From initial fears to HMRC's CEST tool limitations | IR35 Essentials (Vol 1.)

Before IR35 reform dropped, contractors were concerned about how their clients would adapt...

March 7, 2024

Worksome proudly presents Ryan Dawson, an IR35 Project Manager at Kingsbridge. Kingsbridge is a comprehensive business insurance provider and IR35 solution for the self-employed. Worksomes' very own Ray Walker weighs into this expert webinar panel and is our Contingent Workforce Compliance Director, who takes care of anything involving freelance talent. Walker is the guardian of Worksomes' IR35 solution, sporting over two decades of experience in the industry – having provided solutions for freelancers in nearly 90 different countries worldwide.

What is IR35?

The induction of non-payroll working rules began in 1999 when Inland Revenue issued a press release outlining the UK government's plans to tackle the rise of disguised workers. Inland Revenue was a British government department that existed until 2005 and was responsible for collecting taxes, and issuing child tax credits, for example.

Her Majesty's Revenue & Customs (HMRC) formed by the merger of Inland Revenue and Her Majesty's Customs and Excise in 2005. HMRC is the new tax authority in the UK responsible for collecting taxes and enforcing customs, among several other governmental duties. IR35 off-payroll reforms came into the public sector in 2017 after the UK Government announced in 2018 that they would roll out IR35 reforms to the private sector in 2020.

IR35 pains and pressures

Before the reform dropped, contractors were concerned about how their clients would adapt to change, causing uncertainty around whether or not they would still have a ‘job’ or even a market to work within. Recruiters were similarly concerned. Some clients were well prepared because they saw it coming from back when IR35 was first slated to roll out, while many others were not ready at all. Contractors either left the market entirely or switched to a different operating model. "There were a lot of concerns, a lot of risks, mainly around job security and around tax risk," says Dawson.

"56% use self-employment to supplement other income, emphasising the recent shift away from the traditional employment model."

- Contractor Calculator

Is IR35 the end of contracting?

"I think we're in that period, where HMRC are arming themselves and getting themselves into a position where they will come…I know for a fact that they are having investigations already," says Walker, so "it needs to be taken seriously."

Although IR35 is not the end to contracting, Walker knew several end clients in 2020 who were panicked and unprepared; then, when the reform got paused, there was a massive sigh of relief. And again, by 2021, they still weren't prepared! "It's not the end of contracting as some believed. It's just another thing that needs to be addressed," says Walker. "Businesses were worried about losing freelancers they needed for their business to continue, and they were like, 'what are we going to do about this?' What if freelancers leave the market? What if they drastically up their rates?"

Dawson remarks that "the contracting, freelancing, and gig economy space is extremely resilient because it is the natural nature of the market" to bounce back. There have been years of claims that contracting was done and over. Everyone thought, well, that's it, IR35 is the death of freelance contracting, and no one will do it anymore, but that is simply not the case. It's never going away.

If you were to look at the public sector changes, that came first as Managed Service Companies Legislation (MSC legislation) in 2007, which effectively worked like a trial run for HMRC, but in the public sector, again had people thinking it's the death of contracting. "But the one consistent thing you've seen is that every year, there's been an increased number of contractors working. So clearly, there is a need for flexible resources," says Dawson. "It may prove to be more convenient and cost-efficient for organisations to take on contractors."

The IR35 Essentials V.2 webinar is coming soon, but you don't have to wait to schedule a demo and tour the platform today!

"97% of contractors say they are much happier than employees."

The McKinsey Global Institute (MGI)

The number of flexible workers didn't change, but the number of people operating as a limited company has definitely shifted. In 2018, Dawson’s company Kingsbridge started to insure about 50,000 plus limited company contracts in the UK, and as the reform slowly moved in, Kingsbridge saw that number drop. Limited companies had an initial drop-off in 2019, to a drop in 2020, and in 2021 it dropped even further, following the historic pandemic of 2020 - contractor’s operating models had changed due to a tax risk sitting in different parts of the supply chain.

What is PAYE UK?

Most people pay Income tax through PAYE, an HMRC predetermined tax code system. PAYE or Pay As You Earn is when a contractor gets employed, usually by a recruitment agency, for the duration of their contract with an end client. They are paid directly through the agency's payroll. "So it's just that the limited company portion has somewhat decreased. That's led to increased costs because if you're paying a worker £300 a day, the equivalent in PAYE will be at a much higher cost for the end client and agency. Unfortunately, somebody has to take that hit somewhere," says Dawson.

What we see now is, for those contractors who are either inside of IR35 or working via an agency PAYE, or an umbrella company, etcetera, more often than not, you'll see those day rates increase, which adds cost to projects and businesses - something that perhaps many people overlooked.

Is the CEST tool reliable?

Question: I hear that HMRC is not standing behind the CEST tool reports and that they will take action against clients who relied on CEST. Is that true?

Dawson sheds some light on this touchy topic, explaining that "what you're referring to is HMRC's employment status tool called CEST, which stands for Check Employment Status for Tax introduced in 2017. Private sector organisations are at least trying to CEST because it's a completely free tool, however, it does come with a few inherent risks."

