As many of you will know, IR35 is a piece of tax legislation designed to combat tax avoidance by individuals who supply their services via an intermediary – such as a Personal Service Company ("PSC") – but who otherwise would be a direct employee of the end-user company if the intermediary was not used.
These off-payroll working provisions currently apply to the public sector, but will be extended to all large and medium sized companies in the private sector with effect from 6 April 2020. Many affected businesses have begun preparations and those that are yet to take action should do so as soon as possible to avoid potential liability. This is particularly relevant to developers given the substantial number of contractor relationships within the sector. Are you ready?
With just weeks until changes take effect, let's recap the implications of IR35 and off-payroll working rules for developers and look at the most recent developments.
Th effects of IR35 – a reminder
The IR35 provisions apply where an individual contractor provides their services to an end-user client via an intermediary (most commonly a PSC), 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/intermediary, at the end of the tax year, to consider each engagement they have undertaken during that year and decide whether it constitutes "deemed employment". If this is the case, profits of the PSC from that engagement are treated as employment income and the PSC must account to HMRC for tax and national insurance contributions (NICs).
IR35 in the private sector
Currently, private sector companies who contract with intermediaries are not required to consider whether the engagement amounts to deemed employment nor account for tax and NICs as a result.
The April 2020 off-payroll working provisions will shift liability for determining the status of the engagement, from the intermediary to the end-user client. Liability for deducting tax and NICs will also move from the intermediary to the 'fee-payer'.
The fee-payer in these circumstances is the entity responsible for paying the fees of the PSC – this will often be the end-user client, however can also be an agency or other third party intermediary in the supply chain.
What do private sector companies need to do differently?
As of 6 April 2020, end-users will need to make a formal employment status determination, confirming whether the engagement falls within or outside the scope of IR35. They will also need to pass the status determination on to the entity with whom they are contracting as well as the individual worker.
If there are other intermediaries in the chain, these entities will have to pass the status determination down the supply chain. Failure to do so will mean that entity is deemed the fee-payer and PAYE and NICs liability will therefore remain with them.
End-users will need to have a formal disagreement process in place, enabling the individual worker and/or the fee-payer to challenge the status determination.
Where the end-user considers the situation to be "deemed employment", the fee-payer will have 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 the PSC directly, the end-user will also be the fee-payer.
Will there be any exemptions to IR35?
The proposed changes will not apply to 'small companies' – 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
- 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.
HMRC has confirmed that changes to the operation of the off-payroll working rules will only apply to payments made for services provided on or after 6 April 2020. Organisations will therefore only need to determine whether the rules apply for contracts they plan to continue beyond 6 April 2020.
Additionally, whilst the publication of a review into the implementation of changes to the off-payroll working rules at the end of February 2020 did not result in any meaningful changes to the new rules, notable points were:
- an assurance that there will not be penalties for errors in the first year following the rule change, except in cases of deliberate non-compliance
- an indication that HMRC will not use information from the off-payroll working rules to bring historic challenges against contractors, unless there is reason to suspect fraud or criminal behaviour.
These are of limited value or comfort as they would not necessarily be recognised as a defence to any demand by HMRC in the tax tribunals.
How should developers and contractors prepare for IR35?
IR35 and off-payroll working rules will represent a significant change to the implications of using certain types of consultancy/contractor engagements in the sector and could, for some, represent a significant liability to account for tax and NICs.
Many contractors have structured the way in which they provide services to maximise tax efficiencies and so could be resistant to alternative compliant options proposed by developers. Therefore, as well as determining whether arrangements fall within or outside the scope of IR35, developers should hold conversations with contractors and review budgets with the imminent changes in mind.
If you have any questions about this article or would like assistance in reviewing your current arrangements and preparing for the above changes, please do not hesitate to contact Neil Gill, Managing Associate on [email protected] / +44 1752 675017.