6 April 2021 will see the implementation of the biggest reform in the engagement of contractors for decades. The changes were originally scheduled to come into force on 6 April 2020, but implementation was delayed due to the coronavirus pandemic.
What is happening?
The off-payroll working rules (also known as IR35) are designed to reduce tax avoidance in situations where an individual (the “contractor”) provide services to an entity (the “end-user” or “client”) through a personal service company (“PSC”), or other relevant intermediary.
Currently, in relation to private sector clients, the PSC must determine whether the contractor would have been deemed an employee of the client for tax purposes were it not for the existence of the PSC. If so, the PSC must operate payroll, make statutory deductions (through PAYE) and pay employer's National Insurance Contributions on the fees received for the services.
The rules applicable to public sector clients require the client (rather than the PSC) to make this determination. However, from 6 April 2021, those rules will apply to certain private entities too, so responsibility for determining the tax status of the contractor will shift from the PSC to the client.
In respect of payments made on or after 6 April 2021:
- the new rules will apply if they relate to services provided after that date;
- the new rules will not apply if they relate to services provided before that date; and
- a just and reasonable apportionment will be required if some of the payments relate to services provided before 6 April 2021 and some to services provided after that date.
Who will be impacted by the changes?
Medium or large private sector entities with a UK connection will be caught by the new rules. That is, companies, limited liability partnerships and unregistered companies which satisfy two or more of the following conditions:
- an annual turnover of more than £10.2 million;
- a balance sheet total (i.e. the total amounts shown as assets on the balance sheet before deducting any liabilities) of more than £5.1 million; and
- have more than 50 employees.
An entity has a “UK connection” for these purposes if it is resident or had a permanent establishment in the UK immediately before the tax year in which the contractor provided services to it.
Small companies and those which do not meet the above conditions for two consecutive financial years fall outside the regime and, in those cases, determining the tax status of the contractor will remain with the PSC. However, it is important for such entities to have systems in place to identify when they may be caught and take action accordingly.
If a company is part of a group of companies, its parent must fall outside the above conditions in order to be exempt. There are detailed provisions on how group figures are aggregated for these purposes. An important point to note is that this aggregation includes overseas companies within the group. So a small UK company client which has a large overseas parent would be caught.
The new rules do not apply where the arrangement falls within the agency provisions of the relevant tax legislation (i.e. where an agency contracts with the contractor directly, is treated as their employer and operates PAYE on the amounts it pays to the contractor).
Fully outsourced services also fall outside the scope of the new rules.
How to make the status determination
Clients are required to exercise “reasonable care” in determining the tax status of their contractors under the new rules (i.e. act in a way that would be expected of a prudent and reasonable person in the client’s position) and HMRC has issued guidance on what that means.
HMRC has acknowledged that what constitutes “reasonable care” will vary depending on the client. Failure to take “reasonable care” in carrying out the status determination will result in the client being treated as the contractor’s deemed employer for tax purposes.
The status determination exercise should involve a consideration of all the circumstances, including the express terms of the contract between the parties and how the working arrangement operates in practice. However, as recently confirmed by the Supreme Court in its judgment in the Uber case, the key to establishing a worker’s status for statutory purposes is the facts of each individual case and what happens in practice. The written contract is a factor, but not a determinative one, or even the starting point.
HMRC has created an online tool (Check Employment Status for Tax (“CEST”)) to assess whether a contractor would be an employee for tax purposes if engaged directly. There is also more detailed guidance within HMRC’s Employment Status Manual.
Although CEST has been criticised (and there is no obligation to use it), HMRC has stated that it will stand by the result produced by the tool, provided the information inputted is accurate and it is used in accordance with HMRC’s guidance. It is therefore recommended that CEST is used as the starting point when carrying out a status determination, but that clients also put in place clear and consistent policies on how status determinations will be made, particularly in cases where CEST does not produce a result.
Status determination statement
Once a determination has been made, the client must issue a Status Determination Statement (“SDS”) and provide that to the contractor and to the PSC (or any agency with which the client contracts) before the PSC is paid. This is a new requirement that will impact public sector clients too.
The SDS should record the conclusion reached by the client, together with reasons (this could be a printout of the result produced by CEST).
