Employers will now be responsible for determining the employment status of independent contractors in relation to tax, with the potential to become liable to account for that tax themselves if they fail to do so.
IR35 is the industry moniker for UK legislation affecting the taxation of workers working through intermediaries (such as their own personal services companies). The government is currently undertaking a review of the IR35 rules that come into effect 6 April 2020, which is due to be completed by mid-February. However, the Financial Secretary to the Treasury has referred to the review as a “consultation to make sure that the implementation of these changes in April is as smooth as possible.” As the review has been given a very short timeframe, businesses should continue to make preparations based on the existing legislation, as any changes are not likely to be substantial.
It is currently proposed that the tax treatment of those providing work in the private sector be brought in line with the system currently in place for the public sector, whereby it is the end-user’s responsibility to determine the appropriate tax treatment for that individual. Where a worker falls within the scope of the new rules, end-users will then be required to collect income tax and national insurance contributions through PAYE in the same way as they do for employees. This change was introduced after HMRC found that existing legislation in this area has not been being applied effectively and has led to an underpayment of tax.
Although the government has pledged to review the IR35 legislation due to come into effect in April, as there is currently no timeframe associated with this review, companies should make preparations now, to avoid potentially large tax liabilities if and when the proposed IR35 changes come into force.
Who must comply with IR35?
All end-users will be required to apply the new IR35 rules unless they qualify as “small” companies. For this purpose, a private company is considered small if it is a registered entity which satisfies two or more of the following requirements:
- Its annual turnover is not more than £10.2 million.
- Its balance sheet total is not more than £5.1 million.
- It has not more than 50 employees.
Even companies who are based outside the UK may be subject to IR35. In the first instance, where the entity paying fees (e.g., an agency) is based overseas, the liability will move to the next person above that entity in the contractual chain who is based in the UK (e.g., the end-user). Where both the fee-payer and the end-user are based outside the UK (which would include where an overseas end-user contracts with a UK personal services company), the fee-payer will remain liable under IR35 unless it meets the small-company exception set out above.
Where IR35 applies, the end-user must determine the employment status, for tax purposes, of those working through an intermediary, such as a personal services company.
Where an end-user is procuring the services of an individual through an intermediary, it will be required to:
- produce a Status Determination Statement to communicate its determination of employment status and the reasons for that determination to the individual or organisation with whom it contracts;
- make sure it keeps detailed records of employment status determinations, including the reasons for the determination and any fees paid; and
- have processes in place to deal with any disagreements that arise from determinations, as workers and intermediaries have a right to appeal the determination.
The end-user will be liable for tax and National Insurance contributions (NICs) until it updates the relevant parties with its determination and the reasons for it.
If it is determined that the individual is deemed an “employee” for tax purposes, the end-user is required to deduct income tax and employee’s NICs from fees due and pay employer’s NICs.
The worker has a right to challenge the end-user’s determination of the worker’s employment status and failure to respond to a challenge of status from a worker or intermediary within the 45 day time period will mean the worker’s tax and NICs will be a liability of the end-user.
Determining employment status
When determining the employment status of a worker, a key question to ask is whether that worker would have been considered an employee of the end-user if the worker had been engaged directly, rather than through an intermediary. Generally, if the answer to this question is no, then the worker will not be caught by the changes. However, this is not conclusive because end-users have a responsibility to take reasonable care when making their determination and they cannot apply blanket determinations to all contracted workers, even if they decide that they should all be taxed as employees. To do so would carry the risk of a potential fine.
End-users may use HMRC’s Check Employment Status for Tax (CEST) tool to inform their decision making. However, this is a blunt instrument and further consideration will need to be given to a wide range of factors including, but not limited to, whether the worker is obliged to provide a service personally, whether there is a mutuality of obligation and whether the worker has a right to send a substitute in his or her place.
What do end-users need to do?
End-users must make preparations for these changes now. Preparations should include mapping all contracts with workers through intermediaries which will commence or continue on or after the 6 April 2020, in respect of payments made for services provided on or after that date, in order to determine their employment status as well as ensuring processes are in place for completing determinations in a timely manner for all future engagements. End-users should prepare for the increased administrative burden created by IR35 in addition to the potential tax implications for their organisations.
End-users must also arrange for the necessary documents to be produced in preparation for the changes, including:
- Notices of assessment to existing workers;
- Status Determination Statements; and
- Letters providing notice of the outcome of a dispute.
End-users should also put in place processes to manage challenges to status determinations.