UK Off payroll working rules (IR35) – areas of focus for Heads of Internal Audit

The off-payroll working rules (IR35) aim to ensure that individuals who work like employees pay generally the same employment taxation as employees - even if they work through an intermediary such as another individual, partnership, unincorporated association or a company. The rules place the responsibility upon the entity receiving the individual’s services (referred to in the rules as the “client” or “end engager”) to determine whether the individual would have been regarded as an employee for income tax and national insurance contributions if they had been engaged directly. In addition, the client is responsible for accounting for and paying the relevant employment taxes for individuals that fall inside IR35 to HMRC. Previously these responsibilities rested with the individual.

These rules have applied to private sector companies and charities since April 2021 and public sector entities since April 2017. During Autumn 2022, it was announced that the rules would be abolished for the private sector. However, this was reversed shortly afterwards and private sector companies and charities caught by the rules remain obliged to meet their requirements.

What are the requirements for private sector entities?

The rules apply to all medium and large private sector entities and charities that meet two of the following conditions:

Annual net turnover is greater than £10.2 million (turnover after consolidation adjustments and excluding donations and other voluntary income)
Balance sheet net total (total assets) greater than £5.1 million
Monthly average of more than 50 employees.

This also includes overseas entities with a UK branch or subsidiary. Such companies must start applying the rules from the start of the tax year following the end of the calendar year that they begin to meet the above conditions.

The rules require that for each worker that operates through an intermediary (including agency staff) the client must prepare a documented employment status assessment. Employment status can be inside IR35 (to be treated as an employee for employment taxation purposes) or outside IR35 (to be treated as self-employed).

Following the assessment the conclusion is to be communicated through a Status Determination Statement (SDS) that must be passed to the worker and the end engager. An appeal process also needs to be established, permitting the worker or the intermediary to challenge the determination.

HMRC is increasingly looking at this area through its employer compliance audits. Failure to follow the requirements of the rules could result in a settlement with HMRC including unpaid PAYE/NIC, interest on the underpayment, under-deducted auto-enrolment pension contributions and penalties. Several of the early settlements with public sector entities amounted to over £10 million.

In addition, there could be claims by individuals for entitlement to employment rights and protracted enquiries with HMRC. Corporate Criminal Offences obligations also potentially exist. Failure to comply with these could lead to criminal convictions and unlimited fines. For the largest organisations, businesses falling within the Senior Accounting Officer (SAO) obligations could necessitate qualifying an SAO statement, a personal fine for the SAO or potentially court proceedings.

How should businesses approach this?

HMRC expects that entities will exercise reasonable care in performing these assessments. A structured and methodical approach should therefore be adopted for identifying individuals that could be potentially deemed to be employed and for conducting the assessment of their employment status.

The primary data source is the purchase ledger – since this provides the record of supplier invoices received by the business from agencies and intermediaries and the main mechanism through which individuals can seek to receive payments for services outside the payroll process. Only those suppliers that provide labour services require consideration.

The main documentation source for the assessment will be the contractual agreement between the business and the supplier of labour services. Typical indicators that an individual should be treated as an employee for employment taxation purposes are summarised below:

IR35 KEY INDICATORS OF EMPLOYEE STATUS
Personal service	The contractor is required to provide a personal service and is not permitted to provide a substitute or subcontract the work
Control	The client has contractual right of control over the work, what will be done, how, when and where it will be done
Mutuality of obligation	The client has an obligation to provide the work and the contractor has an obligation to perform it
Nature and length of engagement	The contractor is engaged on a permanent basis rather than for a single discrete piece of work
Exclusive service	The contractor is restricted from working for others
Financial risk and pay	The client bears the financial risk of the work
Integration	The contractor is or becomes integrated within the client’s organisation e.g. has line management responsibilities, enjoys the same benefits as permanent employees
Office holder	The contractor is appointed as an office holder (appointed to a post to which he or she can vacate and a successor can be appointed) e.g. a director

The assessment needs to identify and consider the whole labour supply chain for the individual and demonstrate an understanding of how the relationship works in practice, looking beyond the wording of the contract. The labour supply chain is not always straightforward. A common scenario is that a company engages with an agency to appoint an individual. The agency in turn engages with a personal service company (PSC) through which the individual provides services. However, more complex scenarios can arise involving more than one agency, umbrella companies or cross-border activities.

To support businesses, HMRC has provided a Check Employment Status for Tax (CEST) tool. Although this is helpful, it needs to be completed with care. If incomplete or inaccurate data is included, the derived assessment may be incorrect. For some individuals, more evaluation is required than the tool alone provides and specialist advice may be needed. In all cases, sufficient records need to be retained to show how the assessment decision was reached.

The SDS should set out all of these considerations in writing: the overall assessment, the labour supply chain, the reasons for the assessment and the appeal process (including a commitment to respond within 45 days). Where there are changes to an individual’s terms, a new assessment needs to be performed.

Although central functions such as Finance and HR will play a key role in establishing and overseeing the approach of the business, in practice the assessment activity may be outsourced or undertaken by a budget holder or manager within the business. Robust quality assurance mechanisms therefore need to be established to ensure that assessors have sufficient training and guidance and to check that they are complying with the requirements.

Areas of focus for Heads of Internal Audit

In view of the potential penalties arising, Heads of Internal Audit should consider providing assurance in respect of this area with a focus on the quality of the assessments performed and communication of the SDS.

Since much of the assessment work and communication of the outcomes is likely to be undertaken by managers within the business (or even outsourced to third parties) clear policies, procedures and guidance needs to be in place for them to follow, supported by training and access to technical advice. Although the CEST tool provided by HMRC is useful, judgement is required for complex assessments and sufficient evidence must be retained to support the conclusion.

Systems and processes need to capture sufficient information to identify all individuals that require an assessment, to document the totality of the labour supply chain relevant to their engagement and to highlight when there have been any changes to their terms and conditions and a new assessment of their employment status is required. Procurement processes may require amendment to ensure that this takes place.

For businesses with a global workforce, more extensive assessment procedures may be required to take the residency status of individuals/ end engagers into account and to determine whether the services were provided outside the UK. Local country taxation regimes may also need to be considered, since these could include legislation similar to IR35. Such matters could be complex and it is important that the business has sought appropriate advice in this area.

The business may have established a quality assurance regime to check that its procedures are being followed. Compliance checking that is undertaken needs to cover a sufficient proportion of the total number of assessments and also ensure that complex cases are being dealt with appropriately. In the event that this is not being performed by management, internal audit may consider selecting a sample of assessments to check compliance with procedures as part of its review work.

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