The government is consulting on ways to address non-compliance in the private sector with off payroll working rules (also known as the IR35 rules).
It estimates that the losses to the Exchequer from such non-compliance will reach £1.2 billion by 2022/23 and that while around a third of individuals working through an intermediary should fall within the rules and be taxed as employees, only 10% of that group actually are.
The consultation, which closes on 10 August, also provides an early evaluation of the reforms which were implemented in April 2017 to address non-compliance in the public sector.
Whilst the consultation emphasises that no decision has been made, an extension to the private sector of the reforms to the public sector (at least in some form) would seem to be the lead option. This would be a potentially significant issue for private sector organisations engaging contractors through intermediaries and we consider below what early steps organisations could take to prepare for possible reform in this area. Other options included in the consultation are additional record keeping or encouraging clients’ supply chain management and compliance. However, our expectation is that the government will have a preference for an extension of the public sector system, given its clear advantages to the Exchequer.
The contractor workforce in the UK is growing, in part fuelled by the gig economy but also by the general trend towards more agile forms of working and the related arrangements. Self-employed contractors also provide a flexible solution for organisations trying to work within prescribed headcounts.
While an employer is required to pay employer’s National Insurance Contributions ("NICs") and to make deductions through PAYE for income tax and employee's NICs from payments made to its employees, payments to contractors are gross and there is no employer’s NICs liability.
Incorrectly characterising a relationship between an end user client and a contractor as one of self-employment can have potentially significant consequences if HMRC considers the reality to be disguised employment. The extent of the potential liability would depend on the payments made to the "employee" and the length of the engagement, but would likely be a considerable cost. It could also include penalties and interest and lead to HMRC investigating other arrangements within the employer’s workforce.
Where there is a direct relationship between the client and the individual contractor, HMRC would most likely look to recover the unpaid income tax and NICs from the client as the putative employer.
In the private sector (but no longer the public sector), where the contractor’s services are provided through an intermediary (usually, but not necessarily, a personal service company owned by the individual contractor) the risk position is different as such an arrangement will be subject to the IR35 rules.
The IR35 rules
Introduced in 2000, very broadly the IR35 rules were intended to ensure that individuals working through an intermediary, who would have been regarded as employees if engaged directly by the client, pay broadly the same income tax and NICs as if they were employed. Importantly, it is for the individual to determine whether the rules apply (i.e. whether or not they are actually working for the client as an employee) and for the intermediary to pay tax accordingly.
The tax risk in relation to disguised employment therefore lies, currently, with the intermediary rather than the client.
The government has long been concerned that the IR35 rules are not working effectively and that some individuals providing services through an intermediary are taking a fairly maverick approach to determining their true employment status, or are being compelled by clients to provide services through an intermediary to avoid employer’s NICs.
Additionally there are a number of compliance challenges for HMRC in policing the IR35 rules such as the need to deal with each intermediary on an individual basis, and the long period that can often arise between an engagement and collection of the correct tax and NICs in practice.
Changes in relation to the public sector
In April 2017, changes were introduced in the public sector meaning that the public sector entity i.e. the end user, rather than the intermediary, became responsible for deciding whether IR35 applies (assisted by an online tool known as CEST) and if so for paying tax and NICs. This completely changes the risk profile for the end user. The government considers that this measure has had the desired effect of increasing compliance and it now turns its attention to the private sector.
It has been suggested that the public sector reforms have had a damaging impact on the contractor industry and wider economy including that:
some public sector employers have taken an overly cautious approach to determining employment status and are subjecting all payments to deductions for income tax and NICs;
the reforms have led to difficulties for the public sector in recruiting contractors who are now opting for contracts in the private sector;
in addition to employer’s NICs, increased apprenticeship levy and the administrative costs in undertaking compliance, costs for public sector organisations have risen as a result of contractors increasing their fees to counteract the effect of the reforms;
the CEST employment status tool is flawed in, for example, that it does not consider mutuality of obligations as a factor to be taken into account when determining employment status and that it is biased towards a finding of employment.
In the consultation, however, the government refutes and specifically addresses many of these assertions based on evidence from the public sector. It counters that increased administrative costs for employers have only been on implementation and not long term, there has not been the widespread increase in contractor fees that critics suggest and that the CEST service provides an answer in 85% of cases and of those around 60% have a self-employed outcome.
Practical advice and action points
So what is the possible impact for the private sector? How can organisations prepare for possible reforms given the various unknowns at this stage, including in relation to timescales?
Until the government responds to the consultation and the direction of travel becomes clearer it would be premature to make significant changes to existing working practices.
Nevertheless it would be worth assessing the scale of the impact for your organisation should reforms similar to those in the public sector be introduced by considering the numbers of contractors in the current workforce and any plans to grow or reduce this. As part of this you should:
consider whether the organisation would take more individuals on as employees (perhaps on a fixed term basis) bearing in mind that some contractors may demand this if they are to be taxed as employees. This will mean, in addition to paying employer’s NICs, having to factor in increased costs including in relation to paid holiday, pension contributions and benefits as well as increased statutory employment protection;
budget for any potential increases in contractor rates (or agency fees where contractors are provided through an agency);
be ready to develop (and provide training on) the necessary internal processes to determine employment status using CEST and to make the requisite deductions and employer’s NICs payments where these are applicable;
monitor developments in this area.
It is worth remembering that the consultation and possible resulting reforms only relate to employment status for tax purposes. Even where a determination is made that an individual is self-employed, it does not automatically follow that they are self-employed for employment rights purposes, particularly given the additional “worker status” category that attracts some, but not all statutory employment rights.