Q&A: How agencies can ensure IR35 due diligence

The ‘small’ company exemption relates only to the business size of the end-client engager of PSCs, not the agency. Therefore, your agency must meet its responsibilities under the off-payroll rules regardless of its company size.

As the party which pays the PSC, your responsibility will depend upon the end client’s IR35 decision relating to the individual contractor. 

If the end client provides a Status Determination Statement (SDS) that supports an ‘outside’ IR35 opinion, then you can pay the PSC gross without deductions. However, if the SDS supports an ‘inside’ IR35 opinion, then as the fee payer you are required to deduct tax, Employees’ NICs and pay Employers’ NICs and, if appropriate, the Apprenticeship Levy to HMRC. 

It should also be noted that where HMRC can successfully challenge an ‘outside’ SDS as being ‘inside’ IR35, and despite the SDS being incorrect, the end client can demonstrate that it has taken reasonable care in their decision-making, you as the fee-payer will become the liable party in the first instance.

On the face of it, this does seem unfair: one party making a decision, but another having the liability. However, there is a ‘tax logic’ to this. 

As noted above, the party closest to the contractor’s company has the responsibility of being the deemed employer where an engagement is ‘inside’ IR35. Then the deemed employer must put the contractor’s company onto their payroll – as you would an employee – and make the necessary PAYE deductions (Apprenticeship Levy, if applicable, Employers’ NICs & Employees’ NICs and income tax under PAYE, although statutory deductions like sick pay and SMP are payable by the contractor’s company). Therefore, the agency has the liability as long as the end client has taken care in their decision-making and issued an SDS.

The legislation is clear in such circumstances: where an end-client is medium/large in size, unless based wholly overseas with no UK presence, then they have a responsibility to provide an SDS detailing their IR35 decision to the PSC and the next party in the chain - if yours is the only agency between client and contractor, this makes you the fee payer. 

If this has not happened, then the client has not taken ‘reasonable care’, meaning that any potential liability and the requirement to deduct tax and NICs, including the Apprenticeship Levy, if appropriate, rests with the end client, not your agency acting as fee payer.

The short answer is yes. HMRC recognises in its off-payroll guidance that end clients may turn to third parties for assistance in undertaking IR35 assessments and issuing SDSs to their contractors. 

However, the end client must satisfy themselves that the third party’s due diligence process meets the legislative requirements, including consideration of contractual terms and conditions, as well as evidence of the working practices from both the end client and the contractor, in order to demonstrate that reasonable care has been taken. 

The end client will ultimately remain responsible for the SDSs produced and is expected to have full oversight of the process used.

To answer that question, we need to look at the legislative requirements – it follows that a process, automated or otherwise, can only be relied upon if it addresses all conditions of the legislation.

The legislation requires that medium/large end clients must:

1. Make a Decision. Decide the IR35 position of every engagement by reviewing all contracts/paperwork in the supply chain and working practices.
2. Take reasonable care. Evidence that the reasoning behind their decision was reasonable.
3. Issue a decision.  Provide an SDS to the contractor and the agency (if applicable) and keep records.
4. Implement a disagreement process. Create and implement their own process for any contractor disagreement.

This will ultimately be for the end client to decide. However, careful consideration should be given to any such decision. Often end clients opt to use CEST based upon cost implications of dealing with large volumes of contractors and having to pay for IR35 assessments, automated or otherwise, by third parties is less attractive than having access to a free service.

However, CEST has repeatedly come under fire for being inadequate and not reflective of current case law.  A number of public sector bodies had relied upon CEST to their detriment and were collectively found to owe HMRC approximately £268 million in underpaid tax and NICs. 

This strongly suggests that ‘free’ is not always best and can in fact lead to large, unexpected liabilities. Another consideration is that evidence has established that CEST fails to reach an IR35 opinion for one in every five uses, not particularly helpful if you are unable to correctly assess all of your contractor engagements and need an opinion that can be relied upon.

If your end client is based wholly overseas with no link or permanent establishment in the UK, then responsibility for deciding IR35 rests with the contractor in accordance with the original IR35 legislation at Chapter 8 Part 2 ITEPA 2003. 

This answer assumes a basic contractual chain of wholly overseas client > UK based agency > UK PSC. However, in more complex contractual chains, further careful consideration should be given and professional advice sought where necessary. 

The first step would be to ensure that your end client has a robust due diligence process for undertaking accurate IR35 assessments and satisfying reasonable care requirements. Having such a process in place should eliminate HMRC imposing penalties. 

A further consideration would be to take out an underwritten insurance policy that will not only cover any professional fees incurred in defending your position during an enquiry, but will also pay out any additional tax and NIC assessed by HMRC as being due.

You might seek to enforce such a clause, but you need to have four considerations:

• HMRC will nevertheless, recover the tax & NICs from your agency as the liable taxpayer – they will not be interested in any legal action you may wish to take
• You can only take the action once you have paid the tax bill and can therefore demonstrate there has been a loss
• We are not aware that such a claim has been made against either an end client – which HMRC would, presumably, have been deemed by HMRC to have discharged its tax obligations correctly – or a contractor, who under the Chapter 10 legislation, has no liability. Therefore, there is no guarantee such a clause would be enforceable
• Does your agency want a reputation for suing its end clients/contractors?

Surely, it would be far better to have undertaken robust due diligence and then have your own HMRC enquiry defence and tax losses insurance policy, where premiums will reflect your level of compliance and therefore your risk. Your agency is protected; your clients are protected – you become a more reliable business partner.