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IR35 – Changes to off-payroll working from April 2020

  • United Kingdom
  • Employment law

09-05-2019

Background -brief overview of IR35

IR35 is tax legislation intended to stop ‘disguised employment’. It is aimed at combatting tax avoidance by workers, typically contractors and freelancers, who supply their personal services to clients via an intermediary, such as their own limited company (a “PSC”) but who would be taxed as employees if engaged directly. They are sometimes referred to as “off-payroll workers”. Where IR35 is applied, the worker pays broadly the same employment taxes as if they were employed.

IR35 does not apply where those working through their own company are genuinely self-employed for tax purposes.

A key element of the IR35 legislation, as initially introduced, was that it required the individual worker using the PSC to decide whether or not they should be regarded as employed or self-employed for tax purposes. According to the Government, this provided the “means, opportunity and incentives for the wrong amount of tax to be paid”. With the cost of non-compliance anticipated to reach £1.3 billion a year by 23/24, this drove the Government to change the way the rules operate in the public sector in 2017 and led to its latest decision to extend the rules that apply to the public sector to the private sector.

What is changing ?

Some of the detail is awaiting the outcome of consultation. However, what we do know is that the Government is pressing ahead with changes to the way in which the current IR35 rules apply in the public sector and is extending these rules to the private sector. In broad terms, this involves:

For clients (i.e. businesses which engage a worker through a PSC (or other intermediary), by making them responsible for:

  • determining whether the workers should be deemed to have employment status for tax purposes;
  • communicating that determination to the relevant parties in the supply chain;
  • providing written reasons on request; and
  • having a disputes resolution mechanism.

For fee payers (i.e. those responsible for paying the fee to the PSC, which may be the client or, if the client is using an agency or other labour provider, will be the agency) by making them responsible for deducting income tax and employees’ NICs from the fees paid to the PSC and for paying employer NICs and the apprenticeship levy.

The changes in practice will be significant for clients. Furthermore, as explained below, the potential for liability to account for tax, NI (and the apprenticeship levy) to transfer to the client in the event of another party’s non-compliance, such as the fee payer, requires a broader risk approach to IR35 going forwards. Importantly, even if clients have complied with their own immediate responsibilities, liability could “rebound” up the supply chain if another party in the chain defaults.

When will the changes take place?

The changes will come into effect in April 2020 and will apply to the public sector, as well as being extended to the private sector. It is expected that the new rules will not operate retrospectively but will nonetheless apply to workers supplied via PSCs who are already in place on 6 April 2020

Circumstances where IR35 does not apply

IR35 does not apply in a number of situations, such as:

  • where the worker is genuinely self-employed or the agency, umbrella company or similar third party that supplies the worker directly employs them and deducts income tax and NICs;
  • where an organisation has fully contracted out services to a third party (such as an outsourcing company) and the workers do not personally provide their services. An example might be a contract for servicing photocopiers or facilities management, where maintenance workers remain under the control of the third party and the determination of tax status will lie with that party, not with the organisation which is receiving the service;
  • to small companies, small groups of companies or certain small non-corporates are excluded;

Special rules also apply in the construction sector and where the worker/PSC or other intermediary is based abroad.

Will the IR35 changes affect employment rights?

Not directly, no, as IR35 does not affect employment rights. However, the need for clients to identify status may flush out current miss-classifications of status or encourage more organisations to change their engagement practices.

The Government has committed in the Good Work Plan to bring forward proposals on how the separate frameworks for determining employment status for employment rights and tax can be aligned in due course. However, it has stressed that the upcoming IR35 changes do not affect employment rights.

Key IR35 steps from April 2020

Substantially, how IR35 has been applied in the public sector will be rolled forward into the private sector but with certain refinements.

The relevant steps for non-exempt clients in both the public and private sector will be to:

 

Assuming the client complies with its above obligations of status determination and disclosure (and no further changes to the proposals result from the consultation), each additional party in the labour supply chain will be responsible for cascading down to the next party the status determination of the client and any reasons provided for that determination. To ‘short circuit’ this cascade approach, the consultation is also considering whether the client should provide the determination to the fee payer directly, as well as to the worker and to the party they contract with. This seems the likely outcome.

Clients will be obliged to have in place a dispute resolution process which meets minimum criteria set by the Government, to allow for determinations to be challenged and for workers and fee payers to exercise their rights to seek the reasons for a status determination directly from the client.

[*We are currently interpreting the Government’s consultation to mean that reasons must only be provided upon request, as opposed to a default requirement to provide reasons together with the determination. However, this could change once the final details following consultation are announced.]

