financial uncertainties for 2020 (Brexit-related and otherwise) and may be unlikely to approve significant increases to legal and HR teams just to deal with IR35 processes. As a result, these internal teams have, often understandably, said "we're not going to do that thank you very much".

So, let's see where this all ends up. It may be that the VAT savings that direct PAYE engagement offers retail banks will allow a little more budget to gross-up pay rates, such that the valuable contractors are not badly out of pocket if they do push forward with direct PAYE models. We have predicted this for several years, and have helped staffing companies operate these VAT-efficient arrangements for hirers in the NHS and financial services sector. Otherwise we suspect other companies (especially in other sectors) will continue to engage a reasonable number of PSC contractors, some outside IR35.

Are end users really able to track all use of PSCs?

This seems to be a real problem for some major users of PSCs. They can work out relatively easily where PSCs are directly engaged by them, or where staffing companies or Managed Service Providers supply them. But what about consultants supplied on day rates to support projects being delivered by large consultancies and the like? When is a consultancy project inside IR35 and when is it outside? How do the consultancies, systems integrators, and outsourcing companies engage their staff?

We suspect that this area will be a headache, with possible litigation against some end users, that did not realise they needed to do a Status Determination Statement (SDS), within three to four years of when the first IR35 assessments are raised.

Are umbrella PSLs a safe solution?

The answer to this is "maybe". Many of the more sophisticated umbrellas have developed excellent payroll expertise and systems. But it all depends on how you structure your list. We would strongly recommend that end users and staffing companies avoid any connotation of "recommended" or "preferred" in light of various unfortunate incidents over the years with umbrella failures. And there are no prizes for guessing who the umbrella workers threaten to sue when this happens.

You will also need to carry out ongoing spot checks on the umbrellas that are used. Of course it is not unhelpful if the umbrellas have passed some form of genuinely independent audit, but it is unlikely that selecting them on the basis of some accreditation or one-off annual audit is enough on its own to protect you from CFA risk. End users should expect to see much greater ongoing due diligence from staffing companies who use umbrellas. They will increasingly want real-time data about how and where people in their supply chain are being paid.

And one great concern is that the Christianuyi MSC judgement earlier this year may mean that a number of umbrellas have substantial potential historic tax liability to pay at some stage, which could close the company down at any time. The sorts of audits that umbrellas are subjected to will generally not pick this up, so be careful about putting all your eggs in one basket, in the form of a relatively small pool of allowed umbrellas.

What about using one of the new IR35 status determination tools and services on the market?

Obviously, doing an SDS and dealing with contractor challenges could be very burdensome for end users and for staffing companies who try to help end users with the process. There is no standard test and it will be quite complicated to work out IR35 status in some situations, and it is increasingly the view of commentators that the HMRC online CEST tool will not (even after any current upgrade) be of much assistance in more difficult cases.

Independent tools and services have come into the market to address this challenge. Some may be useful. We have seen some operators, who have developed tools which automate SDSs, report generation and SDS notification to the relevant parties. But ultimately whether or not a test is effective depends on the reliability of the information that goes in and the suitability and range of the questions used to carry out the assessment. It is difficult to model what a court would take into account in assessing whether or not an arrangement is one of employment or not. This is because the courts consider employment case law; they look at the arrangement as a whole. They do not use an assessment tool or tick-box approach. Some assessment tools are based on sound legal grounds; others need to be treated with caution. And some simply do not yet apply tests correctly.

Perhaps just as concerning is that some of the tools and services we have seen are structured in a way that may give rise to risk for staffing companies and end users under the MSC legislation (which HMRC have stepped up enforcement of this year following the Christianuyi decision and which can involve personal liability for directors of referrers). We strongly recommend a proper legal analysis of whether the particular structure offering to pay PSC contractors on an "outside" IR35 basis involves MSC risk. Some of these tools and services may be structured safely but, from what we have seen so far, some are not.

Are any sectors in for a particular shock?

It will be interesting to see what happens in construction. After the Intermediaries legislation came into force in 2014 it became unattractive to engage tradesman and construction subcontractors as sole traders. Many moved to PSC models, the thinking being that, so long as some sort of CIS deduction was made, then there was no tax risk for users of these tradesmen and subcontractors operating via PSCs.

But the new IR35 regime will apply even where CIS has been deducted. This may be a big issue for this sector.

What can contractors do if "forced" to work on a PAYE basis or inside IR35?

This is a complex issue, and one that we have been looking at for some time. We find it hard to see how, under current and proposed legislation, contractors have a viable or commercially sensible claim in most cases. But that is not to say that claims will not be attempted, even if they are ultimately unsuccessful. Staffing companies and end users should therefore be taking steps now to minimise the risk of these very time-consuming and potentially destructive claims.

A lasting impact?

In the past, increases in statutory charges in the staffing supply chain (which, for many, is effectively what this IR35 measure will be) have historically knocked pay rates and margins and volumes in the short term. That is often stated to be what happened after Obamacare charges hit the US market. However received wisdom is that, over time, the market tends to adjust (especially for any contractors whose skills are relatively in short supply), such that take home pay and margins after two-to-four years are the same as they were before the change. Whether we are entering a new era such that this historical trend no longer applies, perhaps linked to the general adverse effect on pay rates of increasing automation, remains to be seen.

And we continue to believe that there will be an increase, where appropriate, in the use of statement of work arrangements and/or VAT efficient models to minimise the impact of IR35. We are certainly very busy advising on those.

Osborne Clarke comment

There is a lot of water to flow under the bridge before we know how sensible or effective the various strategies being adopted by end users and intermediaries are. And, of course, we may see changes to the draft legislation. But what is already clear is that some mistakes are being made, and everyone involved needs to proceed with care.

We are running workshops for anyone affected, to help them assess their best options, including how to handle the above issues. We have delivered nearly 150 now over the last few years and are now booking through November. Please get in touch if you would like to book a workshop.