There are a rising number of casual staff and consultants as well as a transient/seasonal work force which involves flexible payment and working arrangements. Employers report that the number of people requesting the right to work flexibly has gone up on average by over 75% in the last three years.

Employers generally want to send out a positive message to the workforce about flexible working to be able to reap the benefit of retaining staff who might know the business well but want flexibility in working. Sometimes employers will offer flexible contractual arrangements and some of these will involve making payments off payroll.

Following the recent decision by the Court of Appeal in Christianuyi Limited & Others v HMRC [2019] WECA Civ 474 and ahead of IR35  changes being rolled out for the private sector, we look at the changing flexible working landscape and consider the tax risks involved in hiring self-employed contractors. Is it becoming harder to engage freelancers?

Personal Service Companies and IR35

In last autumn's budget the Chancellor announced the government's latest measures to combat what HMRC sees as ‘false self-employment’ by shifting who bears the risk of PAYE and employers NICs under IR35 rules. Since then there has been media coverage of cases involving challenges by HMRC to some of the BBC's high earning stars who are being paid through a personal services company (PSC).

Unfortunately decisions of the courts and tribunals used to interpret whether IR35 applies have not always been helpful and HMRC's online checker is generally considered to fail to take full account of an individual situation. The questions asked by HMRC focus on whether the PSC has the right to provide a substitute to provide the services, the extent to which the individual has control over how they undertake their assignment, and whether there is an obligation for the business to offer work. Eagle-eyed employment specialists and HR advisers will recognise these considerations as similar to the recent cases of Uber BV v Aslam [2018] EWCA Civ 2748 and Pimlico Plumbers Ltd v Smith [2018] UKSC 29. In those cases these factors were applied to employment status for the purposes of determining employment rights but they are equally applicable considerations for determining tax status. Unfortunately, although a useful guide, they are not definitive of tax status.

Essentially if somebody behaves and is treated like an employee then the likelihood is that they are an employee and so cannot receive payments gross. If IR35 is found to apply, income tax and national insurance will be deducted before payment to the individual contractor as if they were PAYE employees.

Up until now the risk of a contract falling inside IR35 meant that the payroll liabilities would fall on the PSC and not the paying business (i.e. there would be no transfer of tax liability from the PSC to the business/fee-payer).

Changes in the public sector

In April 2017 responsibility for assessing engagements with PSCs working in the public sector shifted to the public sector end user. Consequently where engagements between a public sector end user and a PSC have the features of employment, the fee payer must account for tax and NIC under PAYE when paying the worker (including employer NICs). This means an extra cost to the end user.

It is worth noting the UK’s PAYE regime is subject to various territorial limitations which are now broadly mirrored in the public sector. The starting point is that the PAYE obligation rests with the end user if it is resident or has a place of business in the UK. In the PSC supply chain the PAYE obligation falls on the last on-shore payer in the chain before the person controlled by the worker (i.e. the PSC) or failing that the client. A client is deemed resident in the UK for PAYE obligations if it is deemed to be the fee payer, the individual worker is UK resident and they spend some time working in the UK.

For corporate supply chains and gig platforms it is easy to see how PAYE obligations could now be missed in cases where it is unclear who the last on-shore payer is in the chain.

Incoming reform to the private sector

In 2018 the Chancellor confirmed that the public sector rules will be extended to the private sector from April 2020, but with an exemption for small businesses.

Using similar criteria to the Companies Act 2016, to qualify as ‘small’ a business must meet two of the following three requirements:

  1. An annual turnover of not more than £10.2m.
  2. A balance sheet total of not more than £5.1m.
  3. Not more than 50 employees.

A similar test will also apply to non-corporate entities such as partnerships. Note that although many charities will fall under the definition of public authority in the 2017 reforms, others may now be caught by the extensions into the private sector.

Manages Service Company (MSC) Rules

The MSC legislation was introduced in 2007 to prevent contactors using third parties to manage their tax affairs under the disguise of a limited company status.

Where a company is set up to provide a worker’s services to an engager and the MSC legislation applies, amounts paid to an MSC for those services that are not already subject to PAYE Income Tax and Class 1 National Insurance contributions (for example, share dividends), are treated as employment income.

Following Christianuyi, the first significant case on Managed Service Company legislation, how do you spot a MSC? The test is not one of disguised employment. Instead a PSC (which falls outside of IR35) will be a MSC if there is a MSC Provider in the supply chain. The MSC Provider will generally promote the use of such companies and provide the structure. The worker, despite being a shareholder, does not exercise control of the company. A business will be a MSC Provider if its business is promoting or facilitating the use by individuals of companies through which the individuals will provide their services to the end client.

Added risk for professionals

If an accountant helps an individual contractor operate their PSC, either by helping to set it up, running the payroll or other administrative/management services, they could risk falling into the trap of being a MSC Provider and HMRC could pursue them for the relevant unpaid taxes. Any business, such as a law firm or staffing company, that refers a contractor to an accountant or other business (who is a MSC Provider) could also be liable for taxes, particularly where there is a referral fee or regular arrangement.

The outcome of Christianuyi potentially makes it much easier for HMRC to use MSC legislation. Parties in the supply chain that were relatively low risk, such as staffing companies and gig platforms, now potentially face a significant retrospective liability. HMRC are already looking to open further cases in this area, but how far their reach will extend and who will be affected is not yet clear.