IR35: why due diligence matters

IR35: why due diligence matters

The rules around off-payroll working (IR35) may be open to interpretation, but it’s crucial for end clients to get it right.

Without undertaking due diligence, you could find yourself facing a large tax bill if you’re ever challenged by Her Majesty's Revenue & Customs (HMRC).

Paul Mason, Head of Markel Tax’s Specialist Tax Services team, explains the importance of doing your due diligence into contracts and working practice before you can insure against the potential IR35 tax liability.

IR35, or the Intermediaries legislation to give it its full title, is a long-standing anti-tax avoidance legislation which seeks to target ‘disguised’ employment, which has enabled some end clients and contractors to avoid tax and National Insurance liabilities. At its inception, IR35 targeted the contractor engaged through their own limited or personal service company (PSC). While the factors which determine the IR35 status of an engagement haven’t changed, who now decides in the vast majority of cases has. Since April 2021 some 60,000 medium- and large-sized end client engagers now have that burden and potentially the tax liability.

The way the legislation is framed, due diligence with regard to IR35 is absolutely imperative. As Paul explains: “The end client is required to do four things: first, they have to make an IR35 decision – they can’t just say that they are undecided. Second, they have to take reasonable care. Third, they have to communicate their decision to the contractor by issuing what is called a status determination statement (SDS). And fourth, they must have a client-led disagreement process, which is basically an opportunity for the contractor to say they disagree with your decision.”

HMRC’s guidance is not prescriptive and with IR35 being a grey area because its principles are based upon case law rather than legislation, there is considerable scope for interpretation when it comes to making that status decision.

Therefore contracts, schedules, statements of work and even end client policies which impact upon a contractor’s working practices in the entire supply chain must reflect an engagement that is outside and must be supported by the actual working practices. As Paul points out, you need to be able to evidence your due diligence and ensure that what the contract says is followed by the people managing projects on behalf of the client as much as the contractors being engaged. “You’ve got to look at it from the point of view that if this went to a tribunal, the tribunal judge will start with the contract and will then look to see if it represents reality. If the contract is poor, a judge is basically going to say ‘well, I hear what you’re saying about the working practices, but that’s not what the contract says…’". HMRC will definitely make the same point.

Paul explains how help from Markel Tax can offer clients the option of defending challenges from HMRC and potentially the tax liability. “Whether your business is manufacturing-based or providing services, you haven’t got the time to be a specialist in tax too,” says Paul. “In an ideal world we can take you to a position where you are comfortable doing most of the compliance yourself, but there might be some ongoing hand-holding necessary and we can work with you to ensure continued compliance.”

Without an expert looking at your contracts, there are details that could be overlooked. For example, a substitution clause might be too restrictive or undermined by another clause elsewhere in the contract. If the client will only accept people they have interviewed, for example, then it’s not the right of the contractor to provide a substitute, it’s a right for them to decide who is going to do the work. Or there might be policies within the end client’s organisation that impact how you do your job – policies that go beyond what is reasonable for an independent contractor. You need to be aware of any policy that is going to treat a contractor the same as an employee. It’s not just about the contract, it’s about what sits behind it as well. And above all, working practices must tie up with the contract.

Due diligence is also a crucial element if a company wants to insure against their potential liability. “It’s there to make sure you’ve got everything right and to put you in the best position possible should you ever be challenged,” says Paul.

He makes the point that quality cover (such as that provided by Markel) should ensure that you receive the best defence paid for by the insurance and backed by tax expertise. In the event that the argument cannot be won, then the tax liability cover kicks in. “As long as you remain insured with us, all previous years continue to be covered,” says Paul. “In five years’ time HMRC could potentially come along and go back four years… to have that comfort of knowing that you’ve done your due diligence properly and your tax position is also protected is really important.”