Organisations engaging self-employed contractors are potentially facing increased income tax and NI liability from 6 April 2020 as a result of a change to the IR35 tax rules.
What is IR35? The IR35 rules were introduced in 2000 to prevent tax evasion through ‘disguised employment’. Disguised employment is where self-employed individuals provide their services through an intermediary such as a ‘personal service company’ (‘PSC’) in order to avoid paying income tax and NI on their earnings. Instead, the client pays the PSC for the individual’s service, and the individual receives payment in the form of dividends from the PSC.
The IR35 rules apply where, were it not for the PSC, the individual would be considered an employee of the client for tax purposes. In these circumstances, the PSC would be responsible for paying income tax and NI on payments made to it by the client for the individual’s service. Until now, the tax liability lay with the PSC. However, this will all change from April 2020 with the introduction of ‘off-payroll working’ into the private sector.
The New Regime from 6 April 2020 The proposed rules shift responsibility to the end user for determining (i) whether there is ‘deemed employment’ for IR35 purposes and (ii) accounting for income tax and NI in the event there is deemed employment. Therefore, if your business engages self-employed individuals, even if this is through another company, your business may be responsible for determining whether IR35 applies AND (if it does) accounting for tax and NI. This is known as ‘off payroll working’.
Off payroll working has been operating in the public sector since 2017. However, from 6 April 2020, the Government has confirmed it will be extended into the private sector. The Government is currently consulting on changes that may be required to make the existing public sector legislation appropriate for the private sector. However, it is likely that the new rules will apply to any organisations with 50 or more employees who engage self-employed contractors through an ‘intermediary’ such as a PSC.
As a result, businesses will be facing additional tax risks, increased cost and administrative burden. If there is deemed employment between a client and a self-employed contractor, the income tax liability will now fall on the client. Clients will need to scrutinise their supply chain and relationships within it to decide which contracts represent the most risk.
The test of employment under IR35 is not the same as that applied in relation to statutory employment rights. It is possible for an individual to be considered an employee for tax purposes, but self-employed for the purposes of statutory employment rights. However, the two tests are very similar. It is not inconceivable that contractors who’s engagement with an end user has been determined as ‘deemed employment’ under IR35 may also seek to claim additional statutory rights available to workers or employees such as holiday pay and pensions. Therefore, the introduction of the new off-payroll working rules in the private sector has the potential to result in a flurry of worker’s rights claims, particularly in the current ‘uber’ driven economy.
Is my business at risk? Whether a contractor is in ‘deemed employment’ with an end user will depend on the terms of their contract and the way in which their engagement operates in practice. Factors likely to increase the risk of IR35 applying are as follows:
- Your business exerts control over how the services are provided;
- Contractors are paid on an hourly or monthly basis according to time worked;
- There is an obligation on the contractor to undertake work or your business to provide it;
- You provide your contractors with equipment; or
- The contractor only tends to work for your business.
The above factors are not conclusive and if at one point the PSC was operating as a proper business, but the ongoing terms of business between them and Client changes to operate like an employment relationship, this will not prevent HMRC from determining the circumstances have changed and demanding payment.
In the recent case of Albatel Limited v The Commissioners for her Majesty’s Revenue and Customs, the EAT held that the IR35 legislation did not apply to the well-known public figure, Lorraine Kelly, in relation to her contract with ITV hosting “Lorraine.” HMRC argued Lorraine had a contract of employment with ITV in that ITV held ultimate control in relation to OFCOM, the agreement allowed for paid holiday and Lorraine was not entitled to provide a substitute for her services. Other factors included ITV’s final editorial control, Lorraine’s restriction on alternative work and ITVs right to require Lorraine’s attendance at production meetings and press launches at no extra remuneration.
However, the appeal was upheld on the basis that Lorraine:
- Had a substantial amount of control. The overwhelming evidence suggested it was ultimately her “name on the door” and she had the final say on most matters.
- Was not entitled to contractual sick pay or other benefits, such as a pension, typically held by employees.
- Was subject to a degree of financial risk as per a self-employed individual. There is no scope for her to increase profits and there was an ongoing risk of having the programme dropped or not being paid due to long term sickness.
- Has no equipment provided to her to perform her role; save for the earpiece and clothes.
Although this judgment is decided on facts of a specific case, it gives guidelines as to what a Tribunal would consider when deciding whether a contractor is working within the IR35 rules for tax purposes.
What should businesses do to prepare for the New Regime? With proposals in place, and a little under a year to go, companies should be doing the following for the best possible chance of avoiding liability under IR35:
- Review 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 consider whether the extra costs are commercially necessary, or whether their current contracts should be amended or terminated.
- Consider how your business is structured and how you currently engage with contractors. While the contractual terms are important, whether the relationship reflects those terms in practice will be persuasive. If the way the relationship operates places it at risk of being caught by IR35 – consider whether this can be reorganised.
- Consider implementing new systems and processes to ensure the new regime is followed
- Estimate any likely cost increase due to the Employer’s NIC and Apprenticeship Levy charges under IR35 and potential changes in the contractor’s rates.
- Introduce training for individuals responsible for determining whether contractors fall under the IR35 rules.