How to take the private sector IR35 reforms in your stride – Criteria 3: Financial Risk

Do you know how you’re going to respond to the changes to IR35 that are coming in April 2020?

We speak to many clients who aren't clear on what these changes are or what they mean for their businesses.

like our clients, you may be concerned about what it means for you and whether you will be able to continue to use contractors after April 2020.

The good news is that done properly you can still use contractors compliantly outside of IR35, you just need to make the necessary changes to ensure your business is set up to do so.

To help you with this we created a detailed guide which walks you through what the changes are and what you need to do to comply with them. You can download it here.

To make our guide even easier to absorb we’ve broken our key guidance in to a series of blogs which walk you through each of HMRC’s four key criteria for assessing IR35 compliance and what you need to do to ensure you can continue to use contractors as you do today.

Today’s blog is on the third key criteria – Financial Risk

What is Financial Risk?

Running a business is riskier than being employed. So in HMRC’s eyes, contractors that are exposed to more financial risk are more likely to be operating outside of IR35.

This criteria often isn’t as clear cut as the contractor being able to provide a substitute, or demonstrating self-direction, even though it’s one of the key areas that HMRC look at.

But there are still several ways you can assess whether a contractor is complying with this criteria based on the financial risks they carry:

  • Fixing errors – If a contractor in a role designated as outside of IR35 doesn’t deliver the services to the required standard, they’d be expected to correct this in their own time and at their own expense.
  • Training & Development – To maintain the level of expertise and skill needed for roles outside of IR35, contractors are expected to invest in training to keep their skills current at their own expense.
  • Equipment – Contractors acting outside of IR35 are expected to provide their own equipment at their own expense, such as laptops containing all the necessary software to complete their work.
  • Furloughs - There are times when your business doesn’t want contractors in the office as there’s little work for them to do (e.g. Christmas). Those operating outside of IR35 should be expected to take this time off unpaid.

If the contractors that you have delivering roles outside of IR35 carry some or all of these risks, it’s a good indication they’re operating correctly in line with HMRC’s expectations.

What companies get wrong with Financial Risk?

There’s a reason they’re called Independent Contractors – they’re expected to work independently. That includes using all their own equipment when undertaking a contract.

A big error we see companies making is when on-boarding new contractors, where they provide the contractor with the same equipment a new employee would get, removing any financial risk.

Another is when a delivery outcome isn’t achieved by a contractor. Having the work corrected should strictly be done at the contractor’s expense. But many firms overlook this and pay extra for amends to be made. In the realm of IR35, this lack of financial risk puts the contractor on a par with employees and more likely to be seen as inside of IR35.

When you have a role requiring an independent contractor, it’s often quicker to bring a contractor into your workplace to mingle with your team, use your equipment, and work just like everybody else.

But the danger of bringing contractors in on this ‘Business as Usual’ basis is that you’ll move the role to being in scope of IR35 and incur unnecessary expenses for expensive equipment and everyday stationery at the same time.

What do you need to do to comply?

For the April 2020 deadline, start by reviewing your contractor roles for equipment and stationery needs. Undertake an audit of your current contractors and only those roles that require equipment for special reasons - such as a computer for data / network security - should continue as they do now. For all other roles, let your contractors and their engagement managers know that this will be changing.

You should also amend your contracts to be clear that contractors undertaking roles outside of IR35 must remedy any substandard work at their own cost. Clarify that the contractor is responsible for correcting any errors they make, and that it won’t affect the agreed fee. Managers engaging contractors outside of IR35 should be aware and request this too, keep records of any poor performance to evidence this.

Lastly, if you don’t do it already, consider using furloughs to give you an extra level of protection and demonstrate that your contractors are indeed incurring financial risk.

Once you understand Financial Risk, the last criteria is Part & Parcel and you can read about this in our next and final blog of this series.

If you want to get our full guide on what you need to do to ensure you are ready for the April 2020 IR35 changes then click here to download it today.