As widely anticipated, it was announced in the Budget on 29 October 2018 that the public sector IR35 off-payroll working rules will be rolled out to the private sector. The government's summary of responses to last summer's consultation on off-payroll working in the private sector was published on the same day. From 6 April 2020, responsibility for assessing IR35 tax status for personal service company (PSC) contractors working on assignments in the private sector will pass from the contractors to the staffing companies that engage them (or to the end user client where there is no staffing company).
Implementation could have been as early as April 2019. However, the government took on board responses to last summer's consultation and delayed the introduction of the new rules until April 2020. In addition, the new rules will not apply where the end user client is a small company, which, according to HM Treasury's Budget brief, amounts to 1.5 million businesses. The government intends to use similar criteria to define a small company as those in the Companies Act 2006 under which a company qualifies as small if it satisfies two or more of the following requirements in its financial year:
- no more than £10.2 million turnover;
- balance sheet assets of no more than £5.1 million; and
- an average number of no more than 50 employees.
What will this mean?
Large and medium-sized private sector end user clients will have a duty to inform staffing companies that supply the services of PSC contractors to them whether they would regard the individual contractor as their employee if they engaged the individual directly. Staffing companies, instead of contractors, will have to deduct employment income tax and employee's National Insurance [it's generally standard practice that National Insurance is capitalised] contributions (NICs) from the contractor's fees and pay employer's NICs if the assignment is within IR35, that is, if the contractor would be deemed to be an employee of the end user client were it not for the other companies in the contractual chain. Payments a staffing company makes to PSC contractors within IR35 will count towards the staffing company's pay bill for the purposes of the apprenticeship levy, which it has to pay if its annual pay bill is more than £3 million.
End user clients will risk any liability to pay tax and NICs transferring from the staffing company to them if they fail to:
- inform the staffing company of their conclusion on employment status within the time allowed;
- take reasonable care in coming to their conclusion on employment status; or
- provide a written response to any questions raised by the staffing company about their reasons for reaching their conclusion on employment status within 31 days of receipt of a request.
The government is planning to issue a second consultation document in the coming months. This will focus on the detailed operation of the reform. Draft legislation, informed by the responses to the consultation, is expected to be published next summer. The new IR35 rules for the private sector will more than likely echo those currently in place for the private sector. However, there may be some additional more stringent requirements for the private sector which will probably be extended to the public sector too. These could include:
- Refinements to help businesses make the correct status determination and make sure that they are not incentivised to make the wrong determination.
- Penalties for end user clients which make blanket decisions on employment status or otherwise fail to use reasonable care in making their status determinations.
- Sanctions imposed on staffing companies which disregard an end user client's conclusion that a contractor is a deemed employee and decide that a contractor is outside IR35. If proposed, an obligation to apply the end user client's status determination should be strongly resisted by staffing companies which should, as the tax payers, seek to retain control over how they assess their own tax liabilities. This could cause particular difficulties if the end user client concludes that a contractor is not its deemed employee and this conclusion is not correct. The staffing company will then be on the hook for the resulting tax and NICs payments, unless this can be covered off in the contract between the staffing company and the end user client.
What should staffing companies do now?
Staffing companies that want to ensure they retain clients and contractors should act now if they have not already started planning ahead. Many staffing companies left it very late when the public sector rules were introduced, although to an extent this was understandable given that significant amendments to the draft legislation were issued only weeks before the implementation date. Even though there will be a further consultation on the roll out of the public sector rules to the private sector and the publication of draft and final legislation is months away, it is fair to assume that we know largely what the new rules will look like and planning can and should start now as implementation will take time. Staffing companies should devise a strategy and consider including the following key components:
- Assigning a team to educate themselves and the business on the new rules and take responsibility for planning for the implementation of the new rules.
- Making a full assessment of their contractor base and considering how to engage contractors going forward, including exploring alternative engagement models, such as project-based contracts or provision of the full outsourced service.
- Reviewing clients by size to work out which are small companies and will be exempt from the new rules.
- Working with all end user clients to educate them on the new rules before they come into force, making sure that large and medium-sized businesses are aware of their obligations and ensuring in particular that they understand that the legislation will not permit them to take a blanket approach to assessing status and simply decide to treat all contractors as being within IR35.
- Finding out from large and medium-sized end user clients which contractors are business-critical and exploring options.
