HMRC’s latest consultation on off payroll working confirms that the new IR35 rules will be based on the rules that have applied in the public sector since 2017. However, HMRC has proposed a number of changes to those rules which, if implemented, will significantly increase the tax exposure and administrative burden of both private sector and public sector organisations.
What is IR35?
In broad terms IR35 applies where an individual personally provides their labour to a client via their own personal service company or partnership (“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.
What are the latest proposals?
With effect from 6 April 2020, the client - rather than the Intermediary - will be responsible for determining whether the IR35 rules apply.
If the client decides that IR35 applies, generally the person paying the Intermediary (the “Fee Payer”) 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.
If the client decides that IR35 does not apply, the Fee Payer will, as currently, continue to pay the Intermediary gross.
A current issue with the existing public sector IR35 rules is that the client is only obliged to inform the entity with which it contracts of its determination (and, if requested, the reasons for the determination). This has caused difficulties in long supply chains where the client is not contracting with either the Fee Payer or the Intermediary directly.
From April 2020, HMRC proposes that both private sector and public sector clients must inform both the entity with which they contract and the contractor of their determination (and, if requested, the reasons for it).
In addition, all recipients of the determination will be required to pass it (and, if requested, the reasons for it) to the person with whom they contract. This must be done before the first payment is made under the arrangements. HMRC are seeking views on whether to short cut this process by also obliging the client to inform the Fee Payer. This will mean that the client must complete sufficient due diligence on the supply chain to identify the Fee Payer.
Under the existing IR35 public sector rules, the liability to account for income tax and NICs can be transferred from the Fee Payer to another party in limited circumstances. For example, if the client fails to make the IR35 determination on time or fails to take reasonable care in making it, the liability to operate PAYE and NICs remains with the client notwithstanding the existence of a separate Fee Payer in the supply chain.
HMRC is proposing to extend the transfer rules in both in the private and public sector so that, in the event of non-compliance, the entity in the supply chain that fails to comply with its obligations will be liable for the PAYE, NICs and Apprenticeship Levy (“Liability”) unless and until it complies with those obligations.
In addition, if for some reason HMRC is unable to collect the Liability from the relevant entity, the proposal is that that Liability will transfer to the first agency in the supply chain and, ultimately if the Liability cannot be collected from the first agency, to the client.
There is no detail on the circumstances in which HMRC could transfer the Liability, although HMRC give as an example the circumstance where the relevant entity has ceased to exist. However, the concern is that HMRC could adopt a similar approach to that taken under the managed service company regime. Under that regime, HMRC can transfer PAYE/NICs arrears to clients where it is of the opinion that the arrears cannot be recovered within a reasonable period (and certain other conditions are satisfied). HMRC’s view is that three months is a reasonable period for these purposes.
This is a significant change from the current IR35 public sector rules. While combatting non-compliance is a good aim, the proposal will impose a significant burden on clients and/or the first agency in the supply chain to complete detailed due diligence on the other supply chain entities. It will also expose clients and the first agency in the supply chain to tax risks in circumstances beyond their control (for example, if an entity in the supply chain becomes insolvent). Contractual indemnities and warranties will prove of little value in these sorts of situations.
Making the IR35 determination
In working out whether the contractor would be an employee of the client, clients need to apply the normal employment status tests. These look at various factors, such as: whether the contractor is subject to control; has a right of substitution; is integrated into the client’s business or carrying on business on their own account; and whether there is mutuality of obligation between the parties. These tests are case-law based and are notoriously difficult to apply in different factual situations.
To help public sector clients make the IR35 determination, HMRC launched Check Employment Status Tool (“CEST”). While clients are not obliged to use CEST, it has the advantage that the CEST result is binding on HMRC provided that the relevant information has been correctly inputted into CEST.
However, CEST has been criticised as being biased towards a finding that IR35 applies. While CEST asks a number of questions (for example, about the nature of the relationship between the contractor, the Intermediary and the client, the method of remuneration, who decides on the work schedule and the place and manner in which work is performed, financial risk, any reporting or line management duties and any benefits received by the individual) there is a heavy focus on the right of substitution and no account is taken of the lack of mutual obligations.
The Government has reiterated its commitment to improving CEST and also putting in place an education and support package for businesses. However, clients will still need to ensure that they have a robust system in place for assessing employment status.
Where a contractor disagrees with a client’s determination that IR35 applies, the contractor’s only current recourse is to appeal to HMRC. HMRC is proposing to change this so that the client bears the burden of resolving disputes - suggesting that clients should develop their own procedures, based on a set of legislative requirements.
Are there any exemptions?
“Small” private sector clients will be exempt from the new rules and, subject to anti-avoidance provisions, will not be required to determine whether IR35 applies.
A corporate client will be treated as “small” for a tax year if it satisfies at least two of the following conditions:
- annual turnover is not more than £10.2 million
- its balance sheet total is not more than £5.1 million
- its number of employees is not more than 50.
A non-corporate client will be obliged to apply the new rules if either:
- it has both 50 or more employees and turnover exceeding £10.2 million; or
- it satisfies either one of those tests.
Where the client qualifies as a “small”, the Intermediary (rather than the client) will be required to determine whether IR35 applies.
Are we any closer to aligning the employment and tax rules on status?
The IR35 rules only apply for tax and NICs purposes. The new rules do not affect the contractor’s status for employment law purposes or the contractor’s eligibility for statutory payments.
Although the consultation document reiterates the Government’s commitment to reducing the differences between the employment law and tax/NICs rules for determining employment status, it simply says that it will do so in due course.
With the proposed changes, it is more important than ever for businesses to start preparing for the new rules. With a little over a year to go, business should consider the following steps:
- Identify those contractors supplying their labour through an Intermediary and complete due diligence on the supply chain (including the financial position of the entities in the chain).
- Ensure there is a robust system in place to assess a contractor’s employment status regularly and document the determination (and reasons for it).
- Train individuals responsible for making determinations on IR35.
- Identify any adjustments to working practices which would result in contractors genuinely falling outside IR35.
- For contractors falling within IR35, consider whether the contractors are business critical and, if so, budget for the extra costs. For contractors who are not business critical, consider whether to renegotiate or terminate contracts.
- Ensure there is a properly drafted contract for each engagement which reflects the working arrangements and IR35 decision, gives the Fee Payer the right to deduct PAYE and NICs, and includes indemnities and warranties.
- Consider what systems changes are needed (for example, to on-boarding procedures, payroll or accounts payable systems).
You can access the consultation document here. The consultation will be open until 28 May 2019.