IR35 and off-payroll working – HMRC scrutiny continues at pace

IR35 only applies to workers supplying their services through a personal service company (“PSC”). Since April 2021/April 2017, the responsibility for status assessment and tax has fallen to medium and large businesses/public sector business (the ‘client’), and as a result, the client must:

• Determine if the worker would be an employee if contracted directly. If so, the worker is considered to be within IR35.
  
  
• Issue a Status Determination Statement (“SDS”) outlining the determination they reached to the PSC and relevant intermediaries, typically an employment agency.
  
  
• If inside IR35, the client, or agency if relevant, must deduct income tax, employee and employer NICs, and the apprenticeship levy (where applicable) from payments made to that worker. 

If the client fails to take “reasonable care” in issuing the SDS to the worker, then the client is liable for the tax that should have been deducted from payments to the worker (irrespective of whether the PSC is paid by an engaging employment agency). 

Prior to the introduction of IR35, businesses typically sought to de-risk themselves by reducing or eliminating the number of PSCs engaged in their supply chains and/or putting in place processes, including software solutions, to carry out the business’s new responsibilities under IR35. 

HMRC’s approach to taxpayers to date has varied, with contact being instigated through:

• Support offers with questionnaires.
• Targeted questions as part of broader employer review.
• General off-payroll working questionnaires.
• Enquiries about specific contractors as a result of targeted intelligence.

The risk with these initial generic queries is that they can escalate to more targeted scrutiny and businesses can sometimes underestimate the seriousness of these generic enquiries and respond without specialist input.

In practice we are seeing an increase in HMRC enquiries into businesses in respect of their off-payroll working arrangements and in particular, their IR35 compliance. We are finding that, following an HMRC enquiry, nearly all businesses will have some correction to make either to the tax that should have been paid or their processes. 

The most common areas where businesses can fall foul of the IR35 rules include:

• Over-reliance on contractual terms preventing the supply of PSCs by employment agencies and thereby not assessing agency-supplied contractors.
  
  
• Outsourcing determinations with limited oversight (the client must always ensure determinations and SDSs are properly issued).
  
  
• Not refreshing determinations for new or changed engagements.
  
  
• Insufficient onboarding time for status assessments.
  
  
• Misclassifying ‘fully contracted out’ services, leading to missed determinations.
  
  
• Over-reliance on software without quality input or oversight.
  
  
• Lack of management review and controls.
  
  
• Insufficient or outdated staff training.

Additionally, we are finding many businesses have not reviewed their systems and processes since the implementation of IR35 and have not paused to assess certain issues, for example: 

• The overall number of PSC workers deemed to be inside and outside of IR35, does the ratio make sense or does the ratio require some further examination? 
  
  
• When were the working practices of employment agencies in supply chains last reviewed?
  
  
• For individuals completing SDSs, whether through HMRC’s Check Employment Status for Tax (CEST) tool or through third-party software, are they being influenced (perhaps unconsciously) by an expected outcome?

Importantly for businesses, taking reasonable care requires ongoing vigilance typically across several business functions. 

Looking forward, businesses are likely to be impacted by the new umbrella company PAYE reforms from April 2026 which will make employment agencies or end clients joint and severally liable for any amount required to be accounted for under PAYE provisions where an umbrella company forms part of a labour supply chain. Businesses could be impacted by the potential changes to contract supply chains as a result of the new legislation. Further, the new Fair Work Agency, will be established in April 2026.  It will be a single enforcement body for employment rights bringing together the work of existing state enforcement bodies to oversee compliance with, among other things, the national minimum wage.  Businesses will need to consider how they engage contractors and there will be an increased need to ensure compliance ahead of the Fair Work Agency becoming operational.

With HMRC’s focus on IR35 continuing, large businesses are particularly exposed to risk due to complex contractor arrangements. There is no standard pattern to HMRC’s enquiries, which can escalate from generic to highly targeted. Effective risk management demands robust, documented procedures and a proactive, collaborative approach across business functions. Businesses therefore may wish to:

• Seek specialist advice at the earliest stage of any HMRC contact.
  
  
• Ensure compliance processes are regularly reviewed to ensure they meet the ‘reasonable care’ standard and withstand regulatory scrutiny.
  
  
• Take care when using third parties/agencies in the supply chain and ensure any third party’s compliance is thorough to minimise any potential tax liability and ensure that the SDSs are provided and reviewed.
  
  
• Ensure any/all staff who conduct SDSs are fully trained. We have found many instances where an individual in a business’ tax team has carried out a status determination but has not been provided with the full information resulting in an incorrect determination.  Consider appropriate supervision.
  
  
• Be wary of how roles are advertised as these can set expectations of workers.  
  
  
• Provide regular, updated training for all staff involved in contractor onboarding and IR35 compliance.
  
  
• Audit and refresh determinations and processes regularly, especially after organisational changes.
  
  
• Audit and review the working practices of any employment agencies in supply chains.