In the run up to 6 April 2017, battle commenced in the public sector against the use of personal service companies (PSCs). Final legislation published in March 2017 confirmed that public sector end users (PSEUs) are responsible for assessing IR35 status and that whoever pays the PSC is liable for PSC tax and NICs if the PSC contractor is “inside IR35”.
These late changes went further than previous tax legislation in this area, placing PSEUs under a duty to take “reasonable care” in making their assessment: it would not be enough to issue blanket assessments without reasonable regard to the circumstances of each PSC’s assignment. For the first time end users, as well as staffing companies, had some skin in the game.
How have suppliers and users of staff reacted? What followed was a desperate scramble to rapidly re-assess categories of PSC contractor, develop procurement policy, draft new contracts, communicate with PSC contractors and migrate them to new arrangements.
We saw early reliance on mis-informed, superficial advice, peddling of “solutions” that created more risk than they solved and widespread confusion amongst PSEUs, staffing companies and PSC contractors. Things seem to have calmed down for now but as with all new legislation it will take time for those affected to adjust and to find a workable middle ground allowing for commercially sensible assessment and risk reduction.
We have already seen the NHS appear to make a U-turn on its original position to deem all PSC contractors inside IR35 (possibly due to a Mexican stand-off it had with locum doctors and the threat by the Locum Doctors Union to seek a judicial review) and we know that other PSEUs have started to back away from issuing overly cautious IR35 assessments. At the same time some of the “obvious” abuse HMRC was trying to close down seems to have ended. HMRC have confirmed that the number of hospital-based nurses working through PSCs has already significantly reduced and we know of other roles that have been treated as highly unlikely to fall “outside IR35”. It seems that PSEUs have taken the IR35 risk very seriously which should be good news for the industry once certainty replaces confusion.
Over the past few months we have been helping staffing companies look at new ways of delivering their services to reduce a range of risks for them and their clients. For years there’s been a blurring between staffing and outsourced services, especially where the outsourced services essentially involve the supply of contract workers. For some, moving into consultancy and outsourcing opens new market opportunities and removes the need to focus compliance effort on complying with an ever- increasing raft of staffing regulation.
Developing an outsourced service model is nothing new and there have always been good commercial reasons for adopting a higher margin model. However, until now, staffing companies and end user clients seemed not to be ready to move away from traditional staffing arrangements. But with the direction of travel of legislation appearing to push liability up the supply chain, it is likely that more end users will be willing to consider alternative ways of procuring contingent resource.
See “How can we help?” below for more information.
So what changed in April? The detail of the final Off Payroll IR35 Legislation
Under the old IR35 rules, the PSC was responsible for determining its contractor’s IR35 status and where it was deemed to have ‘failed IR35’, it was for the PSC to ensure PAYE and NICs were paid to HMRC.
As of 6 April 2017, IR35 was reformed in relation to any supply of services made by a PSC to a PSEU. These reforms mean either the PSEU (where the PSC is directly engaged and paid by the PSEU) or, where one exists, the staffing company/intermediary which pays the PSC (the Fee Payer) will be responsible for assessing whether or not an assignment falls “inside” or “outside” IR35. If the PSC contractor is assessed as being “inside IR35”, the Fee Payer (or, in certain circumstances the PSEU) will be responsible for ensuring that PAYE and NICs are paid in respect of all deemed income received by the PSC.
End users’ caution
Some significant changes were made between the draft and final stages of this legislation, increasing obligations on PSEUs to provide their opinion on whether or not a PSC contractor is “inside” or “outside” IR35 to staffing companies providing PSC contractors to them, and where requested, to provide reasons for their particular opinion. It is important to note that whilst the PSEU must provide an opinion, it is not liable if its opinion is incorrect, unless it fails to take “reasonable care” in making its assessment. If the PSEU fails to take reasonable care in its assessment that someone is “outside” IR35, then any liability for PAYE and NICs on PSC deemed income will pass to the PSEU.
As a result PSEUs now risk becoming liable for PAYE or NICs on payments to PSCs even where the PSEU is not paying the PSC directly.
One big question is: will the PSEU be liable if it finds someone to be “inside” without exercising reasonable care and if so liable for what?
“Reasonable care” is not defined and there is no statutory sanction in the legislation for failure to comply with this duty where, for example, blanket “inside” assessments are given. However the legislation does introduce the possibility of a claim in negligence and, as we have already seen, judicial review challenges have already been threatened in relation to some decisions issued by the NHS. Claims in negligence or judicial review would not be straightforward, but even so PSEUs should guard against issuing blanket “inside” IR35 assessments: to do so risks legal challenge from the contractor community.
