From 6th April 2020, the private sector will be brought in line with the public sector in relation to the IR35 tax regime, which will imply new requirements on to fee-payers in a consultancy arrangement.
What is IR35? HMRC considers there to be just two different types of employment status in relation to tax; employed or self-employed. The current position is that in the case of “self-employed” contractors, it is for the individual to determine their employment status and account for Income Tax and National Insurance contributions. The new legislation coming into force will shift this responsibility onto the end user, meaning that it will soon be down to the end user to determine an individual’s employment status and, if employment status is determined, for whoever pays the consultant’s fees to deduct Income Tax and NI contributions from payments made to them.
Individuals who provide their services through a personal service company (PSC) will not be protected. The IR35 rules will apply where, were if not for the intermediary, the circumstances of the engagement would have the characteristics of employment. It will therefore not matter whether an individual is invoicing a company personally or through a personal service company. If sufficient characteristics of employment exist, the end user will still have to account for income tax and NI. The new IR35 rules will therefore significantly increase the risk involved in mislabelling workers and employees as self-employed. This is particularly the case where the “mislabelling” has occurred for several years and there will be back taxes, interest, penalties, costs and expenses to be settled with HMRC.
What do we know about the draft legislation?
The draft Finance Bill was issued on 11th July which included draft clauses for the new legislation to roll out IR35 into the private sector.
The new IR35 rules will apply only to medium and large business. Small businesses will be exempt. A small business is defined by reference to the Companies Act as having two of the following:
- Annual turnover of less than £10.2m
- A balance sheet of less than £5.1m
- Fewer than 50 employees
All clients will be required to issue a Status Determination Statement (SDS). If an individual disagrees with the determination of their status, the client will have 45 days to review the decision under a “status disagreement process”. The client will either have to change the individual’s status or provide them with confirmation of their original decision and reasons why they came to this conclusion.
Difficulty in determining status
Accurately determining an individual’s employment status requires the application of criteria established by case law. The governments “check employment status for tax” or “CEST” tool has been criticised for not factoring in this criteria when reaching a decision as to whether IR35 applies or not. As a result of this, the CEST tool does not always give an accurate determination of an individual’s status. The government have promised an improved CEST tool to be rolled out over the summer along with guidance to help businesses prepare for IR35. In any event, given that HMRC expects businesses to be ready in time for April of next year, businesses should be starting to risk assess their engagements with contractors now.
When determining whether an individual is employed or self-employed for tax purposes, some of the factors to be considered include:
- Whether the individual is supervised by their ‘employer’
- Whether the individual can provide a substitute
- Whether the individual is responsible for their own liabilities
- Whether the individual is trained by their ‘employer’
- Whether the individual is required to wear a uniform
- Whether the individual uses their own tools or equipment
- Whether the individual is required to have their own insurances
There is further difficulty because some factors will bear more weight than others and no one factor on its own will determine status. Instead, these factors must be considered collectively. Importantly, the terms of any written contract on their own are not determinative. It is how the relationship operates in practice that is important.
What does case law say?
A recent case between a medical practitioner and HMRC highlighted the difficulties in making status determinations. The case concerned a urologist who provided his services to two hospitals through a PSC. The Tribunal considered the employment relationship based on hypothetical contracts between the urologist and the hospitals based on the reality of the situation in practice. The Tribunal concluded that, the engagement with Royal Berkshire Hospital (RBH) amounted to employment but the engagement with Medway Maritime Hospital (MMH) did not amount to employment.
The Tribunal found that the key features of the hypothetical contract with MMH which determined self-employment were:
- A valid substation clause. A substitute could be sent provided that they met the hospitals usual criteria.
- There was no obligation on MMH to provide work.
- There was only one day’s notice period. Were this a relationship of employment, there would be a minimum of one week’s notice required.
The hypothetical contract with RBH on the other hand would have included provisions for:
- A one week notice period.
- A minimum number of working hours each week.
This is an important case as it demonstrates how key differences in working practices produce different tax status results.
How should businesses prepare?
Whilst new guidance expected from the government will be useful to enable clients to accurately determine status, if they are to be ready in time, business should start preparing now. For the best possible chance of avoiding liability under IR35, companies should now be considering how their business is structured and how they currently engage with contractors. This should include:
- Reviewing existing contracts – contracts can be drafted to mitigate the risk of IR35 applying. Similarly, a poorly drafted contract can substantially increase your risk.
- For identified contractors falling within IR35, considering whether the extra costs are commercially necessary, or whether their current contracts should be amended or terminated.
- Estimating any likely cost increase due to the Employer’s NIC and Apprenticeship Levy charges under IR35 and potential changes in the contractor’s rates.
- Reviewing systems and processes around your businesses engagement of contractors.
- Providing training for employees who are responsible for determining the status of contractors engaged by your business.