Since 6 April 2021 private sector employers, apart from small businesses as defined in The Companies Act 2006, are now responsible for deciding whether or not the contractors they use are de facto employees and therefore if PAYE and NIC deductions should be made from payments to them.
However, with any new set of tax rules there are pitfalls for the unwary and engagers could be building up large tax arrears if they make mistakes.
Here are the top five pitfalls to avoid when it comes to IR35:
Be careful: Businesses need to be be careful when dealing with IR35
1. Not identifying all relevant contractors
It is vital to remember that if you are the end user of a contractor’s labour, and that contractor uses a personal services intermediary to engage with you, then you are the organisation responsible for making the 'status determination' and deciding if PAYE and NIC should be deducted from the payments for those services.
This applies even if you use a worker provided by an external agency.
So engagers should be tracking all the invoices they receive to identify the contractors they use, either directly or provided through an agency, and testing each contract involving labour services.
2. A policy vacuum
Having a clearly documented policy on how your business will deal with contractors makes it much easier to ensure that the correct procedures for off-payroll labour are followed and that all parties (even your regular contractors) know the rules.
Even if you do make mistakes on individual contracts, being able to explain to HMRC what your business’s policy is will help to demonstrate that you intended to use reasonable care in your assessments and process.
Get proactive: Inaction will result in practical difficulties when it comes to IR35
Remember that your policy should align with your policies on minimising tax risks (for example your policies to safeguard against committing a Corporate Criminal Office through facilitating tax fraud).
3. Poor internal communication
Even if your HR and finance teams are up to speed on dealing with contractors under the off-payroll rules, other parts of your business may have traditionally engaged contractors locally - with limited paperwork reaching central teams.
So it is vital to educate people across your whole business as to how all contractors should be dealt with and who should be involved in the process to protect the firm.
4. Mistakes with status determinations
Deciding whether or not a contractor should be treated as a de facto employee for tax purposes is not straightforward even if you use HMRC’s CEST tool.
If you don’t have the right data to use the CEST tool or answer the questions incorrectly, you may get the wrong answer: in more complicated cases, the CEST tool often cannot provide an answer anyway.
If there is any doubt over the status of a particular contract you should take expert advice to make sure you deal with payments for the contractor’s services correctly.
5. Ad hoc payment processes
Not having a consistent process for paying contractors who are deemed to be employees will inevitably lead to mistakes and possibly incorrect tax and NIC payments.
The most sensible approach is to pay all contractors deemed to be employees through the payroll and those outside IR35 through Accounts payable.
It is also important to have clear processes for payment of expenses and materials so that the correct VAT treatment can be applied. It is important to note, however, that unless all the circumstances of an engagement are genuinely identical, HMRC are unlikely to view blanket determinations as demonstrating that reasonable care has been taken.
Ultimately, inaction will result in practical difficulties, but while the new IR35 rules have become effective, it is not too late to improve your processes to ensure that you are in the best position to operate the IR35 rules correctly.
Caroline Harwood is an Employment Tax partner at accountancy and business advisory firm BDO. She has over 25 years' experience specialising in all aspects of employment taxes as well as the design, drafting and implementation of all forms of share plans and incentives.