The Government has launched a consultation to tackle non-compliance with the IR35 regime in the private sector.
If the main proposal in the consultation document is implemented, businesses engaging individuals who supply their services via their own company or partnership (“Intermediary”) would be responsible for determining whether the IR35 rules apply. If the business considers that IR35 applies, the person paying the Intermediary would be responsible for operating PAYE and NICs on the fees it pays to the Intermediary.
What is IR35?
Individuals often chose to supply their services through a personal services company (“PSC”) - that is, a company controlled and owned by the individual. In addition to the protection of limited liability, using a PSC gives the individual the opportunity to save tax by paying dividends rather than salary. Unlike salary, dividends are not subject to employee or employer NICs. In addition, a 45% taxpayer will currently pay tax at an effective rate of 38.1% on dividends in excess of £2,000.
Some years ago HM Revenue & Customs (“HMRC”), concerned by the perceived loss of tax through the use of PSCs, introduced IR35. In broad terms, IR35 applies where an individual personally provides services to a client via an Intermediary and:
- ignoring the existence of the Intermediary, the individual would be an employee or office-holder (e.g. director) of the client; or
- the individual is an officeholder and the services he/she provides through the Intermediary relate to that office.
Where IR35 applies, the Intermediary is required to operate PAYE and account for employer NICs on deemed employment income (broadly, the fees received by the PSC excluding VAT, less a 5% deduction for notional expenses).
Under current law, a business in the private sector engaging an individual via a UK Intermediary will not have any PAYE or NICs liabilities in relation to that arrangement provided there is a valid contract between the parties and the parties act in accordance with that contract.
What is the position in the public sector?
With effect from 6 April 2017, where an individual provides their personal service through an Intermediary directly or indirectly to a public authority client (essentially an organisation to which the Freedom of Information Act 2000 or Freedom of Information (Scotland) Act 2002 applies), the IR35 rules were modified so that:
- The public authority client rather than the Intermediary is responsible for determining whether IR35 applies.
- If the public authority client decides that IR35 applies, the “Fee Payer” (i.e. the person paying the Intermediary) rather than the Intermediary is generally responsible for deducting income tax and employee NICs from, and accounting for employer NICs on, broadly, the fees it pays to the Intermediary (excluding VAT). The employer NICs in respect of the fees paid to the Intermediary are also taken into account for determining the Fee Payer’s liability for the Apprenticeship Levy.
What is proposed for the private sector?
In the new consultation, the Government is primarily seeking views on extending the IR35 rules that currently apply in the public sector to the private sector. While the consultation moots a couple of alternatives to this primary proposal (below), it essentially concludes - in our view correctly - that neither of these alternatives are viable.
The alternatives are:
- Requiring businesses to secure their labour supply chains, by undertaking various checks to help ensure that individuals in the chain who are supplying their services via an Intermediary are complying with the current IR35 rules. Suggestions for appropriate checks include: making sure the supply chain is commercially profitable; checking the history of the Intermediary; and adding a clause to the contract requiring the Intermediary to show evidence of the PAYE returns filed and payments made.
- Requiring Fee Payers to obtain and retain certain information in relation to the IR35 arrangement, such as contracts, shift rotas and line-management reporting requirements.
Given the lack of viable alternatives, it seems likely that the public sector IR35 rules will be extended to the private sector.
When is this likely to happen?
This is the million dollar question! We hope the new rules will not be implemented in the private sector until April 2020, in order to give businesses time to prepare, but an April 2019 start date cannot be ruled out.
What will the implications be?
Although extending the public sector IR35 rules to the private sector will have the advantage of levelling the playing field between the public and private sectors, the implications for the private sector are significant and will require a substantial investment in terms of both cost and time.
The private sector can, however, learn from the public sector’s experience of implementing these rules. Particular issues we have encountered in the public sector include:
- It is notoriously difficult to determine an individual’s employment status. HMRC launched an “Employment Status Service” online tool to help public authority clients to determine whether IR35 applies, the advantage being that HMRC is bound by the result unless it was obtained fraudulently. Many public authority clients use this service, which asks a number of questions about the nature of the relationship between the individual, the Intermediary and the public authority client. It focuses heavily on the right of substitution, however, which in many cases means that IR35 applies. The service has been heavily criticised as being biased towards a finding that IR35 applies, and in about 15% of cases it does not produce an answer at all (in which case, public authority clients still have to determine the individual’s employment status using the normal status tests).
- Many public authority clients adopted a cautious “blanket” approach, deciding that IR35 applied in all cases. This has led to disputes both with the individuals and Fee Payers, with many individuals refusing to supply their services to the public sector unless their rates were significantly increased.
- Fee Payers have also sought to renegotiate their contracts and rates to deal with the additional employer NICs (and apprenticeship levy) costs.
- Fee Payers have had to ensure their systems can deal on the one hand with operating PAYE and NICs on the VAT-exclusive amount of the Intermediary’s fees, and on the other hand ensuring that the Intermediary is paid the correct net amount plus the correct amount of VAT.
Businesses in the private sector using individuals who supply their labour via an Intermediary should start considering the preparations they need to make for the likely implementation of these new rules. These may include:
- Responding to the consultation to make sure their views are heard.
- Identifying contracts with Intermediaries.
- Establishing a process to help staff determine whether IR35 applies and to keep the positon under review.
- Ensuring that payroll and other systems will be able to cope with the changes.
- Considering whether any changes to contracts are necessary (e.g. to determine how to deal with the additional NICs costs), and seeking to renegotiate contracts where appropriate.
The consultation remains open until 10 August 2018.