‘Employing’ freelance lawyers

Tax law reforms, to be implemented in 2020, have particular implications for law firms as employers.

An increased reliance on technology in the way legal services are delivered has undoubtedly made it easier for lawyers wanting to make the move from employment to self-employment, and has contributed to the surge in the number of freelance lawyers currently working in the UK.

Background

The IR35 legislation (IR35) was introduced in 2000 with the principal aim of removing the tax advantages for individuals providing their services via intermediaries (such as their own personal service companies) who are not genuinely self-employed. These so-called ‘disguised employees’ work in the same way as employees but pay less tax.

Despite various amendments to IR35 over the years, successive governments have claimed that many contractors are still illegitimately deeming themselves as being outside IR35 rules, and thereby reducing tax and social security liabilities. The government hopes that the introduction of the new ‘off payroll’ rules for contractors working in the public sector in 2017, and the extension of these rules into the private sector from April 2020, will address this issue.

Given the recent growth in the number of self-employed lawyers, the April 2020 reforms to IR35 are likely to have an appreciable impact on the legal profession.

Controversial reforms

From April 2020, medium and large private sector businesses will be responsible for determining the IR35 status of their contracted workers, rather than contractors being responsible for determining this themselves. Where a contractor is deemed by the business to fall ‘inside’ IR35, the business (or the agency or third party paying the contractor) is required to deduct employees’ NICs and income tax from the contractor’s pay, and to pay employers’ NICs.

Only ‘small’ businesses will be exempt from the new rules. The definition of ‘small’ business for the purposes of the new rules has yet to be determined but the government has indicated that it intends to use similar criteria to those found in the Companies Act 2006. This suggests that a ‘small’ business would be one that satisfies at least two of the following conditions in the relevant year: (i) turnover of not more than £10.2m; (ii) aggregate assets on the balance sheet of not more than £5.1m; and (iii) not more than 50 employees.

As above, the April 2020 changes are an extension of the same reforms which were introduced into the public sector in April 2017. The public sector reforms have been heavily criticised by numerous industry bodies in light of the widespread issues associated with their rollout. Many of the reported issues have related to the accuracy (or inaccuracy) of the online ‘CEST’ (Check Employment Status for Tax) tool launched by HMRC – essentially, a series of questions which, when completed, gives a determination as to whether an engagement is considered to be ‘inside’ or ‘outside’ IR35. CEST has been widely criticised as not properly taking into account the specific issues that arise from this form of work and for being biased towards a finding that IR35 does apply (or, in many cases, failing to produce any answer at all, meaning that businesses have still had to determine the contractor’s IR35 status using normal employment status tests). Another criticism of the public sector changes is the speed at which they were introduced. As organisations had little time to prepare, many applied a ‘blanket’ approach of assessing all contractors as falling inside IR35 irrespective of their true employment status.

Introducing the same rules into the private sector could result in similar issues and will undoubtedly result in a significant administrative burden and additional costs for those firms caught by the new rules. We understand that while CEST will be available for private sector businesses to use, HMRC will be carrying out a review of the tool to improve its operation and effectiveness in advance of April 2020. How long in advance it will be updated, and how it will be made fit for purpose, remain to be seen.

Preparing for the new rules

Based on the likely definition of ‘small’ business, we expect that some of the larger dispersed firms and interim legal providers will be caught by the new rules. Those likely to be caught should take steps to prepare for the new rules as soon as possible.

Although finer details of the new rules will not be confirmed until draft legislation is published (which is expected to be some time during summer 2019), key considerations for businesses are likely to include the following:

(i) Existing contracts with personal service companies that are likely to still be in place by April 2020 should be identified and reviewed. Where IR35 is likely to apply, consideration should be given as to who should bear the additional associated costs. This may, for example, depend on the importance of the freelance lawyer to the business and the changes required to relevant contracts.

(ii) Robust procedures will need to be in place and relevant staff trained on the rules in readiness for April 2020 to assist in assessing each lawyer’s true IR35 status.

(iii) Internal systems will need to be reviewed to ensure they can cope with the changes. Payroll and accounts payable systems will need to be assessed to ensure they are able to communicate with each other, and HR and on-boarding policies may need to be updated.

(iv) The cost of engaging freelance lawyers is likely to increase (it is estimated that the annual hire cost of a contractor in the private sector will increase by about 12%). This is because increases in daily or hourly rates are likely to be requested to compensate for the impact of tax and NIC being deducted at source. As a result, some businesses may wish to reconsider (and potentially reduce) their reliance on freelance lawyers engaged via personal service companies, and instead look to engage them directly and be subject to PAYE.

Chris Tutton is a partner at Synchrony Law Limited, London