The Chancellor has confirmed that with effect from 6 April 2020 businesses in the private sector which engage contractors - individuals who supply their services via their own company or partnership (“Intermediary”) - will be responsible for determining whether the IR35 rules apply. If the business considers that IR35 applies, the person paying the Intermediary will be responsible for operating PAYE and NICs on the fees it pays to the Intermediary.
The Chancellor’s announcement (on page 42 of the Budget 2018 document) follows a consultation issued earlier this year on tackling non-compliance with the IR35 regime and will generally align the position in the private sector with the position that currently applies in the public sector.
For further information on IR35 and how the rules apply in the public sector, read our previous article.
What is changing?
With effect from 6 April 2020, where an individual provides their personal service through an Intermediary to a client (whether directly or via an agency):
- The client, rather than the Intermediary, will be responsible for determining whether IR35 applies. In broad terms IR35 applies where an individual personally provides services to a client via an Intermediary and:
- ignoring the existence of the Intermediary, the individual would be an employee or office-holder (e.g. director) of the client; or
- the individual is an officeholder and the services he/she provides through the Intermediary relate to that office.
- If the client decides that IR35 applies, generally the person paying the Intermediary (the “Fee Payer”) rather than the Intermediary will be responsible for deducting income tax and employee NICs and accounting for employer NICs.Broadly, this needs to be done on the fees it pays to the Intermediary (excluding VAT). The employer NICs in respect of the fees paid to the Intermediary are also taken into account for determining the Fee Payer’s liability for the Apprenticeship Levy.
What are the implications?
This is a significant change for the private sector, which will require a substantial investment in terms of both cost and time. There was widespread speculation that the change would apply from April 2019, so it is good news that the new rules will not take effect until April 2020. Businesses need time to prepare, both in terms of being able to properly assess a contractor’s employment status, and also to be able to deduct tax and NICs from consultancy fees.
Key issues are:
- It is notoriously difficult to determine an individual’s employment status.Adopting a “blanket” approach of applying IR35 in all cases is open to legal challenge and in the public sector has led to disputes with both the individuals and Fee Payers.Businesses must therefore have robust procedures in place to assess and decide status.
To help determine whether IR35 applies in the public sector, HMRC launched an “Employment Status Service” online tool (“CEST”). Many public sector clients use this tool as it has the advantage that (in the absence of fraud) HMRC is bound by the result pending any change in the circumstances. However, CEST has been severely criticised as being biased towards a finding that IR35 applies and there has been at least one case where the tax tribunal overturned a finding of employment under CEST. In addition, in about 15% of cases CEST does not produce an answer at all, meaning clients still have to determine the individual’s employment status using the normal status tests.
- Where IR35 applies, the Fee Payer business will face additional employer NICs (and Apprenticeship Levy) costs.The Intermediaries themselves will also face additional costs.Agreement needs to be reached as to who will bear these additional costs and contracts re-negotiated accordingly.
- Fee Payers need to ensure their systems can deal on the one hand with operating PAYE and NICs on the VAT exclusive amount of the Intermediary’s fees, and on the other hand ensuring that the Intermediary is paid the correct net amount plus the correct amount of VAT.
Are there any exceptions?
“Small” business will be exempt from the new rules. No information has been released yet on which businesses will qualify as small for these purposes.
Businesses using individuals who supply their labour via an Intermediary should start preparing now for the implementation of these new rules, including:
- Establishing a process to help staff determine whether IR35 applies;
- Identifying and reviewing existing contracts with Intermediaries (including where the Intermediary is supplied via an agency) that will still be in place in April 2020 and considering whether IR35 will apply. Where IR35 will apply, consideration should be given as to who should bear the additional costs, depending on the importance of the individual to the business and the changes required to the relevant contracts;
- Ensuring any new contracts are compliant with IR35 and the new rules; and
- Ensuring that payroll and accounts payable systems are able to cope with the changes.
For a summary of all the October 2018 Budget measures, read Budget 2018 by Matthew Rowbotham, our Head of Tax.
Finally, a word from our employment team by Alison Clements
Status is a hot topic at the moment, largely driven by three things:
- A need for more flexibility in the workforce, driven by both employers and individuals, leading to more people (rightly or wrongly) working on the basis of being self-employed;
- A consequent reduction in tax revenue; and
- The gig economy, which has tended to categorise individuals as being ”self-employed” with minimal regard for long-standing status rules.
The phrase employment status can mean two things, depending on who is using it:
- Tax status. There are two types of tax status, employee and self-employed. Those who are considered to be employed must be paid through PAYE, and tax and NICs are deducted at source and paid to HMRC on their behalf.
- Employment status. There are three types of employment status - employee, worker and self-employed. The category that a person falls into affects the rights and benefits that they are entitled to receive.For example, holiday pay, automatic enrolment into a pension scheme and national minimum wage are all given to those who are employees or workers, but not to those who are self-employed. Employees have more employment rights, benefits and protections than workers, and workers have more employment rights, benefits and protections than the self-employed.
Similar (but not identical) tests are used for both purposes and the results are usually similar.
Importantly this new proposed change to IR35 is aimed at determining employment status for tax purposes, not for employment purposes. In short, whilst some consultants would need to be paid through the Fee Payer’s PAYE payroll, this does not, in itself, mean that they also need to receive holiday pay, pension provision, and other “employment” benefits.
It is important to note that whilst clients will be involved in the assessment of tax status under the proposed new rules, the individual and any Intermediary will presumably also have a view on their status. An individual who strongly believes they are self-employed for IR35 purposes, and is running their business in order to be IR35 compliant, is not going to simply accept the client’s view on status if they disagree and will be financially disadvantaged. Professional or skilled consultants are likely to be well-advised on this issue and to have strong views on their own status.
It remains the case (from both a tax and an employment perspective) that regular auditing of self-employed contractors who work within a business is best practice, in order to avoid loose practices that treat contractors the same as employees, which risks creating an indication of employee status rather than self-employed status on both the tax and employment tests. This new approach does not change the previous status tests or risks, it simply creates a further mechanism for HMRC to identify when IR35 is not being met.