As we reported last year, the Government is introducing fundamental changes to the tax rules (often referred to as IR35) that apply to consultants engaged through intermediaries (such as personal service companies) in the private sector.
On Friday 11 July, the Government published draft legislation setting out the new rules. Despite calls to delay the implementation of the new rules until at least April 2021 to give businesses enough time to prepare, the Government has now confirmed that the new rules will take effect from 6 April 2020.
The new rules will significantly increase the administrative and compliance burden on businesses that use consultants. This means that all businesses using consultants should be preparing for the new rules now and taking steps to actively address the compliance challenges created by the new regime.
Read on to find out what practical steps we recommend you should take now.
1. What is changing?
Under the current IR35 rules, where a consultant is engaged via an intermediary (such as the consultant’s own personal service company), the intermediary is responsible for determining the consultant’s deemed employment status for tax purposes and, where appropriate, accounting to HMRC for PAYE/employer National Insurance contributions (NIC).
Government research indicates that only 10% of personal service companies are applying the current IR35 rules correctly. The reforms are intended to increase compliance by making the end-client responsible for determining the consultant’s deemed employment status and, where appropriate, making PAYE deductions and paying employer NIC on the consultancy fees. The Government estimates that over 66,000 businesses will be impacted by the new rules.
The reforms to IR35 will apply to large and medium-sized business only. Small companies (those that have an annual turnover of up to £10.2m, a balance sheet total of up to £5.1m and/or fewer than 50 employees) will not be caught.
However, the reforms to IR35 are part of a wider package of measures to crackdown on perceived unlawful tax avoidance. Following a change to the law in September 2017, all businesses (whatever their size) that fail to take adequate steps to ensure their staffing arrangements do not permit the facilitation of tax evasion by third parties in their supply chain are also at risk of being subjected to criminal penalties.
2. How will the reforms to IR35 impact you?
- If your organisation is a large or medium-sized business and engages consultants through personal service companies, once the new rules come into force in April 2020, as the “client” of the consultancy services your organisation will need to:
- Determine each consultant’s deemed employment status. To prevent “blanket determinations”, the legislation provides that a determination will be invalid if the client fails to take “reasonable care” in reaching its conclusions.
- Notify the consultant of the determination and the reasons relied on for the determination. If the consultant disagrees with the determination, the client must provide a dispute resolution process that allows the consultant to challenge the determination.
- Where it is determined that the rules apply and your organisation is responsible for paying the consultancy fee directly to the personal service company then it must:
- Deduct income tax and employee National Insurance contributions from the consultancy fee and account to HMRC for them; and
- Pay employer National Insurance contributions on the consultancy fee.
If the fee is paid to the personal service company via an agency, then the agency (as the “fee-payer” for these purposes) must operate PAYE deductions and account to HMRC for them.
As well as increasing the administrative and compliance burden on businesses, the new rules are also likely to result in increased costs that will need to be factored into business plans and pricing models (not least the costs of employer National Insurance contributions for “consultants” who are deemed to be employees for tax purposes and updating the payroll to operate PAYE in respect of such individuals).
Businesses that fail to comply with the new rules are at risk of financial penalties or unpaid tax and National Insurance contributions. In addition, businesses that cannot demonstrate that they have“reasonable prevention procedures” in place to prevent the facilitation of tax evasion in their supply chains also risk criminal penalties, which can include unlimited fines, confiscation orders and serious crime prevention orders.
The consequences of non-compliance with IR35 and/or a criminal conviction for failure to prevent tax evasion are likely to extend far beyond the immediate financial penalty. It may require disclosure to professional regulators both in the UK and overseas and prevent the organisation from securing and retaining business. It is also likely to trigger increased scrutiny from HMRC in respect of the organisation’s overall tax compliance and result in adverse publicity and significant reputational damage.
3. What do you need to do now?
Many public sector organisations vastly underestimated the time and resources required to comply with the new rules when similar changes were introduced in the public sector in 2017. We strongly encourage private sector organisations to learn from this and start planning for the reforms now. Below is a checklist of the practical steps we recommend you take to help protect your organisation from the risks outlined above.
a) Carry out an audit of the consultant population.
- The first step is to identify potential risk areas by carrying out a critical review of existing consultancy arrangements to identify any individuals that are at high risk of being deemed to be employees for tax purposes.
- Organisations can do this internally by using the Government’s free online “CEST” (Check Employment Status for Tax) tool (although there has been much criticism of this tool) or contact Fox Williams for support.
b) Analyse the results of the audit
- Identify high risk cases where action should be taken without delay.
- Flag cases that require careful monitoring (e.g. where there are indications that deemed employment status may change).
- Identify improvements to contractual documentation and working practices to manage risks going forward.
c) Prepare an action plan
The audit will help you prioritise the follow-up actions required to manage the organisation’s exposure. Steps may include:
- Talking to your consultants about the changes in the rules and how this may impact on them.
- Terminating high risk consultancy arrangements (which clearly needs to be handled carefully to minimise commercial and legal risks).
- Taking steps to “break the chain” of accrued employment liabilities where former consultants are re-engaged as employees.
- Putting in place arrangements to monitor and assess deemed employment status on an ongoing basis.
- Ensuring the organisation has reasonable procedures, including due diligence processes, reporting procedures and staff training, to protect it against liability for facilitation of tax evasion by its consultants.
- Reviewing and (where necessary) improving the organisation’s contractual documentation to protect the organisation’s interests.