IR35 in its current form
The practice of engaging individual contractors through a personal service company (PSC) is widespread and is the standard form of individual contractor engagement in a number of industries. Although such arrangements are a legitimate approach to engagement, the tax savings (largely in the form of NIC savings) make such arrangements particularly attractive.
The off-payroll working rules (typically referred to as IR35) were introduced in 2000 in an effort to ensure that individuals who work like employees (i.e. those who are not genuinely self-employed) pay broadly the same income tax and national insurance contributions as employees, regardless of the structure they work through.
This was implemented by requiring the PSC to deduct income tax and national insurance from the fee received in circumstances where the individual contractor would be considered an employee of the end-user client for tax purposes if, hypothetically, the contractor had been hired directly by the end user rather than through a PSC.
Changes to the application of IR35 in the private sector
HMRC conducted a review of the IR35 regime and concluded that there was widespread non-compliance, estimating that only ten per cent of those who should be applying the rules did so. In other words, HMRC considered that a number of individuals providing services through PSCs were incorrectly treating themselves as self-employed and therefore not applying the IR35 regime.
HMRC considered that IR35 compliance would increase if the responsibility for determining status and operating PAYE shifted away from PSCs to end-users, on the basis that the latter would be better resourced and easier targets for enforcement action.
This approach was partially implemented in April 2017 when the government reformed the IR35 rules for arrangements within the public sector. HMRC asserts that the change led to raising £550 million in a 12-month period as a result. It was therefore not surprising that plans were made to introduce the revised form of IR35 to the private sector.
Outline of the changes - assessment of status
The new regime does not introduce a new tax. Instead, it shifts the responsibility for determining employment status and deducting tax away from the PSC to the end user or, if applicable, an agency.
Assuming that no agency is involved an end-user client will need to:
- assess whether a contractor is employed or self-employed for tax purposes, taking “reasonable care” when making the assessment;
- confirm their decision in a status determination statement (the SDS); and
- provide the SDS to the individual contractor and PSC before making the first payment to the contractor.
To assist with the determination of status, HMRC has developed the Check Employment Status for Tax tool - CEST. Although the end user is not obliged to use CEST, the outcome is binding on HMRC, subject to the significant caveat that the information has been entered correctly and kept up to date. It is widely accepted that CEST is an imperfect tool, but it would nevertheless be a sensible starting point for any status assessment. In circumstances where the CEST tool specifies that an individual is self-employed for tax purposes (i.e. the sort of result which may be subject to HMRC challenge), the end-user should consider documenting contemporaneous backing for the responses to the questions and keeping the review updated periodically.
Although CEST is an important part of the status-determination process, it is advisable for end-users to conduct their own status determination in parallel, focusing on key elements such as control, substitution and whether there is an obligation on the parties to offer or accept work (mutuality of obligation) and document these in the SDS. This might be time consuming at the outset, but a consistent and thought-through process will significantly reduce risk.
If the contractor disagrees with the SDS determination they are entitled to make representations to the end-user. The end-user then has up to 45 days to reconsider the determination and either maintain that it was correct or issue a new one. Ultimately, despite this mechanism, the end-user is in control of the decision making process.
Implications of employment status for tax purposes
If the end-user finds that the individual is self-employed, the fee to the PSC can continue to be paid gross. However, if the contractor falls within the regime and the end-user pays the PSC the fee directly rather than through an agency, for example, it will need to operate PAYE and deduct NICs from the fee and account for employer NICs and the apprenticeship levy, if applicable.
It is quite typical for an agency (or several agencies) to be part of a contractual chain between a PSC and the end-user. In such circumstances the end-user will retain responsibility for the assessment of status but any agency paying the fee to the PSC will be responsible for operating PAYE and deducting NICs.
In circumstances where the end user does not comply with its obligations regarding the status determination, the liability for making PAYE deductions and paying NICs may be transferred from the agency to the end-user.
“Small” private sector end-user clients will be exempt from the new rules, meaning that status determination will remain with the PSC (i.e. the “old” regime will apply). A corporate client will be treated as small for a tax year if it satisfies at least two of the following:
- Annual turnover is not more than £10.2 million
- The balance sheet total is not more than £5.1 million
- Employee headcount does not exceed 50
Broadly speaking, it should be noted that the small company exemption will not be available to businesses which are part of a large group.
The road to implementation
Any business which engages contractors through PSCs should conduct a review of their arrangements and commence status determinations in respect of each arrangement in good time. Depending on the outcome, businesses may then decide to consider alternative engagement models for existing or future arrangements to reduce risk.
A big problem likely to face many individuals and businesses in connection with the changes is one of communication. If a contractor and an end-user can agree an appropriate approach to engagement in advance of implementation, they will be well placed to also agree any required changes to fee levels, structure or working practices. In contrast, it is easy to envisage otherwise functioning arrangements breaking down through lack of communication and timely planning.
Despite the prospect of a delay to implementation, the earlier arrangements are reviewed and conversations start, the better.
See the full ECB publication here.