The status determination must be carried out before payments are made from 6 April 2021 and, thereafter, whenever a new engagement is entered into, or whenever there is a material change to the contract or working practices between the parties.
If the client concludes that the arrangement in question falls outside the off-payroll working rules, it can pay the PSC the gross fee for the services. If, however, it determines that the relationship falls within the regime, it will need to operate PAYE and make the necessary tax deductions and payments.
Clients are responsible for putting in place a dispute resolution procedure to deal with disputes regarding their status determination. If the contractor (or fee paying entity) is of the view that the client’s determination is incorrect, they may notify the client of this (together with an explanation as to why they are of that view) at any point before the last payment is made for the services.
Clients must consider any such notification received and decide whether to issue a new SDS (and withdraw the old one), or inform the contractor that their original SDS was correct, giving reasons. This must be done within 45 days of the client’s receipt of the notification of disagreement. In the meantime, the client may continue to apply the rules in accordance with its original determination.
Failure to comply with these minimum dispute resolution requirements will result in the client (rather than an agency or other intermediary involved) being treated as the contractor’s deemed employer for tax purposes and therefore being responsible for the deduction and payment to HMRC of tax, NICs and the apprenticeship levy.
Contractors who are uncertain about the client’s size (i.e. whether they would be caught by the off-payroll working rules) may formally request confirmation from them and the client must respond to such a request within 45 days. HMRC guidance provides further detail on this.
Implications for clients
The changes may have immediate cost implications for clients in that, if a contractor is deemed to be an employee for tax purposes, that will trigger a requirement on the client to pay 13.8% employer NICs on the fees paid for the services plus, if applicable, a 0.5% apprenticeship levy. Contractors may also seek to make up for any shortfall in their net income as a result of the changes by increasing their fees.
Engaging contractors through a PSC will also carry an increased administrative burden given the above requirements.
Failure to comply with the rules will result in the client becoming responsible for the contractor’s tax and NICs and HMRC penalties would also be triggered, the amount of which may be 100% of the loss in HMRC revenue.
In its briefing paper published on 15 February 2021, HMRC stated that it will not issue penalties for inaccuracies relating to the rules in the first 12 months of their operation, unless there is evidence of deliberate non-compliance. It is therefore important to ensure that all steps taken to comply with the new requirements are well documented.
A determination by a client that the status of a contractor is that of an employee for tax purposes does not mean that they will be deemed an employee under employment law and, therefore, entitled to the legal rights and protections afforded to employees.
Clients engaging contractors via a PSC should take the following steps in preparation for the changes:
- Carry out an audit of all contractor relationships and identify those involving a PSC.
- Carry out a status determination on existing arrangements involving a PSC and issue an SDS before making any payments on or after 6 April 2021. Liaise with the contractor and PSC to agree and implement any changes required to existing contracts.
- Put in place clear processes to be followed by managers and staff responsible for hiring contractors, including guidance on how SDSs will be issued, who will be responsible for carrying out the status determination exercise and how they will be documented and reviewed on an on-going basis and updated if/when necessary.
- Put in place a clear dispute resolution process with regard to status determinations.
- Train staff, including hiring managers and members of the HR, finance and payroll teams on the new rules and any new policies and procedures introduced.
- Consider possible alternatives to engaging contractors through a PSC, such as: a) engaging the contractor as an employee under a fixed-term employment contract; b) restructuring the arrangement so that the client contracts directly with the individual and not through a PSC (so the tax status of the contractor remains the responsibility of the contractor); or c ) engage the contractor through an agency/umbrella contract so that the contractor is engaged directly as an employee by the agency or an umbrella entity which deducts tax from payments made to the contractor accordingly.
- When negotiating terms with a contractor providing services via a PSC in future, ensure the agreement contains necessary protections in light of the new rules, including: a) an obligation on the PSC/contractor to provide certain information upon request to allow the client to meet its legal obligations under the new rules (for example, any information needed to undertake the status determination exercise, or details required to operate payroll);
b) an ability to make changes to, or terminate, the agreement in the event that a status determination exercise concludes that the contractor is an employee for tax purposes (including, for example, an immediate right to deduct tax and employee NICs from the fees payable in such circumstances); and
c) warranties and indemnities with regard to tax.