Which party is liable for payments of tax under IR35 from 2020?

The basic principle is that the fee payer is liable for payment of any income tax and NICs, (as well as for any apprenticeship levy, if applicable) based on the worker being an employee for tax purposes.

Importantly, however, to incentivise compliance with the changes, the new proposals provide that liability for accounting for tax and NIC rests with the relevant party in the supply chain until they comply with their obligations. So, for example, if the client fails to make or to pass on a determination of status and reasons (as appropriate), they bear the tax burden until they have done so. Alternatively, clients which fail to take reasonable care in determining whether deemed employment status applies could find themselves liable. This applies similarly with regard to the sharing of that determination by others in the supply chain.

The proposals operate to transfer liability in certain other circumstances also, for example, where the fee payer is an offshore business; if the worker provides fraudulent documentation or if HMRC is unable to collect payments due from the relevant party. As a result, the fee payer, PSC and, in the future, other parties in the supply chain could potentially be liable to account for tax and NI.

The practical outcome is that both the client and the party they contract with are incentivised to ensure compliant behaviour from all of the parties in the supply chain by choosing to engage with reputable businesses with a strong financial covenant. While indemnities may alleviate some of these risks, they are only of value if the party will remain a going concern with sufficient funds to pay, should the indemnity be enforced. Of course, even a solid indemnity is inconvenient to enforce and commercial relationships can be damaged. Parent company guarantees, escrow accounts and bonds could mitigate but are likely to be resisted.

How should private sector organisations prepare for the April 2020 changes?

The Government has, to date, outlined four preparatory steps (here). In addition, organisations should consider the following:

  • PLAN AHEAD! Put in place a strategy, appropriate processes and communicate the advent of IR35 to affected parties as early as possible. What contingencies do you have in place if current workers were to object/leave?;
  • appraise current use of off-payroll workers and off-shore intermediaries/ labour agencies;
  • review the business case for continuing to use PSC contractors and whether to redesign contractor roles and responsibilities and labour supply models;
  • budget for potentially increased costs;
  • collate information internally (or externally) from which to make an IR35 status determination, by sample, if numbers are high;
  • be consistent in approach but also beware of adopting a blanket policy;
  • assess IR35 status using this information, online tools available, such as CEST, or seek professional advice. Keep a detailed record, including of CEST outcomes. Be aware of time limits/ deadlines;
  • prepare written reasons appropriate for sharing externally, outlining how the IR35 status determination was arrived at;
  • communicate the IR35 status determination to the party with whom you have contracted and to the worker;
  • review known parties in the supply chain providers - is the supply chain comprised of reputable and compliant parties?;
  • think about GDPR. Are your policies, privacy notices, etc., still appropriate to facilitate the lawful collation, use and sharing of information? Are reciprocal arrangements in place with suppliers?
  • check your contractual terms. How should and can current contracts be changed? Think about adding indemnities as a fall back. What additional due diligence steps might you want to introduce?
  • prepare procurement, invoicing and payroll systems and processes for the new PAYE and NICs liabilities, as appropriate (if the fee payer), ensuring PAYE and other administrative process (VAT payments) are reconciled;
  • revise recruitment processes, including on-boarding, information sharing, etc., to demonstrate IR35 compliance;
  • train staff in the issues and the importance of how contractors are engaged and managed to ensure information relevant to status determination is recognised and shared;
  • expect challenges to status determinations especially if applying deemed employment status for the first time; and
  • ensure mechanisms are in place to deal with complaints and to respond which meet the Government’s minimum criteria. Do your contractual terms include a dispute resolution process already?

Key:

  • “worker”: the individual providing personal services to the ultimate client
  • “PSC”: a personal service company in which the worker has a material interest (broadly, an interest in 5% or more of the share capital or distributions made by the company)
  • “IR35”: HMRC off-payroll rules
  • “client”: the organisation or business to which the worker provides services through a PSC or other intermediary
  • “fee payer”: the organisation or business (including agencies or third parties) responsible for paying the PSC (exceptions apply where this party is off shore).

NB This guidance focuses on the 2020 changes to the way IR35 will apply to both the private and public sector for organisations engaging individuals through a personal service company (or a supply chain culminating with the individual’s personal services company). It does not examine in detail the general IR35 rules, nor the consequential tax reporting and processing with HMRC. Whilst the new IR35 rules may impose liability for payment of the apprenticeship levy, this falls outside the scope of this guidance, the focus of which is upon tax and NIC implications.

This guidance is written on the assumption that the client contact is the organisation receiving the individual’s services, rather than an agency/PSC or intermediary etc.

For more information contact

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