How can Oil & Gas companies manage rapidly approaching tax reform?

Words, Nicole Slowey, Operations Director of Qdos, an IR35 specialist and insurance company

Oil & Gas companies now have less than six months to make sure they’re ready for tax reforms which will change the way they engage contract workers and the financial risks associated when doing so.

On 6th April 2020, reform to the IR35 legislation will see medium and large private sector businesses become responsible for determining the tax status of the contractors they engage. As part of these changes, whichever party pays the contract worker - whether the business itself or the recruitment agency placing the contractor - will be financially liable for any mistakes.

Until then, as was the case in the public sector until 2017, contractors will continue to determine their own IR35 status and will also carry the can financially should HMRC launch an IR35 investigation and conclude they have incorrectly set their tax status.

What is IR35?

If you’re still unsure about what the IR35 legislation is, I’ll explain. The IR35 rules, also often referred to as the ‘off-payroll working rules’, were introduced in 2000 to prevent contractors who operate through their own limited company working as ‘disguised employees.’

In simple terms, ‘disguised employment’ occurs when a contractor’s working engagement reflects employment, meaning they should effectively be taxed as an employee and not be allowed to pay themselves with greater tax efficiency through their own limited company, which is also known as a personal service company.

Ultimately, if a contractor belongs outside IR35, the service they provide needs to be a genuine business to business engagement - in other words, not an employer-employee relationship. If the nature of the contract reflects employment, in HMRC’s eyes, the contractor should work inside IR35, where they are considered as an ‘employee for tax purposes.’

How will IR35 reform work in practice?

Given IR35 is a notoriously complex tax legislation, perhaps it might help if I put things into context and describe a typical scenario that a company engaging a contractor is likely to face when reform arrives.

Let’s say you engage a specialist Oil & Gas contractor who works through their own limited company. Under the incoming reform, you (as the contractor’s client) will be in charge of setting the contractor’s IR35 status. In other words, you must decide if the contractor delivers their service as a self-employed individual or in a manner similar to an employee.

If you’re confident the contractor is genuinely self-employed, the worker should be set to outside IR35, where they can operate with greater tax efficiency, like any other small business owner.

However, if you’re confident the relationship bears the hallmarks of employment, the contractor should be placed inside IR35 - where the fee-paying party (you or the recruiter) will be responsible for deducting the appropriate amount of income tax and National Insurance Contributions from their salary before paying this directly to HMRC.

Similar to employees, employer’s National Insurance Contributions must also be paid to HMRC on behalf of any contractors working inside IR35.

How is IR35 assessed in the Oil & Gas sector?

There are three key considerations when determining a contractor’s IR35 status. These are: Control, Personal Service and Mutuality of Obligation. The Oil & Gas sector, for obvious reasons, is highly regulated, which means applying these tests in practice isn’t always cut and dried.

Take Control, for example. Most Oil & Gas contractors provide specialist skills and have a great deal of experience and knowledge of their profession. This is why, in many cases, despite the numerous safety regulations that must be adhered to, contractors tend to have autonomy over their work, with the client not usually exercising control over how they provide their services. Consequently, in this example, Control is unlikely to be a decisive factor, as it is in other industries.

Similarly, because of the need for niche skills and for contractors to be qualified and fully validated by the client, as well as the logistics of offshore work, it’s rarely practical or safe to allow the worker to provide a substitute. This means quite often, the contractor will provide a Personal Service - which is usually a pointer towards an inside IR35 engagement.

That said, Mutuality of Obligation (MoO), which is when there is an obligation for the client to provide work and for the worker to accept it, is rarely present in Oil & Gas engagements. Due to fluctuations in activity, contractors are engaged as and when, to help Oil & Gas companies cope with peaks and troughs in demand. Consequently, contractors will tend to have short notice periods and will not have any guarantee of continuous work. HMRC, however, takes a very restrictive view on this test, to the extent where it doesn’t feature in their CEST tool - something we are seeing being challenged successfully in IR35 Tribunal cases.

