Like many organisations, professional services firms have found that consultancy arrangements are a versatile way of engaging and retaining staff. Consultants can be used to provide extra capacity for big projects or bring specialist expertise, whilst a consultancy arrangement can allow retiring partners to continue to work with their firm in a different capacity.
As we reported last year, the Government is introducing fundamental changes to the tax rules (often referred to as IR35) that apply to consultants engaged through intermediaries (such as personal service companies) in the private sector. Despite calls to delay the implementation of the new rules until at least April 2021 to give businesses enough time to prepare, the Government has now confirmed that the new rules will take effect from 6 April 2020.
Where the new rules apply, they will significantly increase the administrative and compliance burden on firms that use consultants. This means that firms using consultants should be preparing for the new rules now and taking steps to actively address the compliance challenges created by the new regime.
Read on to find out what practical steps we recommend your firm should take now.
1. What is changing?
Under the current IR35 rules, where a consultant is engaged via an intermediary (such as the consultant’s own personal service company), the intermediary is responsible for determining the consultant’s deemed employment status for tax purposes and, where appropriate, accounting to HMRC for PAYE/employer National Insurance/social security contributions.
The Government believes that only 10% of personal service companies are applying the current IR35 rules correctly. The reforms are intended to increase compliance by making the end-client responsible for determining the consultant’s deemed employment status and, where appropriate, making PAYE deductions and paying employer National Insurance/social security contributions on the consultancy fees. The Government estimates that over 66,000 businesses will be impacted by the new rules.
2. Who do the changes impact?
The reforms to IR35 will apply to all large and medium-sized companies, limited liability partnerships (LLPs) and unincorporated organisations (including traditional partnerships) that engage consultants through intermediaries. Overseas LLPs, as used by many US law firms, will also be caught. Only companies, LLPs and unincorporated organisations that are regarded as “small” will not be caught by the new rules.
For these purposes, a company or LLP is “small” if it satisfies at least two of the following conditions:
- Annual turnover of up to £10.2m
- Balance sheet total of up to £5.1m
- Fewer than 50 employees
For unincorporated organisations, only the turnover test is relevant so a traditional partnership will only be “small” if its annual turnover does not exceed £10.2m.
However, whatever the size of your firm, you should be aware that the reforms to the off-payroll working rules are part of a wider package of measures to crack down on perceived unlawful tax avoidance, and firms should expect an increased level of scrutiny over the tax treatment of staffing arrangements. Following a change to the law in September 2017, all businesses (whatever their size) that fail to take adequate steps to ensure their staffing arrangements do not permit the facilitation of tax evasion by third parties in their supply chain are also at risk of being subjected to criminal penalties.
3. How will the reforms to IR35 impact your firm?
If your firm is a large or medium-sized business and engages consultants through intermediaries, once the new rules come into force in April 2020, as the “client” of the consultancy services your firm will need to:
- Determine each consultant’s deemed employment status. To prevent “blanket determinations”, the legislation provides that a determination will be invalid if the client fails to take “reasonable care” in reaching its conclusions.
- Notify the consultant of the determination and the reasons relied on for the determination. If the consultant disagrees with the determination, the client must provide a dispute resolution process that allows the consultant to challenge the determination.
- Where it is determined that the rules apply and your firm is responsible for paying the consultancy fee directly to the personal service company then it must:
- Deduct income tax and employee National Insurance/social security contributions from the consultancy fee and account to HMRC for them; and
- Pay employer National Insurance/social security contributions on the consultancy fee.
If the fee is paid to the personal service company via an agency, then the agency (as the “fee-payer” for these purposes) must operate PAYE deductions and account to HMRC for them.
As well as increasing the administrative and compliance burden on firms, the new rules are also likely to result in increased costs that will need to be factored into business plans and pricing models (not least the costs of employer National Insurance/social security contributions for “consultants” who are deemed to be employees for tax purposes and updating the payroll to operate PAYE in respect of such individuals).
Firms that fail to comply with the new rules are at risk of financial penalties or unpaid tax and National Insurance/social security contributions. In addition, firms that cannot demonstrate that they have “reasonable prevention procedures” in place to prevent the facilitation of tax evasion in their supply chains also risk criminal penalties, which can include unlimited fines, confiscation orders and serious crime prevention orders.
The consequences of non-compliance with IR35 and/or a criminal conviction for failure to prevent tax evasion are likely to extend far beyond the immediate financial penalty. It may require disclosure to professional regulators both in the UK and overseas and prevent the firm from securing and retaining business. It is also likely to trigger increased scrutiny from HMRC in respect of the firm’s overall tax compliance and result in adverse publicity and significant reputational damage.
4. What do you need to do now?
Many public sector organisations vastly underestimated the time and resources required to comply with the new rules when similar changes were introduced in the public sector in 2017. We strongly encourage firms in the private sector to learn from this and start planning for the reforms now. Below is a checklist of the practical steps we recommend you take to help protect your firm from the risks outlined above.
A. Carry out an audit of your firm’s consultant population.
- The first step is to identify potential risk areas by carrying out a critical review of existing consultancy arrangements to identify any individuals that are at high risk of being deemed to be employees for tax purposes.
- Firms can do this internally by using the Government’s free online “CEST” (Check Employment Status for Tax) tool (although there has been much criticism of this tool) or contact Fox Williams for support.
B. Analyse the results of the audit
- Identify high risk cases where action should be taken without delay.
- Flag cases that require careful monitoring (e.g. where there are indications that deemed employment status may change).
- Identify improvements to contractual documentation and working practices to manage risks going forward.
C. Prepare an action plan
The audit will help you prioritise the follow-up actions required to manage the firm’s exposure. Steps may include:
- Talking to your consultants about the changes in the rules and how this may impact on them.
- Terminating high risk consultancy arrangements (which clearly needs to be handled carefully to minimise commercial and legal risks).
- Taking steps to “break the chain” of accrued employment liabilities where former consultants are re-engaged as employees.
- Putting in place arrangements to monitor and assess deemed employment status on an ongoing basis.
- Ensuring the firm has reasonable procedures, including due diligence processes, reporting procedures and staff training, to protect it against liability for facilitation of tax evasion by its consultants.
- Reviewing and (where necessary) improving the firm’s contractual documentation to protect the firm’s interests.