The controversial IR35 provisions have faced significant public challenge since their introduction in 2000; they are notoriously complex and are widely criticised as being disruptive to business. However the government remains committed to their application and, due to widespread non-compliance in the private sector (costing an estimated £440million in the 2016/2017 tax year) it is proposed that the current off-payroll working provisions that apply to the application of IR35 in the public sector be extended to all large and medium sized companies in the private sector with effect from 6 April 2020.
What is IR35?
The IR35 provisions apply where an individual consultant provides their services to a client through an intermediary (most commonly a personal services company ("PSC") in which the individual holds a material interest), but where the relationship between the individual and the end-user client is essentially one of employment. The provisions as they currently apply in the private sector require the PSC at the end of each tax year to consider each engagement they have undertaken during that year and decide whether such engagement constitutes deemed employment. If this is the case, profits of the PSC are treated as deemed employment income in respect of that engagement and the PSC must therefore account to HMRC for tax and NICs accordingly.
Currently therefore, private sector clients who contract with PSCs are not required to consider the nature of the engagement nor account for tax and NICs in respect of the same.
The extension of the off-payroll working provisions
The effect of the off-payroll working provisions however, is to effectively shift liability for determining the status of the engagement from the PSC to the end-user client and the liability for deducting tax and NICs from the PSC to the 'fee-payer'. The fee-payer in these circumstances is the entity responsible for paying the fees of the PSC – this will commonly be the end-user client, however can also be an agency or other third party intermediary in a chain of supply.
As of 6 April 2020 therefore:
- End-users will be required to make a formal employment status determination statement, confirming whether in its reasonable opinion, the engagement falls within or outside the scope of IR35.
- End-users will be required to pass the status determination on to the entity with whom they are contracting as well as the individual worker.
- Should there be other intermediaries in the chain, these entities will be required to cascade the status determination down the chain, whereby a failure to do so will result in that entity being deemed the fee-payer and PAYE and NICs liability therefore remaining with them.
- End-users will be required to have a formal disagreement process in place, enabling the individual worker and/or the fee-payer to challenge the status determination. The end-user then has a period of 45 days in which to respond to such challenge, either confirming or reversing its original decision and stating its reasons for doing so. Failure to comply with this obligation within the 45 day period, results in the end-user being deemed the fee-payer.
- Where the end-user considers the situation to be one of deemed employment, the fee-payer will need to deduct income tax and employees' NICs from the fees due to the PSC and will bear the added cost of employer's NICs. Where an end-user engages with the PSC directly, the end-user will also be the fee-payer. However, should there be an intermediary party between the end-user and the PSC, or a number of intermediaries, the entity which is immediately above the PSC in the supply chain and who is responsible for paying the fees of the PSC will be the fee-payer.
For engagements entered into after 6 April 2020, the end-user is required to make and cascade the status determination prior to the commencement of the engagement; for engagements that are already in place as at 6 April 2020, the end-user must make and pass on the determination before the date the first contractual payment falls due on or after 6 April 2020.
The proposed changes will not apply to 'small companies', that is any company which satisfies at least two of the following conditions in a tax year:
- An annual turnover of no more than £10.2 million;
- A balance sheet of no more than £5.1 million; and/or
- No more than 50 employees.
A company is always small for its first financial year. However for a subsidiary to qualify as small for these purposes, its parent company must also be small.
Making the determination
When making an employment status determination, the end-user will need to consider a number of factors regarding the proposed relationship, including:
- Personal service: where the individual is required to perform the services personally and there is no, or only a heavily fettered right, to appoint a substitute, it is likely that the engagement would be one of deemed employment.
- Control: a self-employed consultant should generally be free to determine the manner, method and timing of the delivery of the services and should be subject to only limited control by the end-user. Should the end-user have a considerable degree of control over the consultant, this will strongly suggest deemed employment.
- Mutuality of obligation: mutuality requires an obligation on one party to provide work and a corresponding obligation on the other party to accept any work offered. There is always a degree of mutuality in any formal contract, however the key in assessing employment is the nature of the obligation; in a genuine consultancy arrangement, the relationship should reflect one of client:supplier.
- Other factors: there are a number of additional factors that are likely to affect the status determination including, for example, the level of integration of the individual into the business, the responsibility for the provision of equipment and the level of financial risk adopted by the individual in providing the services.
HMRC provides a free to use 'Check Employment Status for Tax' ("CEST") tool. There has been a considerable degree of criticism of the CEST tool, however the advantage of it is that HMRC will be bound by the output of the service unless it has been obtained fraudulently. The test can be completed on an anonymous basis and may therefore be useful as part of the assessment; it can be found at: https://www.tax.service.gov.uk/check-employment-status-for-tax/reason-for-using-tool.
Where any party in the labour supply chain fails to meet its obligations and is therefore treated as the fee-payer, but then fails to account for PAYE and NICs, HMRC have confirmed that the liability will transfer up the chain to the first party or agency and will ultimately rest with the end-user if the first party fails to pay. Many believe this to place an unfair and unreasonable burden on the end-user and HMRC have confirmed that they will publish guidance to clarify the circumstances in which this power could be used and will provide further advice for organisations to help ensure a compliant supply chain. However, it is important to ensure that in situations involving complex supply chains, appropriate contractual protections and indemnities are agreed at the outset.
The above will represent a significant change to private sector consultancy engagements and could, for some, represent a significant liability to account for tax and NICs. It is understood that HMRC will commence compliance reviews as soon as the new rules take effect, such that we would strongly advise businesses to take steps to prepare for the implementation of the above now.
We therefore advise reviewing and considering your current and ongoing use of consultancy arrangements and the likely exposure of the business to IR35 risk; reviewing the contractual arrangements and practical reality of any engagements currently in place; reviewing and updating any template documents; and reviewing internal systems such as payroll software and HR and procurement processes to consider whether any changes are likely to be necessary. Should you have any questions in respect of the content of this article or would like assistance in reviewing your current arrangements and preparing for the above changes, please do not hesitate to contact Nathalie Ingles.