Following the introduction of changes to the public sector IR35 rules that apply to consultants providing services through a personal services company, similar rules are due to come into force for the private sector in April 2020. Businesses need to start thinking now about auditing their workforce and ensuring that appropriate indemnities and warranties are in place in contractual arrangements.
What is IR35?
The IR35 rules, or Intermediaries Legislation, aim to remove the tax advantages of providing services via a limited company for individuals who are not truly in business on their own account. These rules mean that if an individual is acting like the employee of a business, but has formed their own limited company (a 'personal service company' or PSC) and used this PSC to provide services to the business, then the PSC needs to operate PAYE on payments made to the individual, in addition to paying employers' NICs. If an individual contracts through a PSC but would be legitimately treated as self-employed if they were directly engaged by the client, then the rules will not apply.
What changes happened in April 2017?
While the IR35 rules in theory could apply to many PSCs, the number of PSCs that assess they need to operate PAYE and pay NICs is low, and HMRC is clearly of the view that it is too low. Consequently, in April 2017 the UK Government introduced new rules for public sector bodies contracting with individuals through PSCs that put the onus for determining employment status and paying payroll taxes on the end client (i.e. the public body) rather than the contractor's PSC. Anecdotally, this has led to a significant increase in the number of cases where the rules are being applied. The rules are now being extended to private sector businesses from April 2020.
As the potential penalties for non-compliance are very high, with HMRC able to go back four or six years to recover unpaid additional income tax and NICs, and charging interest and a percentage penalty on top of this, this could have a major impact.
Who is affected?
Many businesses that engage individuals through PSCs are potentially affected by these new rules.
There is an exemption for 'small' companies, which means a business which, in a 12-month period, meets two or more of the following criteria:
- Turnover – not more than £10.2million
- Balance sheet total – not more than £5.1million
- Number of employees – no more than 50
Unincorporated organisations must operate the off-payroll working rules if their turnover exceeds £10.2million in the previous calendar year.
It is worth noting that if an intermediary agency is involved, they will be responsible for operating PAYE before funds are paid to the PSC, rather than this being the responsibility of the end client. This reduces complexity for the end client, but may still result in increased costs if the agency looks to pass PAYE costs on to the client.
Given the potential scale of the changes we recommend checking the status of individuals providing services through PSCs, and preparing for the new rules, sooner rather than later.
How can we determine whether someone would be an employee or self-employed?
Employment status can be complex, as recent decisions with Uber, Deliveroo, and other 'gig economy' companies have shown. Amidst ongoing confusion among the 'contractor'/'self-employed', 'worker', and 'employee' statuses of individuals undertaking work, tax elements can add further complexity. In HMRC's eyes, the three strands of individual recognised by employment lawyers distil to two: those working under a 'contract of service' (employees) or a 'contract for services' (workers/self-employed individuals). Employees have tax deducted before receiving payment, while self-employed individuals must account for their own tax. There are also major differences in which NICs are payable.
As with the employment tribunals, the tax tribunal will look at a variety of factors to determine the status of the individual, of which the provisions of the contract form only one piece. HMRC has produced a Check Employment Status Test, which can be a useful starting point for those determining employment status; however, this test has been overturned in an IR35 tribunal and described as "irrelevant" by a HMRC official, so further points should be taken into account.
Factors to consider include:
- Mutuality of obligations – does the client have to provide work, and does the individual have to accept work if offered? Can the individual send a suitably qualified substitute to do the work instead of doing it themselves?
- Control – how much autonomy does the individual have in terms of decision-making about their work? Who decides what work is done, how it is done, where it is done, and when it is done?
- Contractual rights to sick/holiday pay – the Tribunal has found in some cases that the absence of worker rights from contracts could point towards self-employment. (Although it is noteworthy that in other cases, differently-constituted Tribunals have found this to be irrelevant as you would not expect these rights to be found in contracts between companies.)
- In business on own account – is the individual offering their services to the world at large, and do they provide services to other clients? In addition, do they bear the burden of financial risk, and expenses/equipment?
There is an obligation on the client to determine whether or not IR35 applies and provide this determination to the person it is contracting with on entering the contract or (if later) before the services are performed. If asked within 31 days, they must also answer questions about the reasons for this determination. If they have failed to comply with the information obligations or to take reasonable care in coming to the conclusion, then where there is an agency involved the client rather than the agency will take on the obligation to operate PAYE.
If the Check Employment Status Test is used, HMRC will stand by the result given unless a compliance check finds the information provided is inaccurate; or if it finds that the result has been achieved through a contrived arrangement designed to obtain a particular outcome from the service.
If there are any disagreements about a determination from an individual, clients will need to respond using a robust "status disagreement process". Failure to respond within 45 days to a contractor's query will make the client itself liable for the tax and NIC under dispute. HMRC has stated that it will provide guidance in relation to how clients can take reasonable care, and what a status disagreement process should look like, but given how soon the deadline is for application of the new rules, businesses should start thinking now about what their process will look like.
What do I need to do now?
In advance of the rules coming into force, businesses are strongly advised to carry out an audit of their arrangements with contractors to assess whether any of them could be deemed employees under the IR35 rules. You should identify current engagements and contracting terms, and decide the process for making a determination of whether IR35 applies.
If there is a risk that this is the case, then businesses should be engaging with contractors to make them aware of the changes to come, and ensuring their payroll teams are prepared. Given the tax advantages associated with operating as a contractor rather than an employee, in some cases it may be appropriate to review how work is undertaken in practice, and consider whether project-based fixed prices may be a way to give contractors more autonomy. Some businesses may wish to introduce an intermediary agency into the contractual chain, to avoid the administration associated with operating PAYE.