We know that 75.6% of SAP contractors working inside IR35 would leave an SAP programme for a competitive opportunity that falls outside IR35 (SAP Hiring Manager’s Playbook 2024).
But the very mention of outside IR35 working can bring fear and stress to your finance and tax colleagues. To them, it’s extra admin, complexity and risk.
It’s challenging to articulate the reasons why they should be more open to hiring contractors outside IR35.
So, this guide aims to support hiring managers navigate that very conversation. Facts and figures that will ease their anxieties and make the prospect of outside IR35 working feel more comfortable.
We’ve enlisted the help of Seb Maley, CEO at Qdos, to support us with the facts here.
A quick history lesson.
People are often surprised to hear that IR35 has actually been around since the turn of the century (originated in 2000). It was initially called the Intermediaries Legislation, but reporters used the term IR35 in the media, which stuck.
The fundamental purpose of IR35 is to counter the perceived tax avoidance of individuals working through their own limited company when they should, in fact, be employees of their client.
HMRC originally planned to put all the risk and liability on the engager rather than the contractor. There was a huge backlash from businesses who didn’t want to deal with this. So, it was decided that the contractor would take that risk.
HMRC were very aggressive in how they policed this in the early years. There were well over 1000 investigations every year for the first few years – a completely relentless pursuit of contractors. And they weren’t particularly successful in winning cases – but it created an environment of fear.
In 2017, the new off-payroll working rules were introduced to the public sector. Technically a separate piece of legislation – but for ease, people still refer to it as IR35. The new rules simply switched the liability from the contractor to the engager (as originally intended). And in 2021 this was also rolled out to the private sector for medium and large businesses. The original rules still apply if a contractor is providing services to a small company.
The IR35 cases we’ve seen go through the court system set case law. With every case that goes through, we all learn a bit more about how status should be determined.
The good news is that things have moved on a lot in the last 20 years. People shouldn’t be so fearful of the rules.
Where businesses are still getting stuck.
Businesses will say they’re assessing each role for the most appropriate classification – but then their working practices prevent them being able to use outside IR35 contractors at all.
The main issues are often around:
- Right of substitution
- Supervision, direction and control
But the issues are often a result of misunderstanding, rather than policy. Let’s explore these in more detail.
Right to substitution is the most misunderstood area.
Businesses are rightly confused about this. Hopefully we can clear this up for you.
In a nutshell, an employee can’t send someone to do the work in their place – but a contractor should legally be able to.
On CEST (Check Employment Status for Tax tool), there’s a somewhat misleading question that says would you be able to reject a substitute?. Of course, most engagers will respond yes, because if someone isn’t fit for the job, then they should be able to reject them. But if you answer yes, CEST will give you an automatic ‘X’ for right to substitution.
However, there’s a little-known separate guidance manual that explains how the question should be answered: if you are able to reject a substitute based on their ability to do the job then you can answer no to that question.
This puts a totally different spin on it. It means engagers have the potential to veto substitutes on the grounds of unsuitability.
The question could be reworded to say ‘would you be able to reject a substitute even if they’re perfectly suited to the job?’.
That being said, security protocols and lengthy onboarding processes can sometimes make substitution completely unviable.
But it’s not the be all and end all. That’s right – you can still have outside IR35 contractors even if there’s no right to substitution. You’d simply have to put more focus on the other areas instead. We’ll explain more on this later.
Right to substitution is the safety net you didn’t know you needed.
The fact is that the right to substitution can actually be a huge business benefit. It actually takes a lot of the risk, admin and cost away from you. Here’s just a few reasons why:
- You’ve paid a contractor to fulfil a specific task or role. So they’re legally required to bring in a replacement that can also fulfil that specific task or role. And if that person is not properly equipped to do so, you can terminate them immediately. So in actual fact, your potential substitute is a great safety net.
- And because it’s the contractor that needs to bring this replacement in themselves, you save time and money on recruitment fees, interviewing, CV screening etc.
- What’s more, if a switch-out happens, you aren’t required to pay extra for any training or handover time. You only pay for what was originally contracted.
- This also means that the day rate wouldn’t increase – that would be as per the original agreement too.
- And while the handover is happening, you’ll effectively have two contractors for the price of one.
The end of double-taxation is a game changer.
On April 6th 2024, HMRC introduced its offset mechanism, bringing an end to the so-called ‘double taxation’ of IR35.
Where a business has engaged a contractor outside of IR35 – but HMRC deems that determination to have been incorrect – the end-client is issued with a tax bill to recover the employment taxes that should have been paid.
However, HMRC had previously failed to account for the taxes already paid by a contractor on the fee they’ve received for that assignment. As a result, HMRC was collecting more tax than it was actually owed. This means businesses have faced a disproportionate risk when engaging contractors.
For businesses, the end of double taxation reduces the perceived risk of engaging contractors and – in the event of an incorrect IR35 status determination – considerably reduces the tax bill they will be issued.
And there’s a way you can remove the risk altogether.
You can ask your recruiter to take on the liability here.
For example, contractually, bluewaveSELECT takes on full liability on each placement (to a maximum of £100,000 per contractor) for any IR35-related imposed penalties by HMRC.
For example, bluewaveSELECT write into their engager contracts that if there’s a substitution then the notice period drops from 4 weeks to 1 week – so the employer can easily disengage if they want to. What’s more, bluewaveSELECT will cover the cost of that week if that substitute isn’t up to par.
“But I want to be able to tell my contractor where, when and how to work.”
Supervision, direction and control is another place where employers get tripped up. They get nervous that the contractor will seemingly hold all the cards and they won’t have a say in their working practices.
In actual fact, this is about working together with the contractor to agree deliverables, working hours, ways of working etc. It’s about coming to a mutual agreement. And this can be agreed before anything is signed.
Engaging an independent expert means not telling them exactly how to do the work. It’s about being on the same page about the framework they work within. It is, however, important that when a contractor is in a role they retain autonomy over how the services are carried out. There should be no right (whether exercised or not) to control them.
HMRC are no longer policing legislation – they’re guiding and consulting.
Once the new off-payroll working rules came in, the big question was ‘how are HMRC going to police it?’.
They are helping them to do things correctly. HMRC works with the business to collect information and ask sensible questions.
And what people need to realise is that HMRC will not be sitting there and assessing whether a contractor has been misclassified. They will just be looking at the steps you’ve taken to make sure you’re compliant.
These days, so much of being IR35 compliant is about the process. Not about the actual classification decisions. It’s really refreshing.
For example, we had a case recently where an organisation was being looked into by HMRC. They saw they were carrying out appropriate due diligence, training and robust processes. So HMRC simply closed it down and said, ‘fair enough, looks like you’ve got your house in order’.
No cases have reached the courts yet. . We have twenty or so ongoing cases – but currently no signs that HMRC are picking up on any particular area.
One of the biggest downfalls we see is where businesses try to find a ‘plug and play’ solution to solve all their IR35 woes. But being compliant is always about taking a holistic approach to risk.
HMRC will instead be asking questions like:
- Who is responsible in the organisation?
- Are the relevant people trained?
- Have you established processes outside of the decision/assessment itself?
- Who are the hiring managers?
- Do they know the legislation?
- Have you got a policy on substitution?
You need to demonstrate that you as an organisation have gotten to grips with what your responsibilities are.
This being said, none of these things will win or lose a case on their own. It’s about looking at everything holistically and making sure everything points towards a genuine engagement between engager and independent contractor.
Success stories are the ones that have taken the opportunity to evolve and encourage independent working. Engaging a contractor isn’t a ‘bum on seat’. Specialists should be treated like independent specialists. It really is as simple as that.
