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The IR35 Virus

For PSCs providing services to the public sector and claiming to be outside IR35 a comprehensive IR35 contract review is vital and it should be undertaken.

HMRC GUIDANCE: "Off-payroll working in the public sector: reform of intermediaries legislation" was published on 3 February 2017 and updated 1 March 2017, this covers the changes to the way intermediaries legislation (IR35) is applied to off-payroll working in the public sector from 6 April 2017.

The Spring Budget 2017 supporting the IR35 reform policy is found here.

HMRC stated that public authorities, agencies and third parties supplying contractors should consider existing contracts and prepare for the change. HMRC advised that an Employment Status Service would be provided in the shape of a web-based tool that was eventually provided on 2nd March 2017, just days before the reforms were to be implemented!


Legitimate Expectation: HMRC and the Employment Status Service ("ESS") Tool

HMRC says:-

  • "Interested parties can use the Employment Status Service tool to obtain the HMRC view of whether any current and prospective workers would fall within the off-payroll rules from 6 April 2017.
  • This new digital service provides the HMRC view of the employment status of a worker. The user answers a number of questions around the relationship between the worker and the public sector client they are contracted with. It is for the public authority to decide whether off-payroll working rules should apply.
  • Use of the service is optional."

This is a mighty fine statement of intent and provides a legitimate expectation.

Using the tool and its rule based questions start with substitution (which I believe is neutral unless it genuinely exists in the working arrangements although a right of substitution and the worker actually engaging and paying the substitution is an important point). A killer Punch.


Employment Status, IR35 and (Fettered?) Substitution

Some notable principles regarding fact-finding and the substitution test, whether fettered, is found in cases such as F. S. Consulting Limited v. Patrick McCaul (HM Inspector of Taxes) [2001]. A sample of other cases are: Synaptek Ltd v Young; Usetech Ltd v Young; Dragonfly Consultancy v HMRC Commissioners; Autoclenz Ltd and Belcher & Ors, and so forth. HMRC’s interpretations and summaries can be found here.

The ESS tool can be used to conduct input/output tests so long as the facts of, say, the above cases are accurately inputted. Others have commented, that HMRC's ESS tool determines that the contractor was outside IR35, which is diagonally opposed to the human judgements and decisions released by judges.

Take for instance the key factors which summarise the Pimlico Plumbers Ltd v G Smith decision below:

  • The UK Court of Appeal commented regarding the ability of appointing a substitute to undertake the work. It was noted that an unfettered right to appoint a substitute is inconsistent with an undertaking to do work personally, outside employment. But also, whether a conditional right to substitute another person is inconsistent with personal performance and this was dependant on the nature and degree of any limit on that right of substitution. There were however restrictions on Mr Smith as he was required to obtain Pimlico's consent if he wished to engage a substitute to carry out the services. This case indicates how the employment appeal tribunal approached the substitution test.
  • The Court was influenced by the overall level of control exerted by Pimlico over Mr Smith, despite some contractual terms which suggested he had a degree of independence and he could provide his own equipment to carry out the work.
  • Whilst Mr Smith had discretion over certain elements of how he performed the work, the UK Court of Appeal upheld that the decision of the UK Employment Tribunal that he was engaged to personally provide the services to Pimlico.



Employment lawyers - I think, but do not necessarily in every case - tend to emphasise the Autoclenz case, which indicated that the actual working practices take precedence over the contract terms when assessing employment status. This is very much in line with the IR35 approach to take. However, my experience is that a PSC contractor will face a hurdle in persuading HMRC that the end-client has no right of control over how the work is done if the contract terms are contradictory. This is just one area where hypnosis starts during HMRC's reviews that are operated without formal enquiry statue and no apparent code of practice in a self-policing fashion.

The main problem is that standard terms do not exclude any right of control by the end-client over the PSC. Indeed, some provisions can give the impression that the written form creates a strong right of control and it is undeniable that a contractor wishing to operate outside of the IR35 legislation cannot be subject to (or to the right of) supervision, direction or control by any person. SDC might be considered as HMRC’s main trump card but as opposed to the ESI, the leading questions for the ESS start with the substitution test.

Whilst the ESS had to start somewhere, it is presumably revealing that HMRC started with substitution and hence the Killer Punch if genuinely part of the arrangements - the subset of personal service.

We shouldn't forget tests such as Mutually of Obligations et al, and cross-overs.


Conclusion about HMRC ESS

There are many critical responses, some technical and founded and then some curious comments by people who promoted the ridiculous notion surrounding “BETs” (subsequently dishonoured and removed).

If only Carlsberg did the ESS tool it might have had a decent decision logic, but instead I believe the tool is flawed. One main reason is rubbish in and rubbish out, passing the outside IR35 test. Try it, using it and applying even HMRC’s own case law summaries - input them into the ESS tool. The Italian Job..."your only intended to blow the bloody door off" (Michael Caine) comes to mind and the explosive effect using the ESS tool - IR35 smashed to smithereens.

