Hiring firms who assess the IR35 status of existing contractor engagements and deduct monies based on an ‘inside IR35’ decision risk being found in breach of contract.
This is according to Martyn Valentine of The Law Place, who explains that the Off-Payroll legislation’s incompatibility with contract law means efforts by firms to comply with the rules will likely leave them vulnerable to legal challenges:
“If you hire a contractor who you have agreed to pay off-payroll ("outside IR35"), any failure to do so could be claimed as a breach of that contract. However, the Off-Payroll legislation requires hirers to assess the IR35 status of contractors, adding a statutory obligation to deduct sums for tax purposes if they find them to be within scope of the rules.
“For pre-existing contracts this poses a problem. The legislation is clear that status can only be decided before the start of an engagement. It is therefore a breach of an implied term, and in all likelihood the express terms of the contract, for a hirer to later re-assess the IR35 status, and begin making tax deductions accordingly.”
Hirers caught in a catch-22 by Off-Payroll
The Off-Payroll legislation creates a catch-22 scenario for hiring firms that have re-assessed contractors and found them to be caught by IR35. The hirer could argue rightfully that they have a statutory obligation to make deductions from the contractor’s fee.
However, the contractor could easily decide to dispute the deductions on the basis that they don’t agree with the status assessment, particularly if the contract has provisions indicating that no taxes should be deducted because it is outside IR35. Where the contract is ambiguous Valentine acknowledges that there is little clarity on the matter.
“There’s no particular guidance for this situation, just statute and contract, which are evidently in conflict. From the contractor’s perspective, challenging the client in this event is relatively simple. If the contract says they will pay you X amount for doing Y on an off-payroll outside IR35 basis, and that hasn’t been the case, that’s a breach.
“The matter isn’t helped by the fact that the Off-Payroll rules do not provide an appeal or arbitration procedure,” he adds. “However, contractors can claim for breach of contract in the county court, or the high court for sums in excess of £10,000. Various other means of recourse exist, such as a complaint to HMRC or the Employment Agencies Standards Inspectorate if a recruiter is involved in an unlawful deduction.”
Employers National Insurance is the main problem
Whilst there will undoubtably be contention if the agency attempts to deduct PAYE and employees National Insurance from the contractors' gross fee, that could prove to be a moot point, because of the problem of employers National Insurance.
The fee-payer (hirer or agency) has to pay employment taxes on top of the gross fee which was agreed with the contractor, and has no lawful basis to deduct it from the contractors agreed fee. These taxes, are the bulk of the new taxes due under the off-payroll tax, and amount to 13.8% employers NI and 0.5% Apprenticeship Levy.
This amount could be more than the agency margin, making the contract entirely unprofitable for the agency unless they can convince the client to cover these extra taxes. Ultimately, because of these issues each contract that is assessed inside IR35 needs to be renegotiated with the contractor, or terminated under the conditions specified in the contract.
A termination and renegotiation then means the contractor is likely to command a higher rate to cover any financial loss due to a change in status, or what is highly likely is that they decide not to offer their services to the client at all, due to the risk of further historic tax risk to themselves.
Failure to act could prove costly for private sector hirers
With the Off-Payroll rules expected to be introduced to the private sector in April 2020, hirers are being encouraged to address the matter urgently to avoid issues encountered by some public sector organisations.
Due in part to the rushed implementation of the public sector reform, and the postponed release of HMRC’s Check Employment Status for Tax (CEST) tool, many public bodies only began assessing contracts months before, or in some cases after, the rules came into force. In many cases, the decisions made upon the re-assessment of IR35 status have given rise to disputes between parties.
“Since the Off-Payroll rules were introduced to the public sector, I’ve helped a number of contractors resolve disputes with clients who had decided that the legislation applied, and subsequently withheld pay, midway through their engagement,” notes Valentine.
“Where it is found that the client made a mistake in assessing the status, I find that the best course of action is to threaten a claim for breach of contract in the county court.
“A common pitfall is where recruiters insist on the contractor signing hybrid contracts containing terms which are applicable whether the engagement is inside or outside of IR35. This type of contract is to be avoided if possible, as considerable time can be spent arguing points of law.”
Renegotiating contracts is a tall order for hiring firms
Private sector firms have little time to get their ducks in a row. A contractor entering a one-year contract any time beyond mid-April 2019 will legally require re-assessing by the hirer before the contract concludes, should Government stick to its anticipated Off-Payroll timeframe.
Where a hirer is required to re-assess a contractor’s status mid-engagement, Valentine notes that the correct approach is to terminate the contract and offer a new contract with appropriate terms: “This is the necessary approach to enable a decision to be made before the start of an engagement, as required by the Off-Payroll legislation.”
However, things may not be so simple in practice. Aside from the disruption that this approach would likely cause to ongoing projects, the chances of an amicable resolution are relatively slim.
“If the contract was initially agreed as outside of IR35, then it is reasonable to expect a right to terminate immediately without cause. However, it’s always advisable to first check the termination provisions, in case the situation doesn’t warrant a termination,” explains Valentine.
“Assuming there is a right to terminate, you then move on to the tricky part. Renegotiating a contract with a contractor whereby you move them from working off-payroll onto a payroll is going to be extremely difficult.
“Firms might consider inserting conditional clauses into contracts to enable re-assessment of status under Off-Payroll to circumvent future risk,” Valentine adds. “Unfortunately, this is forbidden by Off-Payroll’s requirement for IR35 status to be determined up front.”
No easy fix for ‘overly complicated legislation’
Ultimately, it’s clear that legislative amendments to the Off-Payroll rules are necessary to negate the issue. Unfortunately, as Valentine highlights, the simplistic approach that the Off-Payroll rules adopt, coupled with hirer’s lack of familiarity with employment status, makes this a difficult hurdle to overcome:
“The problem is that the client is required to make a status determination before the contract has even begun. In practice, the client needs to decide if the work is project based, and if so, whether its capacity is that of a customer of a business carried on by the individual or a temporary employer.
“Problems inevitably arise when human resources departments with little or no comprehension of professional contracting draft statements of work as job titles, causing significant confusion and dispute. In any case, it’s impossible to determine IR35 status with any great degree of certainty at this stage of the engagement, and so any status determination is vulnerable to being challenged by the contractor.”
Valentine concludes: “By the very nature of employment status, there’s no real easy workaround to the issue because of the rules that Government has set out regarding Off-Payroll. It’s a very difficult situation brought about by overly complicated legislation.”
Technical note: In this article we are exploring the Chapter 10 rules in the public sector, and the term "pre-existing contracts" refers to contracts entered into after April 2017. Whilst we could speculate on what might happen in the private sector, at this stage draft legilsation has not been published.