The UK government has recently published draft legislation that, from April 2020, will require many private sector businesses engaging self-employed contractors through intermediary service companies to consider whether payments made to such service companies should be subject to deduction of income tax and national insurance contributions through the pay-as-you-earn payroll tax withholding system.
Providing Services Through Intermediaries
In the United Kingdom, many self-employed contractors provide their services to their clients through intermediary service companies. Historically, this arrangement has provided a number of advantages for both client businesses and contractors—from the perspectives of both UK employment law and UK income tax and national insurance.
Currently, private sector businesses that contract with an intermediary for the provision of services by a contractor do not generally need to consider whether payments made to the intermediary are subject to deduction of UK income tax and national insurance contributions under the pay-as-you-earn (PAYE) system. Instead, the rules commonly known as IR35 require the intermediary to determine whether PAYE withholding is required, and account for amounts due to HM Revenue & Customs (HMRC).
In April 2017, the UK government reformed the application of IR35 in the public sector, shifting the responsibility for determining whether payments to an intermediary should be made subject to PAYE withholding from the intermediary to the public authority engaging them. In broad terms this requires the client public authority to assess whether the contractor would be an employee of the organisation if it had contracted directly with the public authority; i.e., the contract would be one of service, and not for the provision of services.
Private Sector Off-Payroll Working
From April 2020, private sector businesses engaging contractors will need to apply the same rules to their contractor relationships. If it is determined that a contractor should be treated as an employee for the purposes of IR35, the business will need to deduct income tax and national insurance contributions from payments it makes to its corresponding intermediaries, and account for those deductions to HMRC through the PAYE system in the same way it does for payments of salary and other remuneration made to employees. This may require a business based outside the UK and with a limited UK presence to register for PAYE and operate a UK payroll.
There are a number of conditions for the rules to apply, the key ones being that
- the business must not be “small”;
- the intermediary must be
- a company in which the contractor (or associated persons, such as family members) owns or controls at least 5% of the shares and associated voting rights; or
- a partnership in which the contractor or associated persons are entitled to at least 60% of the profits of the contracting activities; or
- an individual; and
- if the business had contracted directly with the contractor, that contract would amount to an employer-employee relationship.
When is a business “small”?
For the purposes of these rules, a business will be “small” if it is a company and satisfies at least two of the following: (1) turnover of less than £10.2 million ($12.6 million), (2) a balance sheet total of less than £5.1 million ($6.3 million), or (3) fewer than 50 employees. These thresholds are tested for the most recent financial year that ended at least nine months before the start of the current tax year (the relevant year).
Businesses that are not companies (such as partnerships and unincorporated bodies) will be small for these purposes if, in the relevant year (or, in certain cases, the preceding calendar year), their turnover did not exceed £10.2 million ($12.6 million). For joint ventures and business entities that form part of a group or are connected with other businesses, the rules contain provisions that will aggregate these thresholds in certain circumstances.
Indicators of employment
The new rules will only apply if the contractor is under an obligation to provide services personally to the client business and also would be viewed as an employee of the client business for income tax and national insurance purposes if the contractor had contracted directly with the client business. This test of whether the contractor would be an employee is broadly the same for tax purposes as it is for UK employment law purposes, and is a question of fact requiring a number of competing factors to be balanced.
Many of the relevant factors are derived from case law and have evolved over time. HMRC has published guidance summarising the factors it considers to be most relevant in determining whether an employment relationship exists (or would exist absent the presence of the intermediary). HMRC considers the key factor to be “mutuality of obligation,” where the business is obliged to provide work to the contractor and to pay for that work, and the contractor is obliged to perform that work. The importance of mutuality of obligation has been demonstrated in a number of recent UK first-tier tax tribunal decisions concerning the IR35 rules, such as Albatel Limited v HMRC and George Mantides Ltd v HMRC, although the tribunal decisions do illustrate the importance of other factors (also outlined in HMRC guidance), such as
- whether the contractor has a right to substitute another person in his/her place to provide the contracted services;
- the extent to which the contractor bears financial risk (for example, whether the engagement can be terminated at short notice, if there is a penalty if the contractor fails to provide the contracted service on time, or if the contractor has to provide his/her own equipment); and
- the extent to which the business controls the contractor and the manner in which he/she performs his/her services.
Implications of the New Rules
If the new rules apply, a person who makes a payment to the intermediary that can reasonably be taken to be for the worker’s services to the business will be treated as making a deemed payment of employment income for PAYE purposes, from which UK income tax and national insurance must be deducted. This means that generally the client business must make the PAYE deduction. If, however, another person (such as an employment agency) is responsible for making payments to the intermediary, that person is responsible for making the PAYE deduction.
The rules set out how the deemed payment is calculated. For example, the calculation excludes amounts in respect of value added tax, the direct cost of materials, and amounts that would be deductible from employment income.
The deemed payment will also attract employers’ national insurance contributions, at a rate of 13.8% of the amount of the deemed payment.
It is important to remember that under PAYE real time information (RTI), a full payment submission will need to be made on or before the making of a payment to the intermediary.
Businesses that may be affected by these rules should do the following.
- Review their current workforce as soon as possible (including those engaged through employment businesses, employment agencies, and other intermediaries) to identify which individuals (if any) supply their services to the business through an intermediary.
- Determine whether any such individuals are likely to fall within the scope of the new rules, and if so, consider whether it is possible to amend the commercial terms on which they have been engaged to take them outside the scope of the rules.
- Where it is not commercially viable for an affected business to amend the commercial terms on which an affected individual has been engaged, prepare for the ongoing payroll and reporting requirements that will become necessary and the additional costs to the business that the new rules may create (such as employers’ national insurance contributions).
- Design and implement processes for determining whether the new rules will apply to future engagements and factor the additional costs into financial modelling when planning resource requirements.
- Review any template agreements used for the engagement of intermediaries and consultants to check whether they will remain fit for purpose and, importantly, that they adequately address the new employment and tax risks presented by the extension of the IR35 reforms.