With changes to HMRC’s off-payroll tax rules coming into force in less than a month, many businesses are still struggling to understand their exposure to the new legislation.
In this article, Fieldfisher tax and employment experts Matthew Sharp and Ranjit Dhindsa outline some of the steps companies and contractors can take to prepare for the legislative change.
[UPDATE – The April 2020 changes discussed below have been deferred until April 2021 due to the COVID-19 crisis – more details here]
April 2020 changes – a concise summary
From the 6 April 2020, responsibility for compliance with ‘IR35’ (the colloquial name for the off-payroll tax rules) is shifting from consultants to end-users.
The legislation is designed to stop workers from supplying work through intermediaries (usually in the form of limited companies known as personal service companies, or PSCs), in a way that allows them to bypass being designated an employee and reduce the income tax and National Insurance Contributions (NICs) payable on their remuneration.
The forthcoming changes apply to every private sector business engaging contractors in the UK, where those contractors operate through intermediaries such as PSCs.
Subject to some limited exceptions (including where a contractor is located overseas) these end users/clients will be responsible for making tax status determinations for contractors, and for passing this determination back down the labour supply chain to the worker.
There is an exemption for small company end-users. For incorporated entities, this exemption applies where two of the following three criteria are met:
- Fewer than 50 employees;
- Balance sheet total of less than £5.1 million; and/or
- Turnover of less than £10.2 million.
For unincorporated entities, HMRC will just use the turnover threshold to determine whether or not a company is exempt.
It is also important to note that this exemption is for end users only, and does not apply to any agencies responsible for brokering a worker’s services to the end-user clients, even if those agencies pay the worker’s wages.
Get ready for a chain reaction
If a contractor is determined to be an employee for tax purposes, responsibility for making deductions for income tax and NICs under PAYE rests with the entity that sits nearest the intermediary in the supply chain.
In many cases, this will be the end-user client, but in other more complicated labour supply chains, it may be another organisation, such as an employment agency, which may find itself having to operate PAYE for the first time.
Whomever the responsibility lies with, if they fail to operate this system, HMRC may pursue the responsible entity for taxes owed by the contractor, and they could also face fines or other penalties.
There has been some confusion over the interplay between IR35 and other legislation that governs tax in outsourced labour supply chains.
However, HMRC has been clear about the primacy of IR35; with effect from 6 April 2020, IR35 must be considered first and, when it applies, it will supersede both Managed Service Company (MSC) Rules and Agency Worker Rules.
Don’t forget about employment law
It has come as a shock to many individuals who provide services through intermediaries that IR35 does not have a direct correlation with their employment rights.
It does not automatically follow that if you are assessed as ‘employed’ for tax purposes under IR35, you are similarly classed as ‘employed’ for employment law purposes (although the tests for both are very similar).
There has however been a trend towards individuals asserting ‘worker status’ (for employment purposes), where they are deemed to be an employee for tax purposes.
This is because they are paying tax as employees, but have no corresponding protection or benefits under employment law, and want to align the two positions.
Given the complications that can arise and the way tax and employment law treat individuals differently, organisations need to consider carefully how they communicate with individuals and what strategies to adopt.
For example, they should consider whether it is it better to provide individuals with worker status, so the dichotomy between tax and employment law is eliminated; or retain two separate statuses, which can be confusing; or simply terminate the arrangement with some individuals altogether.
Any decision about changes of status need to be considered carefully, preferably in consultation with a professional adviser
Check HMRC’s website
A number of those who stand to be affected by IR35 have expressed surprise and dismay that HMRC has not launched a mass awareness or guidance campaign about the changes to off-payroll working rules, and fear being tripped up by inaccurate hearsay.
Clear communication is key to minimising the risk of being caught out by IR35, but many struggle to put this principle into practice, especially given the lack of understanding around the new legislation and a palpable degree of resentment against it among many businesses and individuals.
Since IR35 is not going away, the answer is to address these concerns before the new legislation comes into force.
Every company should have policies, procedures and contractual protections (in commercial agreements) in place to ensure information can be passed smoothly up and down contract chains.
A simple but surprisingly useful step businesses can take is to maintain IR35 checklists, which can be drawn up in consultation with advisers, or by referring to HMRC’s online ‘Check employment status for tax‘ (CEST) pages.
Several businesses and individuals have reported frustrations with using the CEST tool, and while the questions it asks should be factored into approaches to compliance, advice should be sought before using the questionnaire formally.
HMRC has also published additional IR35 guidance, including an updated Employment Status Manual, which sets out detailed information on the off-payroll working rules, and a number of ‘communication resources‘ to assist businesses in discussing the forthcoming changes with contractors.
Take reasonable care
Although it is often time-consuming and complicated, companies should always assess the impact of IR35 on a case-by-case basis, rather than adopting wide, blanket determinations for workers.
One size fits all approaches can leave businesses open to challenges from individuals unhappy about their determinations and also from HMRC, which may disagree that all workers should be given the same classification.
There are a variety of tests available for both employers and workers to determine IR35 status, including HMRC’s CEST test outlined above.
However, the increasingly complicated nature of client-worker relationships, and the kinds of services workers perform, mean not all tests are applicable to every situation, and the confusion created by the outcomes of these tests has prompted many to reach out for professional assistance.
It should be stressed that the enhanced scope of IR35 is not an end to consultancy or contractor relationships.
For parties who wish to maintain a non-employment relationship, certain steps may be necessary to ensure these arrangements are not caught by IR35.
For instance, it is advisable for clients to agree fixed project fees, rather than hourly rates for time and materials.
Contracts made on a time and material basis are often viewed by HMRC and tribunals as being more akin to an employment relationship (and thus susceptible to IR35).
Fixed project fees, however, tend to fall more on the side of self-employment, although it should be noted that fee arrangements are just one aspect of the employment status assessment.
Additionally, companies should ensure that individuals do not appear in their organisation charts, have company email addresses, use company stationary or computer systems free-of-charge, as these all strengthen the argument that a worker is an employee, rather than a contractor.
Matthew Sharp is a contentious tax specialist and Ranjit Dhindsa is Head of Employment, Pensions, Immigration and Compliance at European law firm, Fieldfisher. Additional advice and resources on how to comply with IR35 can be found on the firm’s dedicated IR35 web page.