HMRC’s on-line tool
Prior to 6th April there was much debate about the use of HMRC’s long awaited online tool to assess the IR35 status of PSC contractors. Made available in late February 2017 after months of beta testing, the tool allows PSEUs, staffing companies and PSC contractors to carry out an assessment.
It seemed to provide a solution to the question of how assessments could be carried out in a reliable way. However, as HMRC would be the first to agree, the online tool is merely an indicator of IR35 status and is not intended to provide a definitive, legally binding opinion. Those hoping to rely on the tool were, therefore, disappointed to find that it did not necessarily provide the “get out of jail free” card they had expected.
We have seen a number of other non-HMRC approved IR35 assessment services develop, some of which offer rigorous and legally meaningful assessment and some of which don’t. The challenge for PSEUs and staffing companies is to work out whether any of the services offer greater protection than the HMRC tool and, if so, whether it is a cost worth paying for.
Sensible informed use of HMRC’s tool is one way forward?
We expect to see a growth in the number of reputable, specialist payment intermediaries, offering legally tested IR35 assessment services. Until then, sensible, informed use of HMRC’s tool seems to be one way forward, especially as it seems that HMRC has confirmed that it will rely on the results unless they suspect they are based on inaccurate or incomplete information. In other words HMRC will regard itself as entitled to dismiss findings of “outside” which stem from “gaming” of the tool.
…but with caution
If using the HMRC online tool it is important to be aware of the following:
- the tool has no statutory effect, so even if it makes an “outside IR35” decision, neither HMRC nor the tax tribunals are legally bound by that decision;
- as it currently stands the online tool may represent HMRC’s views but it does not necessarily fully reflect employment and IR35 case law. There has been much comment about the fact that the tool focusses heavily on the potential ability of the contractor to provide a substitute (regardless of whether or not this happens in practice). Employment case law is relevant because the IR35 test is based on an assessment of a hypothetical contract between the end user and the PSC contractor. If the hypothetical contract would (if it existed) meet the employment case law tests then the PSC assignment should fall “inside IR35”.
- information entered into the assessment tool must be correct. If there are any inaccuracies or misunderstandings (as mentioned above) HMRC can disregard the results;
- some clients and contractors may have a vested interest in entering information to get the result they desire; and
- if all parties carry out an assessment the results may be different. In practice this should prompt a closer look at the information inputted to identify which result is likely to be the best representation of the assignment.
Substitution: when can you rely on this as a “get out”?
Substitution is relevant to the question of whether or not a contractor is obliged to provide their personal service. In most cases an unfettered right to substitute would be enough to remove a crucial part of the employment test. However, in practice, unfettered rights of substitution are rare and employment tribunals have increasingly disregarded substitution rights in all but the clearest cut cases.
Furthermore, from what we have seen, some PSEUs and staffing companies have confused a PSC contractor’s right to substitute with the staffing company’s right to substitute. This has led to the wrong information being inputted into the online assessment, rendering the result inaccurate and unreliable.
Since making the tool available, HMRC have clarified a couple of points relating to substitution rights. HMRC confirmed that if the right of substitution is conditional on the substitute having to be selected from a pre-approved pool of workers regularly engaged by the PSEU, then this would indicate that the right of substitution is fettered. This means that what might appear to be a contractual substitution right does not go far enough to remove personal service.
Conversely, in recent conversations we have had with HMRC, they have clarified that the need for any substitute to be pre-cleared for site and security purposes or to have specialist qualifications would not necessarily be regarded as fettering a right of substitution. This is good news for users and suppliers of independent subcontractors working on public sector construction projects.
After the battle – what seems to be happening now?
We are informed by staffing companies that certain PSEUs continue to issue blanket bans on engaging PSC contractors to the point where even contractors who are genuinely self-employed have been forced onto payroll. As a result the public sector is already struggling to attract PSC contractors, with these contractors demanding sizeable pay increases due to the new legislation’s effects. In certain circumstances, where PSC contractors have not been getting pay increases, they have been walking away from the role, leading to project overruns and staffing crises.
This is clearly untenable for PSEUs. We think it inevitable that they will look to staffing companies/intermediaries to help them resolve these issues. Over time we expect hirers to become more willing to look at new solutions to assist with their growing talent shortage.
Movement to umbrellas?
