Expert Insights

Expert Insights

HMRC’s Crackdown on Contractors: IR35 Changes

As many businesses and contractors will be aware, the Government is planning to introduce wide-ranging reforms to the off-payroll working rules (commonly known as “IR35” or the “intermediaries legislation”). 

These changes represent a significant shift in the tax and compliance landscape for businesses that engage contractors through personal service companies (“PSCs”). Broadly, the changes mean that the reforms introduced in 2017 for the public sector will also apply for large and medium-sized enterprises in the private sector – so that the burden of tax and compliance is shifted from the PSC/off-payroll worker to the fee-payer or end-user client organisation. There are further important changes to the rules which apply to the public and private sector alike.

The changes were originally due to be implemented with effect from 6 April 2020, but on 18 March 2020 the Government announced that the implementation of the reforms would be postponed to April 2021 in recognition of the impact Covid-19 was having on businesses. 

This postponement gives affected businesses more time to prepare, but importantly it is only a postponement. Whilst there are other immediate concerns given the current situation, businesses should not lose sight of the impending reforms, in particular as the April 2021 start date approaches. It appears that the Government is determined to proceed, even despite criticisms following an inquiry by the House of Lords Economic Affairs Committee. It has said it will commission further research into the long-term effects of the reforms in the public sector, with the intention that this will be available before they take effect in the private sector. As a result, further developments cannot completely be ruled out, but what is clear in the meantime is that the reforms will be going ahead.

In this regard, on 18 May 2020, the Government proposed amendments to include the draft IR35 legislation in the upcoming Finance Bill 2020. This is substantially the same as the previous draft legislation published in July 2019, with changes to reflect amendments announced since that date.  Detailed guidance has also been published by HMRC (currently in draft form) in its Employment Status Manual.

This briefing note provides both an overview of the IR35 reforms as set out in the draft legislation and sets out some practical guidance for affected businesses. 


Broadly, the IR35 rules catch arrangements where the following three conditions are satisfied:

  • an individual personally performs services for a client;
  • the services are provided not under a contract between the individual and the client but rather between the client and a third party (typically a PSC, though this can include other entities); and
  • if the services were provided under a contract between the client and the individual, the individual would be regarded as an employee for tax purposes.

The rules are basically designed to catch disguised employment relationships through PSCs. The key point of contention is often the third condition – i.e. whether the worker would be treated as an employee for tax purposes.  There have been a number of cases before the tax tribunals in recent years focussing on this particular point. It is not explored further in this briefing – save to note that it requires a detailed examination of both the relevant contractual arrangements and the actual working practices of the worker. 

If IR35 applies, the worker is deemed to be in receipt of a payment of earnings, with a consequent obligation to account for income tax through PAYE and NICs. Historically, the PAYE obligation fell on the PSC for all engagements within the scope of IR35.

However, in 2017, the rules were amended for engagements where the end-user/client was a public authority (primarily public authorities subject to the Freedom of Information Act 2000). For such engagements, it was the responsibility of the client public authority to determine whether IR35 applied, and the PAYE/NICs liability was shifted to the “fee-payer” (i.e. the entity paying the PSC) – which could be the client, or, in a more complex labour supply chain, the agency procuring the services of the worker.

The Finance Bill 2020 changes

Following a lengthy consultation process, draft legislation recently introduced in the Finance Bill 2020 includes provisions rolling out the public sector changes to the private sector with an implementation date of 6 April 2021.  The changes apply broadly for services provided from 6 April 2021 onwards, regardless of whether the contractor relationship was originally entered into before or after that date. If all the services are provided before that date the changes do not apply to a payment regardless of when it is made. If payment is made in relation to services made both before and after 6 April 2021, then a “just and reasonable” apportionment is required. 

Who is affected?

The changes only apply where the client is not “small”. HMRC say this means they will not affect the vast majority of organisations who engage contractors through PSCs.

For companies, “small” is determined in the same way as for the Companies Act 2006: i.e. currently where 2 or more of the following conditions are satisfied:

  • the annual turnover is not more than £10.2 million;
  • the balance sheet total is not more than £5.1 million; and
  • the number of employees is not more than 50.

There are further detailed provisions for determining “small” in the context of groups of companies, joint ventures, subsidiaries, limited liability partnerships, unregistered companies, overseas companies and other persons. There is also an obligation on businesses to respond to information requests regarding their size from contractors or their agents within 45 days, with the possibility of court orders to enforce compliance. 

The upshot is that where the (private sector) client is “small”, the old rules still apply – i.e. the responsibility for determining whether IR35 applies and any consequent tax liability remains with the PSC (or other relevant intermediary). However, where the private sector client is medium or large, the burden switches to the end client and/or the fee-payer (if different).

How do the new rules work?

The basic purpose of the new rules is to align the treatment for medium and large private sector organisations with that of the public sector. However, further changes have been made, which apply to public sector and private sector arrangements alike.

