Is inside IR35 hiring riskier for end-clients, and more costly?

Based on much of the activity which IT contractors report seeing in the UK hiring market, surely the answer to the question ‘Is inside IR35 hiring riskier for end-clients, and more costly?’ must be a firm ‘No.’

However in terms of getting hold of the best or most flexible resource and talent, inside IR35 determinations are actually more costly to end-client organisations, writes Nikola Nowak of Markel Tax.

End-client risk -- of a different kind

Due to the tax take, it’s no surprise that most independent contractors seek ‘outside IR35’ assignments, and some will simply refuse to take ‘inside IR35’ work. Though we appreciate most individual contractors have very limited choice in terms of being able to refuse ‘inside IR35’ assignments, by issuing blanket determinations, the client is risking deterring many contractors who operate as a genuine business.

When the Off-Payroll Working rules came into force in the private sector on April 6th 2021, it meant medium-sized and large companies were required to determine the IR35 status, so we saw a rapid decline in the number of clients engaging limited company contractors (or ‘Personal Service Company’ contractors).

Back then, clients simply didn’t want a new legislative burden, and placed a ‘blanket ban’ on engaging PSCs. It was seemingly the easier option but perhaps it wasn’t the most effective, with the result being that many workers moved to umbrella companies to stay afloat -- financially.

Tax risk, reasonable care, and blanketing

If we take the issue of ‘fiscal’ risk, HMRC has already confirmed at ESM10014 that the tax department does not consider blanket determinations to be evidence of the client taking “reasonable care.”

As unlikely as it is, it may well be the case that all of a client’s engagements do legitimately fall ‘inside IR35.’ However, HMRC must be satisfied that the client reviewed all of the contracts and individual working practices, effectively deciding each engagement on its own merits.

If the client has not taken this individual approach, but instead has decided to run a blanket determination to protect themselves, is there a risk from HMRC’s point of view -- and is it in fact a protective or harmful measure?

No tax loss = appealing (but not for fee-payers)

Technically (assuming the deemed payment calculation has been applied correctly) there is no tax loss to HMRC, because tax and NICs have been deducted by the client as per the ‘inside IR35’ Status Determination Statements for those engagements. This is what makes it an appealing option for clients, because they have no potential tax and NI risks under the OPW legislation.

By deeming an engagement ‘inside IR35,’ the fee-payer (which is typically the agency unless it is a direct engagement) will need to operate the deemed calculation and pay the correct taxes and NICs to HMRC. Not withstanding ensuring the calculation is correct so as to avoid any potential HMRC issues, this undoubtedly requires a little more administration -- it is a simpler process to pay an outside PSC invoice gross, than it is to utilise software and complete RTI submissions for inside IR35-determined contractors.

Often, where an “inside IR35” determination is provided, contractors are encouraged to utilise an umbrella company instead of their own PSC. This route may be more cost-effective for the individual, it may not -- it will potentially come down to personal circumstances. 

Umbrella doesn’t unlock expenses which you didn’t get previously

Of course, umbrella company arrangements sit outside IR35, but if an inside IR35 decision is given then working through an umbrella company won’t suddenly mean expenses such as travel and subsistence are now claimable. Indeed, the ‘Supervision, Direction, or Control’ test is significantly steeper for umbrella expenses than it is for IR35. So if you have failed one ‘control,’ test you have failed both!

At the same time, though, encouraging contractors to adopt alternate contracting models or promoting those models could come with hefty tax implications. And implications for both the fee-payer and/or the client in the event that those models are not operating correctly and HMRC can show active promotion/encouragement from the fee-payer and/or client.

With the HMRC spotlight still seemingly on umbrella company compliance, and the potential for transfer of debt looming under the last iteration of HMRC’s umbrella regulation plan, we would consider that now is not the time for parties to be pushing contractors to alternate models -- without those parties doing their own ‘due diligence.’ End-users and fee-payers ought to further beware that reliance on third party accreditations does not divest a company of its own ‘due diligence’ checks and processes.

Inside IR35 and umbrella contracting

Whether a contractor operates through their own PSC ‘inside IR35’ or through an umbrella, one of two unpalatable things will have to happen:

1. The contractor will receive less income, because the rates haven’t changed, and tax and NI are being deducted from the original fee.

With the current state of the economy many contractors simply cannot take a hit to their bottom line. Most people would not tolerate receiving less to provide the same service. The result will be that it is difficult to find contractors willing to provide the services; this means longer requisition processes, increasing timescales, and ultimately more costs which cannot be absorbed by the already tight margins of agencies.

2. Rates will need to be increased to account for additional tax and NI to be paid.

Agencies will be unable to fund an increase in rates; this will have to be funded by the client. This may mean the client is able to afford to onboard only two rather than three contractors, or perhaps engage the three but only on limited hours, as the end-user cannot increase cost allocation. Ultimately this means projects will run longer as they have not been adequately resourced on inception.

An avoidable sting?

While there may be no additional tax costs (aside from potential non-compliance of third party models, highlighted above), the economic impacts on clients of inside IR35 hiring are very real, and it is unlikely many can sustain this for the longer term, especially when it is avoidable. 

Dealing with the OPW legislation itself might take an initial outlay of time and cost. However once the knowledge has been obtained and an IR35 status testing process put in place, the ongoing compliance costs are negligible compared to the alternative.

Engaging with contractors fairly, and dealing with the Off-Payroll Working legislation can be a long-term, and safe solution for end-client organisations. There is no need to seek alternative models or effectively ‘blanket ban’ outside IR35 engagements, although convincing end-users of this reality might be another story -- or at the very least another article for another day.