Use of onshore employment intermediaries in the construction industry could spell serious problems for the Construction Industry Scheme (CIS) owing to a recent tax change imposed by the HMRC.
However the tax changes introduced are, in practice, imposing considerable inflationary pay increases on industries just emerging from a long recession.
Wragge Lawrence Graham & Co's John Hayes, an employment specialist in the firm's Human Resources Group, summarises the changes made and provides advice on the best approach to accommodate those changes.
The new tax changes
In a Consultation Document (dated 10 December 2013) headed "Onshore Employment Intermediaries: False Self Employment", the government stated that it aimed to introduce rules to clamp down on what it sees as the use of 'intermediaries' to facilitate bogus self-employment.
The policy driver for the new tax changes is twofold:
- to increase the yield from employment taxes generally (i.e. class 1 National Insurance Contributions (NICs));
- to ensure that employers afford the proper level of employment obligations to workers. The government acknowledges that this tax change will affect sectors such as catering, construction, driving and security where the use of temporary labour is widespread.
The tax change (section 16 of the Finance Bill 2014 (FA 2014) came into effect on 6 April 2014 and is aimed at remedying what the government sees as the above abuse.
The new rule amends section 44 of Chapter 7, Part 2 of Income Tax (Earnings and Pensions) Act 2003 and removes the need for "personal service" before an obligation to collect class 1 NICs is triggered. The compliance burden has been moved 'up the supply chain' from the intermediary that engages with the worker to the employment business who engages with the client (Agency 1).
In practice, large employment businesses (Agency 1 suppliers) are being invited by the government to put workers on their payroll if the worker 'personally provides' services to another person (the client), under a contract between the agency and the client.
The new rules are subject to the proviso that the worker is under the supervision or control of the client or some other connected party. A truly self-employed person (including a person who is supplied to the agency by his own personal services company) will therefore not be subject to the new rules. The normal tests for employment status continue to apply.
Will the government be better off?
It is unlikely. The government estimates that the changes will raise more than £500m in additional Pay As You Earn (PAYE) and NIC in 2014/2015. However these figures are contested, as experts suggest that more workers will seek ways to avoid the effects of the tax changes, for example by using the opaque 'umbrella' model, in which a company acts an as an employer to the workers) where more tax allowances (expenses) are permitted.
However, (and in practice this is the main point) the new rules also do not apply if the remuneration is already taxed as employment income by intermediaries already. If the worker is employed by an agency or an umbrella company and their pay is already subject to PAYE, then the legislation will not apply.
The old rules
Under the old rules, the employment business model, where contractors engage workers through an agency, required the agencies to deduct tax and NIC and pay secondary class 1 National Insurance Contributions (NICs) only if the worker 'personally provided', and was under a contractual obligation personally to provide, services to a contractor.
By including in a contract a provision that permitted the worker to send a substitute, agencies could often circumvent the PAYE obligation, even if the substitution would never happen in practice.
Additional record keeping and reporting obligations
As a concession for the speedy implementation, the associated quarterly reporting and penalties regime attached to these tax changes, only comes into effect from April 2015. Agency 1 must submit a quarterly return giving details of any workers from whom tax has not been deducted and the reason for the non-deduction. Additional record keeping obligations in relation to those workers will also be imposed.
New Directors' Liability for deliberate anti-avoidance mechanisms
There is also a new Targeted Anti-Avoidance Rule (TAAR), which has the effect of reinstating the application of the new agency rules if arrangements are entered into with the main purpose of avoiding the impact of this tax change. These will apply, in particular, if an employment business produces fraudulent documents purporting to state that no supervision or control exists, when, in fact, it does.
New recovery provisions mean that the HMRC can now enforce PAYE debts that have arisen under the 'transfer' powers (i.e. where the PAYE burden has transferred to the client or to Agency 2), or under the TAAR against directors or shareholders of the offending company.
Contractors and agencies are advised to speak to their insurers to confirm that existing (Directors and Officers Liability insurance) policies will meet these potential liabilities (which could, in a disaster scenario, run to six or seven figure sums).
A rushed consultation
The consultation document was published on 10 December 2013. The closing date for comments was 4 February 2014. The government issued its Summary of Responses on 13 March 2014. The new provisions came into effect on 6 April 2014. Many responding to the consultation complained that the changes were being rushed through too quickly, a point acknowledged by the government in its Response.
HMRC has stated that where a worker is engaged via an intermediary they will presume there is the requisite supervision, direction or control (Control), so Agency 1 therefore needs to hold evidence that there is no such Control or otherwise it must operate PAYE. We understand that HMRC will in due course produce more detailed guidance on what 'Control' means in this context. In the meantime, the burden of proof rests on the agency.
The PAYE burden will, however, transfer from Agency 1 to:
- Agency 2 (the next agency in the supply chain who contracts with Agency 1, provided Agency 2 is in the UK) if it gives Agency 1 a 'fraudulent document' purporting to show that the remuneration is already employment income; or
- the client, if it gives Agency 1 a 'fraudulent document' purporting to show that there is no Control.
There is no specific guidance on what will constitute a 'fraudulent document' for these purposes, but the wording of the legislation includes the need for there to be intent, on the part of the person providing the 'fraudulent document', to deceive Agency 1. Having to show that the documents provided are 'fraudulent' in order to transfer the burden of tax liability from Agency 1 to the client or Agency 2 is a very high hurdle and many believe this will not provide sufficient protection, leaving Agency 1 facing what could be a significant tax bill.
What this means - upshot
Contributors during the consultation exercise welcomed the government's policy which prompted this initiative but many have complained about the speed that this legislation has been introduced, as well as some important unresolved questions (including the definition of "intermediary" and greater clarity sought on the test for employment status)
However, both the employment businesses that provide temporary labour and the end users are struggling to respond to these new tax changes… The use of umbrella companies is likely to become more commonplace.
Workers may be (net) worse off - particularly those paid either at or just above the National Minimum Wage (and some large suppliers have said they will not now supply these workers through their employment businesses).
The upshot is unnecessary inflationary pressure and complexity on an industry struggling to emerge from a deep recession. Some large employment businesses and trade organisations have intimated that they want to take on the HMRC in some test cases. Feelings are running high.
For those workers who earn enough to make it worth their while to supply their services through umbrellas (and thus net off their expenses), there may be little change.
Contractors and employment businesses will want to negotiate between themselves how the risks of this new tax change is shared in the commercial contracts between the parties, always assuming that those called upon to meet that cost will be able to do so when the time comes!