The first step is to identify the chain of two or more persons involving the client at one end and the PSC at the other, where each person in the chain makes a payment to the next person which represents payment for the worker’s services.

If the IR35 rules apply, then the fee-payer (i.e. the person making the payment to the PSC) is treated as making a payment of earnings to the worker, and consequently is required to operate PAYE. 

So, in the most simple scenario, the chain involves an end-user client contracting directly with a PSC (and paying it direct), in which case the client is required to determine the IR35 status and operate PAYE. If the chain is more complex (i.e. involving one or more labour or recruitment agencies between the client and the PSC), then the client is still required to determine the IR35 status, although the PAYE obligation falls on the agency that actually pays the worker.

Status determination statement

The new rules introduce the concept of a “status determination statement” or “SDS”. This will be a key compliance issue for client organisations, and applies equally to public sector and medium/large private sector arrangements. 

The SDS is a statement to be given by the client, which in practice will be required in respect of every engagement potentially within scope of IR35.  It must contain two main things: (i) the client’s conclusions as to whether the employment status limb of IR35 is met (i.e. whether the individual would be regarded as an employee for tax purposes if his/her services were provided directly under a contract between him/her and the client); and (ii) the reasons for that conclusion.

The rules effectively contain an explicit requirement for the client to take reasonable care in coming to the conclusion in an SDS (as if they fail to do so, the client is treated as not having made an SDS, with the negative consequences outlined below). It seems likely that this provision has been included at least in part in response to concerns raised during the consultation process that organisations would simply impose blanket IR35 status determinations on all of their contractors performing similar roles. In their Employment Status Manual draft guidance HMRC set out their views on what constitutes “reasonable care” including various examples.

HMRC are also promoting their Check Employment Status for Tax (CEST) services as a tool for making status determinations and include this as an example of taking reasonable care in the guidance referred to above. HMRC state generally that they will stand by the result given by CEST provided the information inputted is accurate and it is used in accordance with their guidance. HMRC updated their CEST toolkit following criticism that it lacked sophistication and provided new Guidance on doing so. The updated version has still been subject to criticism though – in particular on the basis that it does not deal fully and accurately with the “mutuality of obligation” requirement. A number of recent cases (for example the Upper Tribunal decision in HMRC v Professional Game Match Officials Ltd [2020] UKUT 147) have indicated that HMRC’s views on this issue are not correct – this should be borne in mind in relevant cases when using the CEST tool.  

What does a client do with the status determination statement?

Once the client has made its SDS, it must pass this on to both the next person in the chain and also to the worker. If everything works correctly, the intention is for the SDS to cascade its way down the labour supply chain until it reaches the fee-payer (whose responsibility it is to operate PAYE).   

In terms of timing, for ongoing contracts this should be done before the due date for the first payment under the contract on or after 6 April 2021. For new contracts the status should be determined before services are performed and ideally before the contract is signed.    

If the SDS is given by the client but not passed down the chain, then the PAYE liability sits with the party at fault. 

Even where the SDS is correctly passed down the chain as envisaged, there are further provisions which give HMRC the power to pursue the end-user client for unpaid PAYE and NICs, where HMRC consider there is no realistic prospect of recovery from the fee-payer within a reasonable time. HMRC appear to have a wide discretion as to when to exercise this power, albeit the technical note accompanying the draft legislation states that they will not do so “in the case of genuine business failure of the party ordinarily liable for income and NICs”. 

It is clear that the purpose of these transfer of liability provisions is to drive up compliance within labour supply chains. The first agency and the client are considered to be the parties who are best placed to influence and improve compliance within the whole chain. 

The draft Employment Status Manual contains guidance from HMRC on steps businesses can take to help secure their labour supply chains.

HMRC has also confirmed it will take a light touch approach towards penalties in the first year except in cases of deliberate non-compliance. 

Client-led disagreement process

The new rules also introduce a client-led disagreement process. 

This gives a worker (or the fee-payer required to operate PAYE) the right to make representations to the client that the conclusion in an SDS is incorrect. The client then has 45 days to consider the representations and communicate its conclusion (together with reasons, if it does not change its mind). If the client does not do this, then it becomes liable for PAYE/NICs. 

This is presented as a protection for workers against blanket status determinations, which it is to an extent. However, the obligation on the client remains fairly light. Clients are only required to consider representations and give their conclusions, plus reasons. So if a worker continues to disagree with the client’s re-considered status determination, it has no further recourse or mechanism to challenge under the IR35 rules. 

Of course the correct status under IR35 is a matter of fact and law, so a determination by a client is not binding on HMRC. A worker may therefore have additional avenues of challenge. In certain circumstances a PSC may have a contractual claim against a client (or fee-payer) on the basis that it has wrongly withheld amounts that were due to it. There may, however, be a number of difficulties in practice with such a claim (not least if there is an ongoing relationship). An individual may also be able to take up the point with HMRC through his or her own self-assessment process – in which case the client may find itself drawn into the matter. This has the potential to give rise to a significant number of disputes in future – and the exact ramifications will only be seen once the reforms take effect.

