New tax guidance encourages large businesses to comply with the CEST determination – HMRC's tool for checking employment status. This article looks at HMRC's approach.

Since April 2021 large and medium sized businesses in the private sector which engage contractors who are supplying their labour via their intermediary (such as a personal services company) are required to determine the status of those contractors for the purposes of IR35. Businesses must determine whether the contractor is a "disguised employee" i.e. whether the contractor would be an employee of the business if they were hired directly. If the contractor is a disguised employee (and so inside IR35) the entity which has the direct contractual relationship with the contractor's intermediary must operate PAYE and NICs on the fees it pays to the intermediary.

Determining whether an individual is a disguised employee is notoriously difficult. The business must apply a complex multi-factorial test derived from (often inconsistent) case law. Key factors to consider include whether the contractor: (i) is subject to control; (ii) has an unfettered right of substitution; (iii) is integrated into the engager's business; and (iv) is carrying on business on their own account. In addition, consideration should be given as to whether there is mutuality of obligation between the contractor and the engager.

Using CEST to determine status

Recognising the difficulty in determining status, HMRC provides a "Check Employment Status Tool" (CEST) which businesses may use to determine the status of a contractor, whether the contractor is providing their labour via their intermediary or as a sole trader. Businesses are not obliged to use CEST but an advantage of doing so is that HMRC will honour the CEST result provided that the CEST questions have been answered correctly and in accordance with HMRC guidance.

There is a concern that CEST is too blunt an instrument to determine status accurately - for example CEST does not consider mutuality of obligation during the contract term and, in certain circumstances, this may make it more likely that the CEST will produce an "inside IR35" determination. In the light of this, many businesses may use CEST as a starting point but if the result seems surprising on the facts the business may chose to ignore the CEST output and use other methods to determine the contractor's status.

Change in Uncertain Tax Treatments guidance

Going forward those large businesses which are subject to the Uncertain Tax Treatments (UTT) rules (see below) may need to think carefully before using CEST, particularly if CEST is being used to determine the status of a number of contractors operating under the same terms.

The UTT rules, which were introduced with effect from 1 April 2022, require large business (i.e. companies or partnerships which either alone or when aggregated with their group have a UK turnover above £200m and/or a UK balance sheet total of over £2bn) to notify HMRC if: (i) the business has interpreted the law in a way which is different from HMRC's "known position"; and (ii) the tax/NICs advantage as a result of the businesses interpretation is expected to be more than £5m in a 12 month period.

HMRC has recently amended its UTT guidance to make it clear that CEST outputs indicating that a contractor is within IR35 or outside IR35 constitute HMRC's "known position".

This means that if a large business uses CEST to determine status; the CEST output indicates that the contractor(s) are inside IR35; the business chooses to ignore this and use a different method for determining status which indicates the contractor is outside IR35, an obligation to notify HRMC may arise. In practice, given the £5m threshold, the notification obligation is unlikely to arise unless the business is using CEST to assess the status of a group of contactors operating under the same terms and conditions.

Even if the circumstances in which the strict UTT rules will apply are relatively limited, however, the UTT and the change to HMRC's guidance is of more general interest. It shows both HMRC's willingness to challenge a status determination not in accordance with the CEST result and how HMRC will increasingly require taxpayers to be transparent in their dealings with HMRC and to disclose potential issues rather than waiting for HMRC to discover those issues on a future PAYE/NICs audit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.