While the reduction in National Insurance contributions (NICs) and repeal of the health and social care levy had been widely trailed, one of the most surprising tax changes in the recent ‘mini-budget’ was the complete reversal of the off-payroll working rules.
These rules make businesses responsible for deciding if workers providing their services through personal service companies (PSCs) would have been employees if they provided their services directly. If so, the business has to pay tax and NICs as if they were employees.
In August this year, the new Prime Minister indicated that there would be a review of the IR35 rules. However, without any warning, the Chancellor has announced the entire repeal of the 2017 reforms - which apply IR35 to the public sector - and the 2021 reforms - which extended the rules to the private sector – with effect from 6 April 2023. As a result, only the original IR35 rules from 2000 will remain in place.
What did the original IR35 rules require?
Tax legislation introduced in 2000, commonly known as IR35, was designed to reduce the disparity between the amount of tax paid by people providing their services through an intermediary and direct employees. Under the original IR35 rules, the contractor's PSC had to account to HMRC for tax and NICs if the contractor would have been regarded as an employee of the client in the absence of the PSC.
Under the rules, it was the contractor’s responsibility to make this determination. Given the consequences a determination has on the contractor, there was a strong motive to reject a characterisation of deemed employment.
How were the original IR35 rules reformed in 2017 and 2021?
The off-payroll working reforms were designed to combat widespread non-compliance with the original IR35 rules. They did this by shifting responsibility for assessing whether a contract resembles self-employment or employment from the contractor to the end client. However, the rules have been widely criticised as overly complex and onerous.
What changes have now been announced?
The changes announced by the Chancellor will mean, from 6 April 2023, contractors who provide their services via a PSC and not their clients will once again be responsible for determining their own employment status and paying the appropriate amount of tax and NICs.
Although the government is presenting this as a deregulation measure aimed at supporting businesses, it is worth remembering the predominant driver for the off-payroll working rules was concern that only about 10% of the cases within the original IR35 rules were being properly reported to HMRC and so tax was not being collected from contractors on payments that should otherwise have been characterised as employment income. Valuing administrative costs over cash for the exchequer does seem to be a curious change of taxation priorities.
Notably, HMRC is yet to publish any commentary. But we understand that the department is “looking into” updating its guidance. What this is likely to mean remains unclear. For example, when the rules were extended to the private sector in 2021, HMRC said they would not use details “acquired” from IR35 reforms to open enquiries into past tax returns. One question now is whether we will see a similar commitment for contractors who, in future, assess themselves as outside IR35, despite their “employer” being on record as having previously assessed them as inside the rules.
What do these changes mean for businesses?
The return to the original 2000 IR35 rules means that, from next April, employers should no longer need to carry out such extensive investigations into the status of their contractors. Nor will they be subject to the same requirements to deduct tax and NICs.
However, the background against which companies contract with individuals has altered. So it would be a mistake to view this abolition as signalling a complete rewind to the 2016 position. Since the off-payroll working rules were first introduced, new corporate criminal offences have been enacted. In particular, a company can now be guilty of failing to prevent the facilitation of tax evasion. These developments could mean that if a company suspects a contractor will not comply with its obligations under IR35, it could still be held responsible.
It is against this backdrop that businesses must consider their contracts with contractors going forward.
What practical steps should businesses take now?
The off-payroll working rules continue to apply until their proposed repeal next April so employers must continue to meet their obligations under the existing legislation. Equally, the changes to the rules will not absolve companies of historic (or on-going) non-compliance issues.
The usual tax indemnities should continue to be included in contracts with individuals. However, an indemnity will not protect the company against corporate criminal liability. Therefore, businesses may also wish to consider including an undertaking that the contractor will comply with their obligations under IR35. As always, businesses should continue to retain proper records of their arrangements with contractors.
Outside the contractual position, businesses should remain wary of obviously artificial situations, particularly where it is clear that IR35 applies and they have reason to suspect the contractor will not comply with the rules.
Finally, a further review of the remaining IR35 rules is expected over the next year. It is unclear whether there will be other changes. Perhaps government policy will now turn to the Managed Service Company legislation instead or, perhaps, following HMRC’s recent warning, the use of umbrella company arrangements will now come under greater scrutiny.
On the horizon, the off-payroll working rules could stage a reappearance under a Labour government. It is also just possible that the Conservative backbench MPs rebel and the government cannot get the legislation through Parliament.
As the situation remains fluid, we suggest businesses consider entering into new arrangements with contractors only on a short-term basis. They may well want to have the ability to review and change the terms on which they contract and avoid locking themselves into non-negotiable terms.
At this point, businesses need to keep a close eye on what could be a fast-moving situation.