We understand that many former PSC contractors have as a result of the Off Payroll IR35 Legislation moved into umbrella arrangements. In many cases this seems a potentially efficient way for staffing companies to cope with the demands of running payroll although they will tend to involve reduction in take home pay.
Even this has caused confusion in the market as a result of some recruitment consultants quoting an umbrella rate to the contractor without fully explaining that the rate is the rate paid by the staffing company to the umbrella company; not the pay rate to the contractor.
More worryingly, initial reports (and the situation is very fluid) suggest that in some cases former PSCs are being lured into very aggressive tax arrangements by what often seem to be new umbrella companies. These arrangements can involve loan schemes, new types of expenses schemes and use of the small employer NICs allowance to name but three. Possibly offshore and/or sole trader arrangements are also being used.
Staffing companies and hirers should note that all these schemes could lead to tax debt transfer claims by HMRC. They are very risky and even if not picked up by HMRC immediately, will be picked up if and when you are subjected to due diligence associated with an investment by a third party.
As such some staffing companies have started looking at alternative approaches.
Contracted Out/Output based supplies?
It seems that a genuinely contracted-out service which is not a labour supply will not be affected by the new IR35 legislation. In practice this means that suppliers of deliverables-based services to the public sector will not need to apply the new IR35 rules even if the service is resourced by PSC contractors.
For example, many of the large construction companies and consortia working on public sector infrastructure projects engage the services of PSC contractors to work on their projects on a fixed price deliverables basis. In these cases the contractors’ client is the private sector construction company – not the public sector organisation; and it is the old IR35 regime that applies to the engagement of PSCs such that the PSC remains liable for assessing IR35 status and tax.
We have seen a rise in staffing companies and intermediaries considering developing a contracted-out offering (otherwise referred to as a statement of work (SOW) or consultancy or outsourcing).
This is an entirely different business model to staffing and not appropriate for all. It’s not simply a case of changing a few contracts.
The basis for selling and charging for the services is different and works only if end users are prepared to accept a new way of structuring and procuring contingent resource. As a supplier of a deliverables-based service the service provider becomes responsible and liable for the delivery of the entire project, not just the provision of labour. This is important because staffing arrangements are usually not geared up to risk-manage deliverables and so typically exclude liability for deliverables. Insurers to the staffing industry also tend to exclude liability for deliverables (beyond the supply of staff) from their cover, and invoice discounters can prefer not to lend against deliverables–based invoices.
Having said all this, offering deliverables-based consultancy to clients offers great commercial benefits: margins can increase, a greater share of client spend can be won (winning market share from consultancies), the model is easier to export to new countries without the hassle of local recruitment regulation, and investors may well apply a much higher multiple (if and when you exit) than they would to a staffing business.
Word of warning – if it looks too good to be true, then it probably is
We are aware that some advisors are selling consultancy models as a quick and easy way for intermediaries to pay expenses tax-free and, in the case of public sector contractors, as a way of operating outside the new IR35 rules. If it looks too good to be true then it probably is. We would strongly advise against adopting any of these models without first taking specialist legal advice.
HMRC are likely to regard any arrangements which are clearly designed to make a staffing supply look like a consultancy arrangement to be a sham intended to avoid tax, especially where the service to the end client remains one of labour supply.
Anticipating future battles – supply to private sector end users?
The new legislation leaves IR35 “as is” for supplies to private sector end users. It’s by no means a foregone conclusion that the IR35 changes will be extended to the private sector any time soon. Indeed, we think it’s likely that current political turmoil and Brexit may delay any plans to implement the IR35 changes more widely. That said, many in the industry are predicting a wider scale roll-out in the next two years and with that in mind, are looking at ways to future-proof their business models.
The lessons of the latest public sector IR35 changes suggest that users and suppliers of PSCs may want to start thinking about:
- How many PSC assignments are likely to be considered to be outside IR35? Which types of assignments are definitely “inside”? (For example, it looks like the NHS has generally accepted that nurses are “inside” IR35).
- How PSC contractors working in these roles will react to a rate reduction and conversion to PAYE payroll?
- What might be the cost implications of reducing PSC usage?
- What engagement options will PSC contractors move to?
- What new checks will be necessary?
- Might deliverables/output based consultancy services be a way forward for some clients?
- Check change of law clauses and/or make appropriate amendments to their standard terms to allow higher margins/rates where necessary.
- Prepare to discuss (and where possible, negotiate) rate increases with clients to compensate “likely to leave” PSC contractors for the reduction in their take home pay.