As announced in the 2018 Budget, the public sector off-payroll working rules will be extended to the private sector from 6 April 2020. The rules will only apply to large and medium-sized businesses.
Government authorities have been engaged in a crack-down on what they view as the ‘mislabelling’ of employees as contractors. The Treasury has long held the view that a number of people claiming to be self-employed and operating through personal service companies (PSCs) are actually employees who should be paying tax accordingly.
A short introduction to IR35
Many self-employed contractors use personal service companies (PSCs) to supply their services to their clients. This is a way of saving tax and NICs, which is why HMRC introduced IR35 as a way of combatting the risk that PSCs and other intermediaries posed to the tax base. In essence, this asks whether, but for the interposing PSC, the individual would have been regarded as an employee of the client organisation engaging them. This involves considering the nature of the work performed under the contract, and the terms under which it is performed, and is known as “deemed employment”. If the answer to this is yes, then the PSC has to account to HMRC for income tax and NICs on the payments received from the client.
At present, the tax liability rests with the PSC. The change will be accompanied by obligations on the client organisation to determine the correct position for each engagement, and notify any other parties involved regarding “deemed employment” or genuine self-employment status.
It pays to be prepared for this reform. When similar changes were introduced in the public sector two years ago, many organisations were caught out, or attempted to impose “global” determinations, which were then challenged by their contractors.
Whilst the focus is on the private sector, the rules are also aimed at charities. Many charities will be small, so may well be exempt.
Four key questions the Client must ask itself in respect of each contractor:
- Will the off-pay roll rules apply at all? The rules do not affect contractors supplied by an employment agency or umbrella company, where they directly employ them and operate tax and NICs on earnings they pay them, or staff supplied though a managed service company that deducts PAYE on ‘pay’.
- Where the rules do apply in principle, is the contractor using an intermediary which meets the relevant conditions for the new rules to apply? An “intermediary” would be a company (i.e. commonly known as a Personal Service Company – PSC) in which the contractor has a material interest (i.e. holds more than 5% of shares), but could include certain partnerships which the contractor is a member or even an individual.
- If the contractor is using a relevant intermediary (e.g. a PSC), is there a “deemed employment”? This will be for the client organisation to determine and to inform the relevant parties as mentioned above.
- Where there is a deemed employment, who pays the PSC? In a chain of intermediaries between the client and the contractor’s intermediary (or PSC), it is the lowest UK based intermediary in the chain (that is, the one that pays the PSC) that must operate PAYE.
The problem with these new rules is that they have encouraged some organisations who hire contractors, to apply blanket decisions on whether certain contracts fall within IR35. Blanket solutions are not appropriate.
Practical Implications of the off-payroll working rules
- Determining deemed employment is not always clear cut, and it is often necessary to seek legal advice. Although there is no obligation to use the Government’s new online tool (the CEST) for this purpose, the advantage of doing so is that HMRC will be bound by the output of the service, unless it has been obtained fraudulently. The HMRC have introduced a new tool as the previous one was subject to major criticisms that it asked the wrong questions, and seemed ‘rigged’ to produce ‘guidance’ that the individual PSC should be paying income tax. It is better but still not conclusive in three respects :-
- It regularly produces an ‘inconclusive result’.
- CEST currently seeks to produce an answer out of a few questions on what can be a very complex and nuanced indicators.
- The HMRC still reserve the right to challenge the ‘decision’ if they believe that it was not answered honestly/accurately.
- Informing the Agency/PSC about the determination of deemed employment. Having determined employment status, the client must inform both the PSC/contractor and, if applicable, the Agency which pays the PSC, of the outcome of the review and, if requested, provide a written response as to how the conclusion on employment status was reached. The client needs a clear process to comply with this information requirement.
- Extra costs. A key consequence of the new rules is that the client is responsible for an additional cost of 13.8% employer NICs and, if applicable, 0.5% apprenticeship levy on top of the payment. Broadly, the levy is 0.5% of pay bills over £3 million in the relevant tax year. The client is not entitled to deduct these costs from the fee payable to the PSC. The contractor, on the other hand, is likely to be in a better position (although this depends on the circumstances) as the PSC no longer has to account for PAYE and NICs on the fee received from the Agency. For a contractor who formerly considered themselves to be self-employed and that IR35 did not apply, deduction of payroll taxes will result in a significant reduction in profit for the PSC that would otherwise have been available to draw as dividends.