- Communicating with and educating contractors.
- Training recruitment consultants to understand the new rules and be able to deal with straightforward queries from clients and contractors and know where to refer more complex queries internally.
- Reviewing existing client and contractor contracts and varying them where necessary or entering into new ones. Remember that contracts must reflect reality and the correct status. Look out for "own goals" because of inaccuracies in contracts.
- Anticipating the introduction of the new rules when tendering for new client contracts and factoring this in when negotiating and entering into new contracts.
- Changing or setting up systems for onboarding, invoicing, payment and payroll processes to take account of and apply the new rules.
- Forward planning to monitor employment status during assignments.
What can be learned from the public sector roll out?
When planning ahead, it is worth noting that the introduction of the off-payroll working rules in the public sector prompted the following:
- Rate increases for business-critical contractors within IR35 and lower fees or termination of assignments for others, with some contractors becoming permanent employees of end user clients.
- Contractors moving to the private sector. Will contractors on assignments in the private sector with large and medium-sized businesses move to assignments with small companies when the private sector rules come into force meaning that they can continue to assess their tax status?
- The engagement of contractors directly as PAYE workers. This model of engagement brings with it increased compliance burdens in relation to social security benefits and certain employment law protection rights, such as the entitlement to paid holiday and the 48 hour weekly working time limit.
- The engagement of contractors via umbrella companies which take them on as employees. Staffing companies supplying into the public sector significantly favoured this option over continuing to directly engage PSCs they assessed as being within IR35 or directly engaging contractors as PAYE workers. It is important that staffing companies only engage with accredited umbrella companies and avoid those with contractor offerings that sound too good to be true. Staffing companies face increasing risk exposure in the areas of facilitating and enabling tax evasion and avoidance.
- "Margin only" contracts under which the end user client engages and pays the PSC directly and pays the staffing company its margin only. This moves IR35 liability to the end user client. It also makes the Agency Workers Regulations an irrelevant consideration because the "margin only" model takes PSCs completely out of scope. The downside to this model is that the staffing company potentially loses ownership of contractors. However, appropriately drafted restrictions in client contracts and, where the Conduct Regulations do not apply, in contractors' contracts can prevent this.
- Contracts for the full outsourced service rather than the provision of workers' services. These have become known within the industry as "statement of work" contracts and mean that the off-payroll working rules do not apply. Some staffing companies have built in-house expertise in the skills of the contractors whose services they supply and are able to contract with clients to provide these services. This has added burdens, such as increased liability exposure and insurance costs, but these should not be insurmountable.
- Project-based contracts. Historically, contractors and clients have been reluctant to enter into project-based contracts rather than time and materials consultancy contracts. However, contracting on a project basis, with fixed prices for the provision of pre-defined deliverables and, for example, success fees for achieving milestones and project credits for failing to meet key performance indicators, is outside the scope of the off-payroll working rules.
- Assignments that allow substitution of the contractor with substitution occurring in practice. The right to substitute is an indicator of self-employment which, combined with other self-employment indicators, will mean that a contractor is outside IR35.
Staffing companies that embrace the challenges and continue to engage and supply PSC contractors will need to work with clients and contractors to assess IR35 status. Options for how to do this include:
- Making their own status assessments, possibly with guidance from advisers.
- Using HMRC's online CEST (Check Employment Status for Tax) tool. This tool has crucial deficiencies, including not testing for one of the three key employment indicators, mutuality of obligation (the obligation on an employer to provide work and the obligation on an individual to accept that work), and is not suitable for some types of contractors nor for assignments in certain sectors. It also does not align with decisions in recent tax tribunal cases. HMRC does, however, plan to work with stakeholders to improve CEST and associated guidance to ensure it meets the needs of the private sector before the new rules come into effect. It is intended that enhancements to CEST will be introduced before the new rules come into force. Whether or not any such improvements are sufficient remains to be seen.
- Outsourcing the IR35 status assessment to a third party provider, some of which provide an insurance-backed offering. These, however, must be scrutinised beyond the sales pitch to ensure that the written contracts properly reflect the offering.
The key to a successful transition will be the ability of staffing companies to educate and work with their clients and contractors from an early stage. Making sure that clients and contractors understand the off-payroll working rules and are not unsettled will be a valuable investment of time which should help smooth the process and retain client and contractor loyalty.