Why CEST is the worst IR35 determination tool out there

Many clients we work with first turned to HMRC’s Check Employment Status for Tax (CEST) tool after changes were made to the off-payroll working rules.

If you’ve been given the responsibility for determining IR35 status for off-payroll workers in your company and you want to know if you should use CEST to check employment status, welcome. We’ve written this article especially for you.

In the next 2-3 minutes, we’ll cover:

A reminder of what IR35 is and the value of contractors
The CEST tool and why you shouldn’t use it
Why you need human involvement in determining employment status

To speak to the IR35 determination for employers specialists, please call CoComply on +44 (0) 203 051 9792, email hello@cocomply.co.uk or fill out the form below.

Self-employment, contractors and IR35? A quick primer on why it’s better for all to be “outside IR35”

IR35 is how HMRC determine employment status for tax purposes.

If a contractor is deemed to be inside IR35, the working arrangement they have with your company resembles that of someone in employment.

If a contractor is outside IR35, they have a lot more independence over how they do the work you’ve hired them for meaning that HMRC would consider them in self-employment.

The tax system incentivises companies and public sector bodies to choose contractors over employees.

As a hiring manager, you may have had pressure put on your before by colleagues to hire contractors to keep projects within a certain budget. We understand that, since the rule changes, you may now be under pressure to declare all contingent workers outside IR35.

Why contracting makes financial sense for your organisation

Using temporary contractors is often more expensive than paying someone to do the same work as a full-time employee. But what makes it worthwhile for an employer is that the type of work contractors do is often very specialist and needed for a limited time only.

You might need a contractor to make a one-time change to your business. An example might be taking on a contractor with technical expertise to tie together different apps and programs to make a CRM or an ERP system. After the work is done, you have no further need for their service except perhaps in a maintenance role.

It could be that you’ve opened a new part of your business and turnover doesn’t yet justify taking on a full-time member of staff. Until you reach that point, using contractors makes more sense commercially.

Contractors give employers the flexibility to experiment, improve performance, introduce new products and services and a lot more.

Why being outside IR35 makes sense for contractors and clients like your organisation

When someone leaves the world of full-time salaried employment to become a contractor, there is a big financial risk on their part. They leave a predictable, stable monthly salary behind every month when they become self-employed.

Traditionally, the tax system rewards self-employed company directors for the risk involved in starting a company. This is in recognition of the fact that they walk away from the safety of employment law, sick pay, holiday pay, parental pay and more.

Contractors need to maximise income from every assignment because work is not guaranteed for them. Over the last 20+ years, they became experts at navigating the IR35 system and making sure their roles were outside IR35.

They took full legal and financial advantage of their employment status and HMRC did not like this one little bit.

So they switched the responsibility of declaring employment status away from experienced contractors to often inexperienced, senior HR, procurement and finance managers. Their gamble was that the lack of confidence these managers felt would push them to declare all contract work within IR35 to protect themselves from the large fines that would result in getting it wrong.

They were right but this presents companies willing to work with IR35 experts an opportunity to poach the best contractors by creating an outside IR35 environment.

What’s so bad about being inside IR35?

Contractors outside IR35 invoice your company for services provided. They bill you via their own limited company (sometimes called a personal service company). They are wholly responsible for dealing with their own tax affairs.

Contractors inside IR35 have income tax and National Insurance contributions deducted from their invoices at source and at the same rate as full-time employees. If they are employed via an umbrella company, they also have to pay employer National Insurance contributions.

Contractors outside IR35 pay Corporation Tax. They normally pay themselves the annual allowance in salary and the rest in dividends. The amount they pay in tax overall is often much less than the tax paid by employees. When a contractor is outside IR35, your company or organisation does not pay employer National Insurance contributions which saves you the 15.05% you would have to pay on top of their gross salary.

It makes financial sense for you and your off-payroll workers to operate outside IR35.

HMRC’s Check Employment Status for Tax (CEST) tool

Public bodies and private sector businesses often use HMRC’s CEST tool for employment status determinations prior to a contractor starting work.

There are a number of big problems with HMRC’s tax tool, the major ones of which are:

It’s hopeless with borderline tests. In one out of five cases where there is a minor degree of complexity, CEST is unable to determine IR35 status.
Mutuality of obligation is not considered. The assumption is that it exists in all contracts even though when cases reach the First Tier Tribunal, they do consider it as a factor.
HMRC doesn’t stand by the test even though they claim otherwise. If they disagree with the assessment made by the tool, then they claim that you filled in it wrongly.
HMRC does not record the tests. Nor does it provide a print-out of a test showing how you answered the questions to get the result you arrived at. You need to keep paper or digital copies of each CEST test to prove that you took them.
Assumption of knowledge. IR35 guidelines are over 500 pages long and that doesn’t include the considerable body of case law that’s been growing since 1999. It’s very hard to make a test based on multiple choice reflect that level of detail and it’s another to assume that an inexperienced user of the CEST tool truly understands the precise meaning of every question.
The source code is buggy. The latest release of/upgrade to CEST in November 2019 did not fix the fundamental flaws in the prior version.

The best IR35 determination tool is an experienced professional

When you engage contractors, it’s fine to use CEST as an indicative tool only. We strongly recommend that you never base a status determination statement on CEST.

Instead, focus on creating a contractor-friendly, outside-IR35 environment across your business.

We understand the pressures put on HR, finance and procurement leads to get IR35 right. What’s important to remember is that how HMRC defines self-employment has not changed – all that has changed is who is responsible for determining it.

For a compliance first approach to IR35 stretching from before a contractor engagement begins, please contact us at your earliest convenience.