Staffing companies considering using a consultancy model to escape the complexities of the new private sector IR35 off-payroll working rules, which come into force in April, will find that it is not the 'get out of jail free' card initially anticipated. If done correctly, however, in terms of ensuring compliance with the new IR35 rules, operating a consultancy model should still be less complicated than supplying resource. However, it does have other risks.
On 6 April 2017, responsibility for assessing IR35 tax status transferred from personal service company (PSC) contractors (and other intermediaries such as partnerships) to staffing companies that place PSC contractors on public sector assignments. Under these rules, an assignment is within IR35 if the individual contractor who works on the assignment would be regarded as an employee of the public authority client for tax purposes if that client engaged the individual contractor directly. The public authority client must assess the contractor's status and provide the staffing company with its status determination. If the public authority client determines that it would regard the individual contractor as its employee if it engaged the individual directly, the staffing company is then responsible for deducting and paying deemed employment income tax and employee's National Insurance contributions (NICs) from the fees it pays for the PSC contractor's services and for paying employer's NICs. The staffing company is also treated as the employer for employment allowance purposes. Payments the staffing company makes to PSC contractors within IR35 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.
Postponed by a year to allow businesses to deal with the effects of the COVID-19 pandemic, these rules will be rolled out to the private sector on 6 April 2021 with some changes for both the private and the public sector.
"Contracted Out" Services
In the build-up to the introduction of the new private sector IR35 off-payroll working rules, a number of staffing companies have explored the option of becoming an outsourced service provider contracting with end user clients to supply the services performed by the contractors they place on assignments rather than recruitment and resourcing services. This is because, under the current public sector IR35 off-payroll working rules introduced in April 2017, where there is a provision of outsourced services, such as IT or construction, rather than the supply of labour, the PSC contractor assesses IR35 status and, if the assignment is within IR35, pays the deemed employment income tax and NICs. This is the case if there is any entity in the contractual chain which does not make a "chain payment", defined as "a payment, or money's worth or any other benefit, that can reasonably be taken to be for the worker's services to the client". However, from 6 April 2021, although for this type of engagement model the private or public sector end user client will not have to consider whether or not IR35 applies, the entity which contracts with the PSC contractor (i.e. the consultancy/outsourced service provider) instead of the PSC contractor must assess IR35 status. That is unless it falls within the small company exemption. If the assignment is within IR35, unless exempt, the consultancy/outsourced service provider will have to pay to HMRC the tax and employee's and employer's NICs. This is because the consultancy is supplying services (for example, software development services) to its end user client, not labour (for example, IT contractors), and is therefore regarded as the "client" for IR35 purposes. Contractors engaged by consultancies (or staffing companies) who genuinely work under project-based or statement of work contracts are much more likely to be outside IR35 than those on time and materials contracts.
This is a significant change which will make the consultancy model less attractive when the new rules come into force in April. Although the consultancy will not need to rely on the end user client making and providing it with an accurate status determination, it will now have the burden of assessing employment status itself and making the relevant deductions and payments to HMRC if the contractor is within IR35. Only if the consultancy falls within the small company exemption will it remain the PSC's obligation to assess employment status and account for deemed employment income tax, and NICs if the assignment is within IR35. A company qualifies as small if it satisfies at least two of the following three requirements in its financial year: (a) no more than £10.2 million turnover; (b) a balance sheet total of no more than £5.1 million; and (c) an average number of no more than 50 employees. For qualifying small companies with the right expertise, the consultancy model may therefore remain an attractive option. However, it should be noted that, if a consultancy company is a member of a group of companies, the size of each member, including the consultancy company, is determined by aggregating the relevant figures of all the members. The outcome applies to all members of the group, which might mean that the small company exemption does not apply to a consultancy company by virtue of the size of other members of the group.
In any event, staffing companies should only operate the consultancy model if they are genuinely able to provide the services the contractors perform, including having in-house expertise at least in the form of a project manager. The consultancy model requires the consultancy to take responsibility for the delivery and quality of the services, usually on larger projects resourced by contractors and any internal staff with the relevant expertise. Businesses operating this model should therefore protect themselves by ensuring they have insurance cover which is appropriate for the services being provided. Finally, those converting to a consultancy model should be alert to client fears that the model is not being operated correctly. If poorly set up, HMRC might not consider the services to be consultancy services, but the supply of labour, potentially leaving the end user client with tax liabilities for failing to provide status determinations. HMRC will always look behind the contracts at the reality on the ground.
Properly run consultancy models should, however, mean reduced complexities for IR35 compliance and be more lucrative. The provision of consultancy services generally commands higher fees than labour supply, reflecting the level of risk involved, the higher project management costs and better customer satisfaction. Many staffing companies have in any event (often reluctantly) been operating as consultancies for years under client-imposed contracts and may well have adapted their businesses and insurance cover to take account of this, thus giving them the experience they need to run a successful consultancy model and avoid some of the complexities of the new IR35 rules.