- Pressure to re-negotiate contracts between the Client and the PSC – due to these extra costs, it is likely that the client will wish to re-consider the contractual terms :-
- Where possible the client may wish to re-negotiate its fee with the PSC/contractor to take account of the transfer of NIC liability to the client.
- The client may consider getting the contractor to abandon their PSC and supply their services instead through an umbrella company, or on a fixed term employment contract.
The Consequences for the Client of getting it wrong
Even where the client is not the fee payer (and therefore not normally liable to account for PAYE and NICs of the relevant contractor), liability could apply in certain circumstances, including if the client organisation :–
- fails to notify its decision about deemed employment to the contractor/PSC or Agency with whom it has a contract to provide the services, within the timescale;
- fails to reply to the written request from the contractor/PSC or Agency for the reasons for the decision within 31 days of receiving it; or
- fails to use reasonable care in providing its view about employment status;
Private sector companies and charities should familiarise themselves with the rules and start thinking about how they will apply to them. In particular, companies should:
- Conduct an audit of contractors used in their organisation. It is likely you will need to make individual decisions, and have different communications with each PSC. The audit will be a factual investigation, looking at what each individual does in practice; how they do it; what contracts they are engaged under; how they are paid etc. This may also be a good time to audit any off-payroll labour that is not provided through PSCs. Questions to be asked include:
- What would the workers’ employment status be?
- Who will be responsible for accounting for PAYE/NICs?
- Who should bear the cost of any employers’ NICs?
- What contractual protection is available in cases of non-compliance?
- Should we consider bringing the worker on-payroll?
- Liaise with agencies and specialist service providers to determine which contractors may potentially be caught by the new rules.
- Assess who will likely be primarily responsible for PAYE; then estimate any likely cost increases due to employer NICs and Apprenticeship Levy charges, and any potential changes in contractor charges.
- If liability lies with the engaging business, calculate, report and pay income tax and NI contributions or consider alternative ways of engaging them.
- The audit is likely to have knock-on consequences that may require legal advice. As well as determining employment status, you may need specialist tax advice to amend or draft contractual documentation.
- Review existing policies for engaging the different types of contractors – these may vary between business functions.
- Put in place comprehensive, joined-up processes to ensure consistent decisions are made and communicated in relation to the employment status of workers engaged through intermediaries, and to allow for such determinations to be challenged.
- Review internal systems, such as payroll software, HR and on-boarding policies to see where changes are required.
Client organisations will be required to address status determination disagreements. The Government recognises that, in some circumstances, an off-payroll worker may disagree with a client’s status determination. The Government proposes that clients should develop and implement their own processes to resolve disagreements based on a set of requirements set out in the legislation. As a minimum, the Government would expect any process to include the consideration of evidence put forward by the off-payroll worker and/or client, and advising the party of the outcome of that consideration and the reasons for that outcome.
No change for “Small” Organisations
Only medium and large organisations will be subject to the 2020 rules, so will not need to determine the status of the off-payroll workers they engage. The definition of “small” has been widely awaited, and the Government have confirmed that it intends to use the existing Companies Act 2006 definition. That is where the business satisfies 2 or more of the following features:
- Annual turnover of £10.2 million or less;
- Balance Sheet total of £5.1 million or less;
- 50 employees or less;
“Small” organisations will be outside of the new obligations and services supplied to such client organisations will continue to be dealt with under the current IR35 rules with the worker and his or her personal service company effectively self-assessing whether the rules apply to that particular engagement. It is also worth noting that the IR35 rules do not apply to sole traders.
We recommend that organisations, if they have not already done so, thoroughly prepare for the introduction of the revised IR35 rules on 6 April 2020.
Clients should raise any concerns with their Accountants/Financial Advisors regarding any element of the issues arising from this newsletter. We provide a link here to our Control Test, which is solely focused on the employment not tax status of individuals acting as contractors.