If a worker provides services to a client or end user through an intermediary, typically a personal service company (PSC), then they can be subject to off-payroll working rules, commonly known as IR35. These make sure that any workers who would have been an employee, had they provided services directly, pay roughly the same tax and National Insurance (NI) contributions as employees.
Where the regime applies, the PSC is treated as having made a deemed employment payment to the worker, and this in turn is subject to income tax and NI. The PSC is solely responsible for determining whether the regime applies, and it must also account for any resultant liabilities; the end user has no obligations in this regard.
In 2018, the UK government announced changes that would, with effect from 6 April 2020, extend the off-payroll working rules that already apply in the public sector to the private sector, although implementation was subsequently put back to 6 April this year as a result of the pandemic.
Under the new regime, the following changes will be made.
The changes will not apply to end users defined as small under the Companies Act 2006; that is, companies satisfying two or more of the following criteria:
In a basic supply chain, an end user might contract directly with the PSC, so it would count as the fee-payer under the new regime. This will result in the end user being liable for:
Often, however, off-payroll worker supply chains are more complex, and may involve one or more intermediaries such as agencies between end user and PSC. Generally, where the new regime applies, the fee-payer rather than the end user will be responsible for including the individual worker on its payroll and accounting for the consequent income tax and NI contributions.
It will therefore be crucial for end users and fee-payers alike to use the time before 6 April to review the nature of, and their role in, any existing off-payroll engagements. They will need to determine which of these are likely to fall under the scope of the reforms, and what their potential obligations and liabilities will be as an end user or a fee-payer.
Where the services of an individual worker are provided through an intermediary, the new regime will only apply if that company is a PSC as defined for the purposes of the regime. Where an end user contracts directly with the intermediary, the worker is required to inform the end user whether it is providing its services through a PSC, which will only be the case where it has a material interest of 5% or more in the company.
More complex supply chains, however, can involve numerous parties between the end user and the intermediary. In this situation, the worker would not be required to inform the end user whether they are providing their services via a PSC, but only let the fee-payer know. An end user may not even be aware of the other parties in the supply chain.
Unless the individual worker informs the end user otherwise, the end user should assume that the intermediary company is a PSC for the purposes of the new regime. If the individual worker falsely advises the end user that the intermediary is not a PSC, the end user is absolved of any obligation to conduct a status determination or account for any payroll taxes that might otherwise be due.
If the circumstances show that an end user did not exercise reasonable care in completing returns it may have to pay a penalty, which will be a percentage of the tax and NI contributions HMRC would have lost if it had not made an enquiry. End users that do not want to risk being caught by the new compliance regime may therefore prefer to engage only with third-party agencies that are not themselves PSCs, and oblige those agencies to supply only the services of individuals that they directly employ.
Regardless of whether or not an end user is also a fee-payer, it will be responsible for determining whether the individual worker providing services through a PSC is a so-called disguised employee – that is, a contractual worker who fills a permanent position in a company but does not pay the corresponding income tax and NI – and therefore whether the engagement is subject to the new regime. The legislation does not stipulate how to do so, although the end user will need to demonstrate it has taken reasonable care in this regard.
It is therefore for the end user to consider what approach to take, and what training or further resource is required to make such a determination. Where an end user has failed to take reasonable care in determining the status of an individual, it will be deemed not to have provided an SDS for these purposes.
Some end users may rely solely on HMRC's online check employment status for tax (CEST) tool in this determination. Introduced in 2017, this was designed to help public-sector clients determine the status of off-payroll workers they engaged. It asks the user a series of questions, and generates an automatic status determination from their answers. However, the CEST tool has been widely criticised for being oversimplistic, for producing inaccurate determinations, and for not taking into account or keeping up to date with the ever-increasing number of case law employment status decisions.
HMRC has recently affirmed its commitment not to issue penalties for IR35-related errors within the first 12 months of the regime's rollout. Penalties in any event should not be levied where taxpayers have taken reasonable care to establish their correct tax position.
The legislation requires an end user to have a client-led process in place to resolve any disagreements about status determination. Where an individual worker or the fee-payer, if different to the end user, makes any representation to the end user that the SDS is incorrect, the end user must reconsider its conclusion and confirm its position within 45 days of receiving the representation. Failure to do so will result in the end user being deemed to be the fee-payer if it was not already.
Meanwhile, where a deemed employer has failed to deduct income tax on a PAYE basis from payments to an off-payroll worker, regulations allow HMRC to recover that tax from other parties in the supply chain if there is no realistic prospect of doing so from the deemed employer in a reasonable period of time.
HMRC has stated in certain guidance that the liability provisions will not be transferred where the failure to account for tax and NI contributions by the fee-payer is a consequence of a genuine business failure and the fee-payer has not knowingly benefitted as a result. The provisions will only apply where, for example, a party has entered into the labour supply chain with the intention of avoiding tax and NI liabilities. It is important to note, however, that this concession is not included in the legislation and will inevitably be subject to interpretation and HMRC's discretion.
The challenges presented by IR35 can be avoided by hiring contractors as fixed-term employees, or by engaging them as agency workers or employees of umbrella companies with no PSCs in the chain. Agency workers are liable for PAYE income tax and NI contributions, provided it can be shown that they are subject to supervision, direction or control by any person over the manner in which they provide their services. Some businesses have stated that these alternative methods will be the only ways in which they engage contingent labour from April, while others have imposed this restriction since April last year.
The IR35 rules apply to clients for which a worker personally performs services, or is under an obligation to do so. The new rules do not apply where a client procures a contracted-out service; consequently, in the run-up to April, many contractors have sought to rebadge their services as contracted-out in the statements of work they already provide.
Some contractors have even grouped together to form a new consultancy that purportedly falls outside the scope of IR35 because it does not provide personal service, on the basis that, first, it does not name consultants who are being provided, and second, it is defined as small when the new rules only apply to medium or large businesses.
However, while it is possible for contractors to provide a contracted-out service, they will not do so by simply calling a contract a statement of work or by not naming contractors. The true nature of the services will be determined by other factors, including which party has control over the contractor, and which is exposed to most – or all – of the risks and rewards for the services provided; if the contractor has control over its work and is exposed to the brunt of the risks, it counts as a contracted-out service. The position may be further influenced by having clearly defined outcomes rather than a description of activities or a fixed price rather than just time and materials, both of which mean that a service is contracted out. The number of contractors involved is another consideration, with a higher number making it more probable that the service is contracted out.
It is highly likely that any end users getting this wrong – buying what they are led to believe is a contracted-out service but which is in fact a personal one – will be liable in full for any PAYE and NI contributions due. End users should ensure they are adept at spotting this potential pitfall.
The reforms will have a significant impact on end users, fee-payers and any other party or agency situated between the services of the individual and the end user. It is therefore important that all such organisations act now to prepare fully for the introduction of the rules on 6 April.
Figure 1: Typical supply chain arrangement, indicating responsibility for determining worker’s status
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