HMRC has said that if you use CEST and input the information correctly – use the tool perfectly; then they'll stand by the outcomes. "However, in the public sector, many organisations rely on CEST and take their guidance from HMRC directly. And as it stands currently in the accounts, some public organisations are liable for roughly £263 million in tax liability because of the incorrect use of CEST," says Dawson.

If one government department can't get another to align with using CEST in-house, then the dominos can fall. "I could sit here all day and give you reasons not to use CEST. I think the tool doesn't fit its purpose, and most commentators in the space would agree. If you rely on CEST at a bare minimum, get a second opinion," warns Dawson. The main crux of CEST is that it doesn't follow the same standards or case law as anybody else. The CEST tool is trying to oversimplify, in some instances, what is quite a complex area of employment status.

"60% would seek an alternative assessment to CEST. Only 4% trusted HMRC to stand by the tool's results, with just 5% saying they thought CEST was accurate."

IR35 Impact Survey via The Register

Technology to replace HMRC's CEST tool

The cost of IR35 reform has increased considerably, meaning businesses have to engage with companies like Kingsbridge and Worksome to navigate the new terrain and stay profitable in the competitive gig economy. The phoenix rising from the ashes is that technology like Worksome and insurance services like Kingsbridge have created such enhanced tech to work alongside enterprises' existing products, which greatly helps them cope with new reforms like IR35.

Certainly, Worksome tries to help businesses stop the haemorrhaging of money because many companies had set budgets beforehand and lost margins due to unexpected IR35 costs. This added cost often trickles down to the talent who are perfect for the job but now want more money.

Want more in-depth information? Read, "When you can't rely on CEST: How to stay IR35 compliant."

"426 Respondents surveyed said they had moved to permanent work due to IR35. 60% Said working inside IR35 was not financially viable, and 73% said they were worse off. 74% Said they would move back to contracting if they could secure outside IR35 contracts. 41% were out of work for 6-months or more following the roll-out."

The Freelance Informer

The benefit is that you've now got supply chains working much closer together, and agencies and recruiters are in tandem, working much closer now. Indeed, people are doing precisely what HMRC was hoping for; people have had to adapt and change their working practices to engage freelancers the way HMRC wants them to. The choice was either take on the added cost or change your working practices.

"In the EU, 68% of independent workers have chosen this route (working as contractors), and in the UK alone, 57% of independent workers are female."

The McKinsey Global Institute (MGI)

Are HMRC investigations happening? Is HMRC actively fining companies?

Question: I find that clients are successfully disguising agency workers under statements of work (SOW). Is there any evidence to date that HMRC is investigating companies? Validating or auditing compliance, and has HMRC given any fines to the private sector?

"There is a misconception that if you operate via a statement of work, you can mitigate many IR35 risks because the burden and financial implications will transfer to somebody else in the supply chain," says Dawson.

Thus, you have businesses that don't have much experience trying to use a statement of work as a workaround solution. They are simply packaging the supply of labour (SOL) as a statement of work. "But you can't do that because in HMRC's eyes, if it acts like an agency and places workers like an agency, it's an agency, and therefore HMRC is going to come after you find you at some point," says Dawson. “HMRC is conducting quite a broad compliance check. Part of that check is looking at the things businesses use to place and engage workers, including SOWs, umbrella companies, etcetera.”

"It's too early to see those fines in public. Typically, a new law comes into place, and HMRC will give 18 months to 2 years for it to set in. In the meantime, they will look for faults and cracks within the law, then they'll correct the faults, and will look to enforce it," explains Dawson. "In another six months, you will start to see fines and penalties for businesses that disguise agency workers under SOWs."

"If you were an SOL before and now are trying to be an SOW, what material change actually happened? Then ask, will HMRC buy that? Probably not."

Ray Walker, Contingent Workforce Compliance Director

The growing importance and need for a flexible workforce: Adapt or miss out on the best talent available

HMRC has given a lot more education to the private sector with things like the employment status manual, which is super useful. There are many webinars and content they put on to help businesses. Because of education, enterprises are changing their minds and saying, 'we want to hear about it.' They are ready to learn how to manage IR35 properly – giving them a fighting chance to work with skilled professionals who have embraced contingent work.

"Clearly, there is a need for flexible resources," says Dawson, and "it may prove to be more convenient and cost-efficient for organisations to take on contractors." Ultimately, the best contracting talent will continue to find roles outside of IR35, and businesses that don't want to engage with workers outside of IR35 are the ones who will miss out. Enterprises need freelancers' skills to operate their businesses, so they must get educated and continue to rely on valuable tools and services like Worksome and Kingsbridge.

Trusted by over 1,500 companies worldwide, Worksome is the new standard in external workforce management. We are helping you save time and money on your contracted workforce. Worksome clients can benefit from finding, contracting, and paying external workers in one click while optimising external workforce operations. We also indemnify IR35 worker classification.

Worksome is the proud winner of the Tiara Talent Tech Star Awards for best compliance solution where judges praised Worksome for vastly reducing the risk of exposure for large employers and removing freelancers' unnecessary stress, enabling them to begin projects faster. Book a demo with us today to see how we can help you get the IR35 essentials you need!