IR35 changes: how to handle existing contracts
8 January 2020

IR35 changes: how to handle existing contracts

With off-payroll working rules set to be extended to the UK private sector in April 2021, should end-clients be amending contracts, issuing new terms, or sticking with existing contracts? Ian Machray, partner at Field Seymour Parkes solicitors, assesses the options available to employers


Ian Machray

Ian Machray


Employment law


With off-payroll working rules set to be extended to the UK private sector in April 2021, should end-clients be amending contracts, issuing new terms, or sticking with existing contracts? Ian Machray, partner at Field Seymour Parkes solicitors, assesses the options available to employers

The extension of the off-payroll working rules (often referred to as ‘IR35’) to the private sector is due on 6 April 2021 (with an exclusion for small entities).

One issue that clients are still grappling with is how to manage existing contractual relationships with Personal Service Companies (PSCs) where there will be a deemed employment. Should they retain current terms, amend the contract, or terminate it and issue new terms? 

Out with the old, in with the new?

For a client making payments to a PSC under a pre-existing contract, where a deemed employment arises, they will be faced with a new obligation to deduct income tax and employee national insurance contributions (NICs) from payments to the PSC and will also have to pay 13.8% employer NICs and 0.5% apprenticeship levy.

This is likely to cause problems as contracts will have been negotiated on the basis that the worker and PSC take responsibility for income tax and NICs, and that the client would not be liable for employer NICs.

For a worker who had previously considered themselves self-employed, the deduction of payroll taxes may result in a significant reduction in profits for the PSC that would otherwise have been available to draw as dividends. Equally the client will have additional employer NICs costs to bear and they will be prohibited from deducting these from the payments owed to the PSC.

Businesses are most likely to resolve this issue by terminating existing contracts and entering into new contracts that reflect the transfer of the NICs liability through a reduction in the level of fees charged by the PSC, or encouraging a worker to abandon their PSC and provide services through an umbrella company, or by offering a fixed-term contract of employment. However, terminating an existing contractual relationship may not always be so straightforward. 

Termination troubles

The vast majority of PSC contracts will be linked to a short-term project or will be terminable by the client on short or no notice. In these circumstances, termination of the contract (provided the terms are adhered to) and offering re-engagement on new terms is unlikely to result in any breach of contract.

However, where the contract is of a longer duration with no provision for early termination or where the PSC/worker is crucial to an ongoing project, the position may be more problematic.

In an ideal world there would be early discussions between the client and the PSC concerning the off-payroll changes and any impact on the existing contract. A new contract or a revision to the existing contract could then be agreed in good time with the consent of both parties, avoiding the need for any dispute.

However, in the real world, such discussions may not be possible or an agreement may not be reached. If the business is unable to reach an agreement with the PSC, they may be tempted to just continue with the existing contract and make the legally required deductions and cover the additional NICs and apprenticeship levy costs.

While most historic contracts with PSCs will not include an express clause allowing for deductions for tax and NICs, the end client will still have a statutory obligation to make such deductions where there is deemed employment. The client is therefore likely to be able to argue that such statutory obligation legitimately overrules the express contractual terms and permits deductions from payments to the PSC.

However, this is not necessarily the end of the matter, as there may well be a dispute as to whether the deductions are actually required by law. It will be open for the PSC to argue that there is in fact no deemed employment, the status determination is flawed and therefore such deductions constitute a breach of the terms of the contract.

Even if the issue of deductions can be successfully resolved, this still leaves the client with an employer NICs liability which legally cannot be passed to or recouped from the PSC.  Accordingly, even if the client is able to continue with the current contract and justify deductions as a matter of law, this does not stop them from being hit with an additional employer NICs liability.

Furthermore, where the potential application of the rules from April 2021 may raise concerns about whether tax has been accounted for properly historically, renegotiating the contract may provide certainty and help draw a line between historical and future periods.

Accordingly, in the majority of cases, termination and re-engagement is likely to be the preferred option – but businesses still need to be aware of potential claims that may arise as a result, and understand how to handle situations where termination is not possible. 

New contracts

If you are going to issue new contracts to deemed employees it is important to ensure that these are well-drafted and reflect the nature of the relationship and the deductions that need to be made.

It may also be wise for contracts with PSCs that are currently deemed to be outside IR35 to include provisions allowing for deductions to be made and/or early termination in the event of any change in deemed employment status. It may also be wise to include a positive contractual duty to disclose information reasonably required by the client to determine if the PSC is within scope of IR35 and if the worker is deemed to be employed. 

Taking reasonable care

In addition to the above contractual issues, businesses have an obligation to take reasonable care when making a status determination for deemed employment. There is a disagreement process that enables the worker to challenge a status determination, and obliges the client to respond to such challenge within 45 days, either confirming its original ruling, stating its reasons for doing so, or reversing its original decision.

There are accordingly a number of potential issues with terminating and re-engaging PSC contracts where there is deemed employment and businesses should approach such issues carefully. It is also important to ensure that any new contracts are well drafted to avoid further IR35 issues in future.

This post was updated in March 2020 to reflect the delay of IR35 reform introductions to April 2021.

This article is for general information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from taking any action.