As part of the government's crackdown on 'disguised employment', the IR35 ‘off-payroll’ rules that apply to the public sector will be extended to the private sector. From 6 April 2020, private sector businesses will become responsible for assessing the employment status of the off-payroll workers they engage. These changes are intended to increase compliance with the IR35 ‘off-payroll’ rules that have been in place since 2000 and will directly affect a large number of businesses and contractors.
In the Autumn 2018 Budget, the government confirmed that it planned significant changes to the IR35 tax regime. With effect from 6 April 2020, medium and large companies in the private sector that contract with intermediaries (often, but not always, a personal services company (PSC)) for the provision of workers' services will have to account for tax and national insurance through PAYE in the same way as the public sector has been required to do since April 2017. The requirement applies if, ignoring the intermediary, the underlying relationship between the end user and the worker would be one of employment. At present, the intermediary is responsible for operating PAYE rather than the end user so this represents a significant shift.
Our August 2018 article summarises the IR35 regime and discusses the government's initial consultation on the proposed changes. In Spring of this year, a second consultation was launched, which ends on 28 May 2019. The government is due to publish responses to the consultation this summer, with the proposed legislation to be included in the 2019 Finance Bill.
In the public sector, this shift in responsibility for assessing status and liability for unpaid tax has been in place since 6 April 2017. It has made it considerably less attractive for public sector organisations to contract with intermediaries and, as a result, many individuals who would previously have been engaged via a PSC are now engaged directly on the payroll and tax is deducted through PAYE. It seems likely that the planned changes in the private sector will have a similar Impact.
May 2019 Consultation
In essence, from April next year, new rules will require an end-user client to make a determination on the employment status of an individual supplied via an intermediary and communicate its determination and written reasons directly to: (a) the party that it directly contracts with; and (b) the individual themselves. If the end-user client determines that, but for the intermediary, the individual would be an 'employee' of the end user for tax purposes, it will be the end-user rather than the intermediary that will need to account for income tax and NICs (both employer and employee) on any fees it pays to the intermediary (excluding VAT).
In addition, for more complex arrangements involving a supply chain, HMRC intends to impose an obligation on the parties within the supply chain to pass on the determination and information to parties further down the chain. All such communications must take place at, or before, the time of the first payment under the contract. In the event of non-compliance, the party which failed to cascade the information would bear the tax liability. If HMRC is unable to collect the outstanding liability from that party, for example, because it has ceased to exist, the government proposes that the liability should transfer back up the chain.
HMRC also recognises that there will be situations where the individual providing the services disagrees with the client’s determination. There is no proposal for a formal resolution process: it will be for the client and the individual to resolve. It is proposed that the individual will have a right to request the reasons for the determination and this is intended to accelerate the discussion, with the hope that it will be resolved promptly. However, absent of a challenge from HMRC, the decision as to status will ultimately rest with the end-user client.
Small Company Exemption
The government has decided that the smallest organisations will not be affected by this reform and will not need to determine the status of the off-payroll workers they engage. In these situations, the intermediary will continue to be required to make the necessary determination and operate PAYE where appropriate. The government intends to use the existing Companies Act statutory definition to determine whether or not a corporate client is "small". So where a corporate client satisfies two or more of the following requirements:
- annual turnover of not more than £10.2 million;
- balance sheet total of not more than £5.1 million; and
- number of employees of not more than 50, they will be deemed to be "small" and outside the scope of this reform.
Preparing for Change
As the government reports that the cost, in terms of lost tax revenue, of non-compliance with the off-payroll working rules in the private sector is growing and will reach £1.3 billion a year by 2023/24, it is clear that change is coming and businesses need to take action now.
Last August we recommended that businesses that depend on individuals engaged through intermediaries consider fundamental changes to their engagement models, on-boarding processes, payroll systems and – possibly - their ability to retain talented individuals in flexible roles. The government has since recommended that businesses affected by the proposed reform also:
- look at their current workforce (including those engaged through agencies and other intermediaries) to identify those individuals who are supplying their services through PSCs;
- determine if the new off-payroll rules will apply for any contracts that will extend beyond April 2020. Businesses are encouraged to use the Check Employment Status for Tax service to do this;
- start talking to contractors about whether the off-payroll rules will apply to them; and
- put processes in place to determine if the off-payroll rules apply to future engagements.
Additionally we would recommend that businesses:
- appoint key stakeholders within various business units (e.g. legal, procurement, HR, tax, line management) to assist with determining status;
- ensure that all new contracts (and any extensions of existing contracts) are compliant with IR35 and the new rules. Consider also whether contracts can be 'beefed up', for example by introducing (or enhancing) indemnity protection and introducing a mechanism to enable employment taxes to be withheld, if necessary; and
- assess the likely cost of employers' NIC charges arising under IR35; potential increases in contractors' rates; impact on profitability, cash flow, and supply chain; and the potential for terminating non-compliant arrangements.
Finally, the forthcoming changes to IR35 present businesses with an opportunity to review their current practice on Right to Work checks. Businesses may wish to consider extending the checks beyond the traditional employee/worker population to those considered up until now to be 'independent contractors'.
Businesses now more than ever before need to think very carefully about the labels that they apply to those who work for them to ensure that the label accurately reflects what is happening 'on the ground'. The UK tax authorities will not be swayed by 'sham' contractual arrangements that do not reflect reality and will consider an extensive array of (non-exhaustive) factors when determining status for tax purposes. HMRC provides guidance on these factors as a helpful aide for businesses.