Finally, HMRC have been at pains to stress that the reform is not retrospective. They have stated that they will not use information resulting from the reforms to open investigations into PSCs for past years unless there is reason to suspect fraud or criminal behaviour. HMRC state: “This should provide reassurance to individuals that any change in status as a result of the reform will not lead to HMRC opening a historic enquiry.” This does provide a level of practical comfort to workers and PSCs; however, it should be remembered that this is only HMRC guidance and the ability to rely on it in the event of a change of policy or practice by HMRC may be limited.

International aspects

The most recent draft legislation includes provisions which limit the scope of the new IR35 reforms to clients with a “UK connection”. That is, the changes will not apply to clients who are neither UK tax resident nor have a permanent establishment in the UK. In such a case, the existing rules apply, and any payroll obligations under IR35 fall on the PSC.

However, where a client is part of a group of companies, it is the whole worldwide group that needs to be taken into account for the purposes of determining whether the client is “small” (and not just the UK part).

The position where the worker and/or the PSC are non-UK can be more complicated. It will require consideration of whether the worker is within the charge to UK tax and/or NICs and the amount of work done in the UK; and may well also require consideration of any relevant double tax treaty. 

Summary of new rules

In summary, the new rules represent a major change – and potentially a major compliance issue – for medium and large private sector organisations that engage individuals through PSCs. Previously such organisations had been able simply to pay amounts gross for work done by such contractors, safe in the knowledge that any PAYE risk sat with someone else. However, that is no longer possible. Businesses will need to give proper consideration to the employment status of all PSC contractors, both existing and new, and will need to update their systems and processes accordingly. They should bear in mind that HMRC see the new rules as being a key tool for correcting compliance failures and are anticipating a significant increase in tax take as a result. 

What should affected businesses be doing to prepare for the changes?

Affected businesses should ensure they are prepared for the introduction of the new rules in advance of the planned April 2021 start date. Many businesses have already done significant work prior to the recent deferral – they should ensure that all their preparation is completed (and they have reflected any recent changes, e.g. in their workforce or working practices) before next April. Even in the current climate, HMRC are likely to focus on reviewing compliance once the new rules take effect (and may have limited sympathy if work has not been done in time, particularly given the recent deferral). 

Set out below is a (non-exhaustive) list of steps affected business might consider taking by way of preparation. There is no “one size fits all” approach here though. Each affected business should consider carefully the steps that are appropriate to it, depending on various factors, such as the size of its contractor workforce and commercial priorities.

  • To the extent this has not been done already, consider forming a cross-functional IR35 project team (across the various relevant functions, e.g. HR, legal, finance, tax and procurement) to manage the upcoming changes and work towards implementation.
  • As soon as possible, undertake a full audit of the status of existing contractors whose contracts extend beyond the April 2021 start date. The first step is to identify those contractors who contract through PSCs (or other intermediary entities). The status should be reviewed by reference to both the relevant contractual terms and the actual working practices of each contractor. If an audit had already been undertaken in the run up to April 2020, this should be reviewed to ensure it reflects any subsequent changes in the workforce or working practices.    
  • As a result of this review, businesses may find that some contractors are clearly caught by IR35, while others are clearly not. For those that are caught, consider whether the simplest thing is to bring them onto payroll (though consideration should also be given to any employment law consequences). A number of contractors may be of more uncertain status – in which case, consider whether genuine changes to working practices might be able to take them more clearly outside of IR35. 
  • Once the audit exercise has been carried out, businesses will also need to manage how the results are communicated to contractors. Individuals may understandably be worried about this, as switching to PAYE could reduce their take-home pay significantly. It is important to be transparent and ensure that the contractors are fully informed and understand how seriously the reforms are being taken. Businesses should show that they are considering each individual case on its merits and not just imposing blanket determinations on similar groups of people. 
  • It is inevitable, however, that some contractors may disagree with status determinations. Put in place a process for dealing with this.
  • It may also be advisable to audit current engagements with intermediaries and agencies that are used for the supply of workers. Businesses will need to be confident that each party in the supply chain has robust procedures and processes in place. 
  • Undertake an assessment of the financial impact of the new rules and increase budgets appropriately.
  • Going forward, review current HR, procurement and other processes and procedures for onboarding contractors, in particular to build into that an assessment of the IR35 status.
  • As part of this exercise, review standard form contracts and consider whether any changes are required. It may be necessary to implement a formal dispute resolution procedure (perhaps with named people in the business being responsible). 
  • Build into all engagements a process for review of the IR35 status at particular intervals. Given that IR35 status can depend so heavily on what actually happens in practice, as a contractor relationship develops over time, the real position may be different from that envisaged at the outset.     
  • Take into account HMRC’s guidance on practical issues in the draft Employment Status Manual Guidance.

For more information, please contact Hugh Gunson.

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