The UK Government has conﬁrmed that it will extend to the private sector tax rules designed to target tax avoidance by contractors who operate through an intermediary personal service company (PSC).
The UK Government has announced that new “off-payroll working” tax rules (commonly known as IR35) will apply to the private sector from April 2020. The move will shift responsibility for determining the tax status of individuals who personally provide services through an intermediary personal service company from that PSC to the end user client.
The IR35 rules apply if
- An individual personally performs services for a client, or is obliged to do so
- Those services are provided under arrangements involving an “intermediary”, i.e., the arrangement for the provision of the services is made between the client (or an agent on its behalf) and the PSC, rather than between the client and the individual; and
- The individual would be regarded as an employee or office-holder, e.g., director, of the client for tax purposes, if the arrangements had been made directly between the individual and the client.
As the sole director and shareholder of a PSC, the contractor can pay himself the bulk of the fees received by the PSC by way of dividend, rather than as remuneration. The rate of tax paid on a dividend is much less than income tax and does not attract National Insurance contributions (NICs).
Currently, it is the PSC’s obligation to decide whether or not the contractual relationship in question falls inside or outside IR35. If it falls inside IR35, the PSC must account for income tax and NICs. If the PSC gets that analysis wrong, it is also responsible for any associated penalties and interest.
What Will Change?
From 6 April 2020, the client will become responsible for determining whether or not IR35 applies. Where it does apply, the “fee-payer” (i.e., the client or, where there is an intermediary agency, the agency) will be responsible for deducting income tax and employee NICs, and accounting for those together with employer NICs, at a rate of up to 13.8 per cent. If the client gets the analysis wrong, it will be liable for the underpaid tax and associated penalties and interest.
Only “small” businesses will be excluded from the new rules. To be considered small, a business will need to satisfy two or more of the following criteria: i) have an annual turnover that is not more than £10.2 million, ii) have a balance sheet total of not more than £5.1 million, or iii) have no more than 50 employees.
The UK Treasury expects this new measure to net over £1.1 billion per year.
Determining Whether or Not IR35 Applies
Clients will need to assess the true employment status of the individual.
There are two types of status for tax purposes: employee and self-employed; as opposed to the three types of status for employment rights purposes: employee, worker, and self-employed. Similar tests are used to decide status for tax and employment purposes, and the results are frequently the same.
Whilst one does not necessarily follow the other, it can at least be anticipated that a contractor who is an employee for tax purposes is more likely to claim to be an employee or worker for employment status purposes. As a minimum, this entitles them to the key worker rights of holiday pay, automatic enrolment into a pension scheme, and national minimum wage; and possibly the more extensive employee rights, such as unfair dismissal protection.
The starting point will remain the written contract between the parties, but it is often alleged that the contract does not reﬂect the true relationship. In this case, Her Majesty’s Revenue and Customs (HMRC) and/or a court or tribunal will consider evidence on the day-to-day conduct of the parties and determine status based on the reality of the situation.
The test is multi-factoral and considers all the circumstances. However, whether or not an individual is an employee is generally judged against four key pillars.
- What mutual obligations exist? In an employment relationship there must be an obligation on the individual to provide his or her work or skill, and an obligation on the employer to pay for that service.
- To what extent is the individual required to provide services personally? If a PSC has a meaningful and genuine (rather than token) right to provide someone other than the individual whose status is being assessed, particularly if the PSC is responsible for paying that other person, this would be a strong indicator of self-employment.
- What degree of control does the client have over the individual? An employee is generally subject to a reasonable degree of control by his or her employer. This may manifest as the way in which the services are to be performed, what tasks have to be performed, and when and where they must be performed. A genuinely independent contractor is likely to have the freedom to work when, where, and how they want, as long as they provide the services in question.
- How is ﬁnancial risk attributed amongst the parties? Individuals who risk their own money, e.g., by rectifying unsatisfactory work without additional payment, are less likely to be employees. A self-employed contractor would also generally provide whatever equipment is needed to do the job.
Other factors that might indicate an employment relationship will also be considered, including the length of the engagement, the degree of the individual’s integration into the client organisation, and how they are treated relative to employees.
Given the potentially signiﬁcant costs and risks involved, it would be prudent for affected organisations to start planning for these changes now.
Decide Who Will Be Responsible for Assessing Compliance
In practice, a multidisciplinary approach is likely to be required, potentially including procurement, ﬁnance, human resource, and legal functions. Organisations may need to provide training for anyone dealing with the issue.
Audit Contracting Arrangements
Organisations should review the arrangements under which they engage independent contractors, and identify how reliant they are on services provided via PSCs, as opposed to individuals who contract directly; the risks in relation to these individuals remain unchanged.
Ultimately, each PSC relationship will need to be assessed, using “reasonable care”, and a Status Determination Statement (SDS) issued to both the individual and the contracting party, i.e., the PSC or intermediary agency, if there is one. Notably, the SDS must specify the reasons for the organisation’s determination.
The UK Government has created an online tool to assist with this process, which can be pointed to if HMRC subsequently questions a status determination. The tool has, however, been subject to widespread criticism. Pending an updated version and guidance expected later this year, organisations may be best served by working with legal advisors to implement their own, more robust, review system.
If an individual disagrees with a status determination, draft legislation anticipates a mandatory organisation-led dispute resolution process that must be complied with.
Plan for Change
Organisations should consider what action they will take if an independent contractor is determined to be within IR35 and have employee or worker status. The organisation will need to decide, in dialogue with the contractor, whether to
- Amend existing contracting arrangements so that the contractor becomes genuinely engaged on a self-employed basis, and carry out these changes in practice; or
- Engage the contractor in question as an employee or worker. The parties will need to decide which of them will bear the additional costs of the engagement, including holiday pay, pension contributions, sick pay, and employer’s NICs.