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February 26, 2021updated 17 Oct 2022 10:29am

IR35 is changing. What do UK CIOs need to know?

New off-payroll rules will come into effect on 6 April and it will impact the relationship hiring firms have with contractors. Tech Monitor explains what CIOs need to know.

By Cristina Lago

After a year’s delay, changes to the UK’s off-payroll tax legislation, known as IR35, will come into effect on 6 April 2021. The changes are expected to shake-up the talent pool of technology contractors, and employers who can fairly and effectively assess their contractors’ status may have the pick of the bunch.

IR35 rules are used by HMRC to tackle tax avoidance from what it calls “employment in disguise”: contractors who the treasury would consider employees under tax law and therefore would be taxed as such. The rules apply to contractors who get paid through intermediaries, such as limited companies, and the businesses that use their services. If contractors are deemed to fall under IR35, they are obliged to pay broadly the same tax and National Insurance contributions as employees.

The rules have been in place for more than two decades. Until now, though, it has been up to the intermediary company to decide whether their employees are contractors or full-time employees. But as of 6 April, public sector authorities and medium and large-sized private sector companies that use contractors will be responsible for deciding whether their relationship falls under IR35.

IT departments rely heavily on contractors and consultants, so this rule change will have significant implications for CIOs and other UK technology leaders. Tech Monitor asked experts what they need to know before 6 April.

What CIOs need to know about IR35

From 6 April, changes to IR35 will affect the relationship between hiring businesses and contractors for tax purposes. (Photo by Ascannio / Shutterstock.)

What do UK CIOs need to know about IR35?

The first step that any medium or large business needs to take in preparation for IR35 is to evaluate the employment status of any contractors that are working for a personal services company (PSC), says Dave Chaplin, CEO of IR35 Shield, a tax assessment software tool.

The term PSC was coined by HMRC when IR35 was introduced in April 2000 by then-Chancellor Gordon Brown. Although there is no legal definition of PSC (something HMRC has been accused of using to its advantage when carrying out tax investigations), the generally accepted definition is a limited company that has a sole director – the contractor – who also owns most or all of the shares.

“Hiring businesses need to look at what would effectively be the employment status of those contractors if they were hiring them directly,” adds Chaplin. If the relationship is deemed to be one of employer and employee, then the hiring business will need to treat their fee as employment income, and therefore must pay national insurance and employment tax. But if the relationship is one of client and contractor, the hiring business can pay for the services in gross amounts and the contractor is responsible for their taxes.

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How is the nature of the relationship determined? There are a range of factors, including the provision of equipment, the degree of integration into the organisation, the hiring organisation’s right to terminate the contract and the workers’ opportunity to profit.

HMRC provides an online self-assessment tool, CEST, to find out if a worker should be classed as employed or self-employed for tax purposes. However, the tool has drawn criticism: in a survey of more than 3,000 contractors by IR35 Shield, just 2% trust the HMRC tool’s assessment and 41% are disputing the outcome.

For CIOs working on an interim basis, their IR35 status will depend on the contribution they are making to the business, says Will Jones, director of workplace solutions at Harvey Nash. “If you’re managing a team day to day and therefore involved in their performance-related pay structures, having these hierarchy conversations of managing a team, you could be seen to be more likely to be inside IR35 [deemed an employee].”

Are my contractors inside or outside IR35?

Once they have identified the status of their workers, hiring businesses must produce a ‘status determination statement’ to explain their decisions.

“It will need to give reasons as to why they’ve come to that conclusion,” says Chaplin. “That statement must be passed down to the agency if they’re using one recruitment agency. And it must also be given to the worker. The worker is allowed to dispute the conclusion that the company has come to you and say, ‘well, actually, no, I don’t think it applies to this relationship and these are my reasons why’. The company can choose to change their mind or stick to the decision.”

If the worker is told that they are inside IR35, they are what is called a ‘deemed employee’ for tax purposes. This means that the hiring business needs to pay an extra 13.8% of taxes on top of the money agreed to pay the contractor. As a consequence, many employers are trying to cut contractors’ fees to cover the tax bill, says Chaplin. This can cause friction, he adds, and contractors may decide to work elsewhere.

Determining that a contract is a ‘deemed employee’ only affects their tax status. It does not necessarily mean they are entitled to all the benefits employees receive. However, the recent ruling by the UK Supreme Court that Uber’s drivers are employees, not contractors, means that a contractor might still be entitled to those benefits, says Chaplin. “We’ve had the Uber judgment of the Supreme Court that now says, ‘well, it doesn’t matter what any of the paperwork says, really. We look at the status and if someone is in a relationship with one of employment or worker status, then they should get all of the benefits and rights associated with that’.”

The impact of IR35 on the supply of technology talent

The new IR35 rules are likely to shake-up the contractor talent pool on which many companies rely for their technology needs. IR35 Shield’s survey found that 65% of contractors are avoiding contracts to which the new rules would apply; 72% expect to increase their rates, and only 32% are confident they will remain in the current contracts after the rules are updated.

Chaplin expects that companies who rely on particular contractors will either treat them as employees or hire them through agencies. “That comes with lots of rights as well, because you’ve got agency workers regulations and there are there are rights that contractors would get or agency workers get after 12 weeks: holiday pay, sick pay and so on,” he explains. “It’s not quite the full set of rights you get as an employee, but you certainly do get lots of rights.”

Recruiting agencies are legally required to provide workers with a ‘key information document’ (KID) before agreeing contractual terms to ensure that the worker has all the necessary information before entering into a contract with a hiring business. However, 86% of contractors had not yet been provided with a KID, according to IR35 Shield’s survey. More worryingly, 67% of respondents were not even aware of what a KID is.

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Fears of non-compliance have prompted some firms to classify all their contractors as ‘deemed employees’, says Harvey Nash’s Jones. That means companies that can assess contractors’ IR35 status more discerningly will have their pick of the talent.

“We know from working in technology for so long that a lot of contractors out there are going to prefer to work outside IR35 contracts,” Jones explains. “Therefore, the organisations that have the ability to attract contractors, both inside or outside IR35 – depending on the role and the outcomes they’re looking for – are going to be the ones who probably get access to the best talent.”

At the same time, the increased costs of hiring ‘inside IR35’ contractors will increase competition for those willing to work outside it, Jones adds, especially in areas where demand outstrips supply. “Where we are going to see a real war for talent is around software architecture and engineering, and specialist areas such as CRM, ERP and security.”

These factors mean fair assessments and maintaining good relations with existing contractors will prove essential for those CIOs who want to avoid a brain drain from their talent pool as a result of April’s new IR35 rules.

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