HMRC’s yes/no ESS development surely continues, but rubbish in/out danger exists, which means HMRC will probably not give a jot to its own ESS tool pass result. The risk factor is high and confidence must be low in such a tool.


IR35 Assurance Reviews: Onus on the Public Sector Contractor (“PSC” – not to be confused with a PSC?!)

Such reviews whether just in time with the ESS tool roll out or previously (remember "Use of the service is optional") mean that the PSC contractor had/has every reason to believe that his IR35 Assurance Review by a competent tax adviser was met and I cannot think of any reasonable measures that could have been taken beyond what the PSC contractor relied upon. This approach means that the PSC director would have had reason to think he had undertaken reasonable care as the PSC’s contractual arrangements maybe (more or less) very similar for each contractual engagement. Evidence of what is surely regarded as a reasonably diligent businessman who had understood and operated his Director's fiduciary duty.

However, HMRC reform (statutory new rules) places onus on the public sector fee-payer. In reality these last minute new rules have been rushed and sloppy resulting in the Public Sector default position of every PSC being inside IR35 or having to go through an umbrella/agency neatly sidestepping the issue but apparently being outside of what was intended to be a critical IR35 evaluation.

The legitimate expectation laid down by HMRC guidelines, ESS and what was presumably intended, has resulted in many PSC bodies not even considering IR35 as it’s too risky, judgemental and practically impossible to look at each case in such a short space of time.

IR35 over the years has been responsible for wasted costs, confusion, and its metamorphosis has displayed something akin to the law of unintended consequences.


Unintended Consequences of Tax Regulation and the Killer IR35 Virus

In the best-case scenario, I believe an action produces both the desired results and unplanned benefits; in the worst-case scenario, however, the desired results fail to materialise and there are negative consequences that make the original problem worse. It is not enough for Parliament to endorse legislation that promises to do something good. HMRC need to think through the full consequences of a policy, because often it will lead to a cure worse than the disease. This is magnificently illustrated by this “IR35” 17-year-old and the sticking plasters applied by HMRC in attempts to reform the intermediaries legislation.

Of course "deeming" PAYE is subject to conditions and specified rules. Take for instance agency regulations that were circumnavigated by the creation of PSCs which resulted in the birth of IR35 and then Management Service Company (MSC) legislation - the "Chapters" of wasted costs.

Equally, genuine personal small companies have operated before these elephant in the room tests and true businesses have been attacked, probably because of others operating in contrived schemes.

Whilst the attack on self-employed/small personal service businesses continues, these risk-taking enterprises prevail despite increases in NICs and cuts in dividend tax reliefs.


Enforcement of IR35 "Fuzzy" Logic

When perfectly enforced(?), IR35 tax legislation obligates the Personal Service Company ("PSC") to consider whether a hypothetical employment exists between the worker/director and the end client/employer exists. This is broadly subject to employment status principles - or status tests, some of which are mentioned above and displayed in the ESS tool - established in case law. A highly subjective interpretation and application that has confounded mostly everything and everyone including HMRC since IR35 was introduced in 2000 (and employment status generally for many years beforehand). IR35 was always going to be a road crash.

If IR35 applies then (broadly) PAYE/NICs are operated on the net profit perhaps analogous to say a dividend.


Illustration of Some IR35 Substantive Issues

However, there are substantive issues due to HMRC resources and technical capacity to police legislation that applies to the many PSCs in the supply chain. Same applies to the PSCs and tax advisers.

This has been a massive logistical problem for HMRC resources. I believe that this is why the new "rules" (Off-payroll working in the public sector: reforming the intermediaries legislation) effective from 06/04/2017 were introduced compelling the public sector end client/agency/paymaster to operate IR35. However, this apparently prejudices the PSC operating in the public sector and it appears that some unintended consequences will result in IR35 being applied by default, or massive emphasis being placed on an HMRC web-based decision tool (the "ESS") that is an ineffective public relations exercise (similar to the woeful Employment Status Indicator).

PSC migration to private sector will mean that the public sector has an increased cost to directly employ skilled operators. Another unintended consequence.

The other apparent issue I mentioned above is the competence and application of relevant status tests - relevance to establishing hypothetical and sometimes undefined working practice arraignments. Impossible to perfectly police in the many to many world of arrangements.

That also leaves the issue I have mentioned above about HMRC development of the ESS web-based tool and the myriad of consequential technical matters, but also just out of time publication late on 2nd March 2017 as stated above.

It is clear that IR35 tax yield is negated by the overall cost in complying with judgemental legislation incapable of being policed by HMRC.

In reality, there are genuine risk-taking PSCs which are prevalent in the supply chain, but HMRC does not have the resources or capacity to perfectly enforce IR35 regulations - nor can it simply reform the delinquency of bad legislation.

I believe the Chancellor's Spring 2017 Budget had to go along with the IR35 reform but at what cost to the Public Purse and people who provide personal consultancy services?

Please feel free to call or e-mail me for advice in relation to IR35 resolution, employment status or the agency regulations.