In the Government's Autumn Statement, the then-Chancellor Kwasi Kwarteng announced the repeal of the recent IR35 reforms and a return to the 'old' IR35 rules from 6 April 2023. This potentially would have seen contractors once again being responsible for assessing their employment status for tax purposes and accounting to HMRC for tax if 'inside IR35'.
Since then, the new Chancellor, Jeremy Hunt, announced in an emergency statement on 17 October 2022 that the repeal of the IR35 off-payroll working rules will not go ahead next April. While this news was disappointing for the recruitment services sector, the possibility of a repeal served to focus minds on supply chains in the recruitment services sector and the opportunities and risks they present.
The off-payroll working rules were introduced for the public sector in 2017 and for the private sector in 2021. They require the end user client to assess the contractor's status and issue a status determination statement, and give the staffing company the liability for any tax due. The introduction of these rules has led to some positive results, including driving up compliance by helping ensure that the correct engagement models are used. They have also helped staffing companies build stronger relationships with their end user clients and the contractors they place when working together to ensure status is correctly assessed.
Failure to prevent the facilitation of tax evasion
When the proposed repeal of the off-payroll working rules was announced in September, much was said about the risk of staffing companies facing unlimited fines and serious reputational damage by being convicted of committing the corporate criminal offence of failure to prevent the facilitation of a UK tax evasion offence by an associated person under the Criminal Finances Act 2017 (CFA). If the repeal had gone ahead, this risk could have arisen, for example, if, come April 2023, inside IR35 contractors, who had been pushed into direct employment or engagement via umbrella companies, returned to engagement via personal service companies (PSCs), but paid tax on a self-employed (outside IR35) basis when they should have been paying it on an (inside IR35) employed basis (thereby committing the offence of cheating the public revenue or one of the other statutory tax offences). It should be remembered though that, even without the repeal, staffing companies should have procedures in place to ensure tax compliance by contractors in order to reduce the risk of falling foul of the CFA. This can be particularly relevant when engaging contractors via umbrella companies.
Since the introduction of the off-payroll working rules, many contractors, who would have been deemed employees of the end user client and inside IR35 if they had provided their services via their PSC, have moved to (or been pushed into) different engagement models. These include providing their services via an umbrella company which engages them as an employee for tax and employment law protection rights purposes. However, it is well known that some umbrella companies are involved in tax avoidance and tax evasion by, for example, operating loan schemes, using offshore arrangements or even engaging contractors via PSCs to which they make payments on the basis that the contractors are outside IR35 when the end user client has determined that the contractors are inside IR35. Staffing companies that turn a blind eye to these and similar practices risk falling foul of the CFA. Staffing companies must ensure that they have reasonable measures in place to prevent the facilitation of tax evasion. This could include only contracting with accredited umbrella companies and ensuring that the umbrella companies directly engage the contractors as employees under contracts of service and provide evidence of deducting and accounting to HMRC for employment income tax and National Insurance contributions (NICs) correctly.
It should also not be forgotten that, if the end user client is a small company, the 'old' IR35 rules (not the more recent off-payroll working rules) apply. PSC contractors on assignments with small company end user clients are responsible for assessing their employment status for tax purposes and, if they are a deemed employee (or an actual or deemed officeholder) of the end user client (meaning that they are inside IR35), accounting to HMRC for employment income tax and NICs on the fees they receive for their services. If a PSC contractor on such an assignment pays tax on a self-employed (outside IR35) basis when they should be paying it on an (inside IR35) employed basis and no checks have been carried out to find out how the PSC contractor is accounting for tax, this could mean that the staffing company (and the relevant end user client) have failed to have reasonable measures in place to prevent the facilitation of tax evasion. In order to try and protect themselves against corporate criminal liability under the CFA, staffing companies which place inside IR35 contractors on assignments with small company end user clients via PSCs should ensure that their contracts include an undertaking from the contractor that they will deduct and account for tax and NICs on an inside IR35 basis and an obligation to provide evidence of this.
Fraudulent evasion of income tax
In addition to the possibility of committing an offence under the CFA, staffing companies should also be aware that, under the Taxes Management Act 1970, the offence of fraudulent evasion of income tax extends to a person who is knowingly concerned in the fraudulent evasion of income tax by another person. A person will be "knowingly concerned" if they have knowledge of the fraud and actual involvement in it.
It is possible that, in a scenario where a staffing company knows that a PSC (on an inside IR35 assignment with a small company end user client) or an umbrella company is dishonestly failing to account properly to HMRC for the purposes of income tax, it may itself fall within the remit of this offence. Any director who holds the requisite intention for the offence may also fall within its remit.
The maximum sentence for fraudulent evasion of income tax for a corporate entity is an unlimited fine. Serious reputational damage is likely to accompany this.
A money laundering offence may also be committed. Under the Proceeds of Crime Act 2002, it is a criminal offence to enter into or become concerned in an arrangement that you know or suspect facilitates the acquisition, retention, use or control of criminal property by or on behalf of another person.
Where a person has obtained a pecuniary advantage, they are treated as having obtained criminal property in the sum of that advantage. A pecuniary advantage can result from the evasion of tax. In such a case, the value of the pecuniary advantage is the amount of the tax unpaid.
In a scenario where a staffing company knows or suspects that a PSC (on an inside IR35 assignment with a small company end user client) or an umbrella company is failing to pay the appropriate amount of tax to HMRC, but nevertheless continues the commercial arrangement, it may be committing this money laundering offence. Any director who is aware of the arrangement and holds the requisite knowledge or suspicion may also fall within the remit of the offence.
The maximum sentence for a company guilty of this offence is an unlimited fine. Again, serious reputational damage is likely to result.
The managed service company tax regime
The managed service company (MSC) tax regime can also pose a risk to staffing companies.
Some contractors engage an accountancy service provider to set up and administer a company through which the contractor can provide their services. HMRC regards these contractor companies as MSCs and liable to pay employment tax and NICs. If a company is an MSC, but the off-payroll working rules apply, the off-payroll working rules take precedence. If, however, a company is an MSC and the 'old' IR35 rules apply, as is the case when the end user client is a small company, the MSC legislation takes precedence.
Under the MSC tax regime, HMRC does not have to investigate the nature of the relationship between the contractor and the end user client to establish whether, in the absence of the contractor's PSC and the staffing company in the contractual chain, an employment relationship would exist between them. Instead HMRC looks to see if the contractor has been helped with setting up and running their company. This is much easier to establish than assessing employment status.
The obligation on an MSC to pay employment tax and NICs can move up the supply chain. To avoid this risk, staffing companies should not refer contractors to accountancy service providers (MSC providers) in return for referral fees from these providers, however strong the lure of extra profit may be. This could lead to a finding that the staffing company has facilitated company set up and is liable to pay HMRC any employment tax and NICs the MSC, its directors or the MSC provider have failed to pay. Staffing companies should also obtain a warranty from contractor companies that they are not an MSC.
What does the future hold for IR35 and the off-payroll working rules?
Although the 'old' IR35 rules and the off-payroll working rules appear to present more risks than opportunities, the risks can be managed and staffing companies that understand these tax rules and related risks are able to prove their worth to their clients and contractors and cement these valuable relationships.
What is really needed is a full-scale review and reform of the tax system to make it fairer and less burdensome for businesses and contractors and remove the current vulnerabilities to tax avoidance. In the meantime, continued compliance with the current rules is essential.