In the above examples, you might have noticed I say ‘tend to’, ‘unlikely’ and ‘often’. This is because there is no one rule for every contract. IR35 is complicated and it’s vital that status is assessed by standing back and taking into account the entire picture.

How are Oil & Gas companies reacting?

Refreshingly, a number of Oil & Gas companies are taking IR35 reform seriously and - unlike several banks - do not seem to be planning on stopping engaging contractors as a result of the incoming changes.

At Qdos, we are working with a number of leading Oil & Gas operators, service companies, and specialist recruitment agencies, helping them prepare for the arrival of IR35 changes next year.

We are advising them to assess every contractor’s IR35 status on a case-by-case basis and to prioritise accurate IR35 determinations, meaning contractors will want to continue working with these organisations. By resisting an unnecessary risk-averse approach to IR35 reform, these businesses will also be well-placed to minimise the risk they might carry as the fee-payer.

In giving contractors the opportunity to work outside IR35 beyond April 2020, these organisations will reap the financial benefits of compliantly engaging genuine contractors outside the legislation. They will also continue to enjoy the skills and flexibility these workers offer.

What must Oil & Gas companies avoid?

On the face of it, placing all contractors inside IR35 might look like the simplest and safest response to reform. But in reality, it poses a far greater risk to Oil & Gas companies. Blanket assessments - when every contractor is deemed inside IR35 irrespective of their contractual details - are not compliant and, more to the point, will deter contractors who simply want a shot at having their tax status assessed fairly.

Blanketing aside, relying on HMRC’s much-maligned IR35 tool, CEST, is also unwise. Having been dismissed in numerous IR35 court cases and given it ignores key aspects of the IR35 legislation, including Mutuality of Obligation which, as described above, is an important test for workers in the sector, determining a contractor’s tax status based on information provided by CEST poses a risk not only to contractors but their clients and the fee-paying party in the supply chain.

Expanding on this, CEST also relies heavily on the right a contractor has to provide a substitute. If it hasn’t been agreed in the contract that the worker can sub in another contractor then it’s likely that CEST will consider them inside IR35. However, in reality, a contract shouldn’t be decided on substitution alone, particularly in the Oil & Gas industry where substitution isn’t so simple.

IR35 status must look at the bigger picture of the working arrangement, taking into consideration the nuances of the industry, which CEST does not allow for.

Overall, Oil & Gas companies must learn from the mistakes that public sector companies made following the introduction of initial reform two years ago. Along with blanketing and an over-reliance on CEST, public sector organisations weren’t ready for the arrival of changes. This resulted in knee-jerk, panicked and incorrect IR35 determinations across the board.

How should you prepare for IR35 reform?

So if we’ve established that scrapping contractors and forcing them onto the payroll is unnecessary, expensive and will jeopardise the completion of business-critical projects, how should Oil & Gas companies go about getting ready for IR35 reform?

Here are a few pointers to get you started, should you not have already kicked off the process...

1. Assess the impact of IR35 reform: consider how changes affect the contractors you engage who work on projects key to the success of your business.
2. Communicate with contractors: reassure independent workers you will conduct in-depth IR35 reviews to ensure accurate IR35 assessments.
3. Consider your method: will you rely on HMRC’s controversial IR35 tool, CEST? Will you engage the help of a specialist to conduct independent IR35 status reviews that can be supported with IR35 insurance?
4. Put processes in place: ensure your HR team relays information to the finance department or fee-paying party, to ensure appropriate tax deductions are made on ‘inside IR35’ contracts.
5. Get to work: with 6th April 2020 looming, Oil & Gas companies must ensure they are ready well before this date.

Perhaps the key takeaway from this article is that IR35 reform can be managed. With the right approach and prioritising accurate IR35 decisions supported by insurance, Oil & Gas companies - that rely on contractors for their specialist niche skills and flexibility - will be in a position to continue engaging them compliantly outside IR35 and, at the same time, protect any liability they might carry.