From 6 April 2021 businesses engaging contractors via specific intermediaries, such as a personal service company (PSC), will be required to carry out an assessment of the contractor’s tax status. This will also be the case if there are other parties in the chain, such as agencies.
If, following this assessment, the contractor is considered to be in ‘deemed employment’, which means that they would have been considered an employee for tax purposes if they had been providing their services directly to the organisation (rather than through an intermediary), then income tax and NICs will need to be deducted from the fees paid to them for their services. Employer NICs will also be payable.
This reflects a significant change to the IR35 rules (also known as the off payroll-rules), which were first introduced as a tax avoidance measure in 1999 and aim to ensure that contractors providing services through intermediaries and who essentially did the same work as ‘employees’ were taxed as such, instead of being able to draw their earnings in tax efficient ways (such as via dividends and by offsetting expenses against taxable profits).
For the first 16 years, the rules provided that the responsibility for assessing tax status and, where appropriate, deducting income tax and NICs, lay with the PSC.
Since 2017 this has no longer been the case in the public sector, with the responsibility for assessing tax and making appropriate deductions shifting to the public sector client.
This will now also be the case for medium and large-sized organisations in the private and third sector, who until now have had no obligations under IR35.
While there is a possibility of a further delay to the rules coming into force given the ongoing impact of the Covid-19 pandemic on businesses, attempts to postpone the introduction of the rules have so far failed.
This is not surprising, given the tax revenue expected to be generated from the changes and Rishi Sunak’s comments when he introduced the Self-Employment Income Support Scheme in 2020 that it was now “much harder to justify the inconsistent contributions of different employment statuses” and “if we all want to benefit equally from state support, we must all pay in equally in the future.”
Will my organisation be affected?
If your organisation engages with contractors and off-payroll workers, you could be impacted by the IR35 changes as it is likely that you will be engaging some individuals via PSCs or other intermediaries.
However if your organisation is classed as a small business, IR35 does not apply and PSCs will continue to be responsible for compliance with the regime. A small business is defined in the Companies Act 2006 as an organisation which meets two of the following three criteria for two consecutive years:
- An annual turnover not exceeding £10.2 million
- A balance sheet total not exceeding £5.1 million
- An average over a year of not more than 50 employees
For charities it is important to note that the definition of ‘turnover’ is intended to have the same meaning as defined in Section 474 of the Companies Act (turnover is the amount derived from the provision of goods or services within the company’s ordinary activities after deduction of trade discounts, VAT and other relevant taxes). Therefore, charities which receive donations and other voluntary income which does not derive from the provision of goods and services, should not count this towards their turnover.
If you are a medium or large-sized company, your obligations will include:
- Carrying out an employment tax status assessment;
- Confirming your findings to the contractor via a Status Determination Statement (SDS);
- Putting in place a dispute resolution process in the event that the contractor or another party in the chain disputes your conclusions; and
- Deducting tax and NICs if the contractor is found to be in deemed employment, or notifying the party in the chain responsible for paying the contractor their fees to do so. Employer NICs will also payable.
How do we know whether there would have been an employment relationship and if the contractor is in ‘deemed employment’?
Unfortunately, you can’t just rely on what the contract says. To get to the crux of this question, organisations will need to consider the reality of all aspects of an individual contractor’s working arrangements.
Relevant issues that should be considered include:
- Does the client exercise a high level control over the individual?
- Is there a right of substitution or does the service have to be provided by the individual contractor?
- Is there a mutuality of obligation? Is the client required to provide work and is the individual contractor required to perform it?
- Is the individual contractor ‘in business on their own account’? i.e. can they make a profit or incur a loss?
- Does the individual contractor provide their own equipment and insurance?
- Is the individual contractor integrated into the workplace? E.g. do they share the same perks as other employees and do they line manage other staff?
- Does the individual contractor work for other clients?
- Are the terms of the contract consistent with an employment relationship?
To assist with determining an individual’s tax status, HMRC has developed an online tool to help clients check the employment tax status of their contractors (Check Employment Status for Tax (CEST)). However, the tool has been criticised for being biased towards making a finding that the off-payroll rules apply (even where a court would disagree). In complex cases, the tool may also conclude that the individual’s status is “undetermined”.
Seeking legal advice and carrying out further analysis will therefore be prudent, particularly in borderline cases or where the parties want to explore what legitimate changes can be made to the relationship such that it does not fall within IR35.
What happens if we conclude that there is an employment relationship for tax purposes?
In the first instance, you will be required to communicate your conclusion to the contractor via a “Status Determination Statement”, along with your reasons. This will also be the case if you find that the individual is not an employee for tax purposes.
The contractor, or any intermediary in the chain responsible for collecting and paying the fees (such as an agency), must be given the opportunity to challenge the status determination.
If the determination is challenged, you must respond within 45 days, either confirming the original determination or replacing it with a new one and giving reasons. Failure to respond within this time frame may increase the tax liability faced by the client.
It may be that both parties are strongly committed to an arrangement that falls outside of IR35. In those cases, it will be appropriate to explore whether the arrangement can be changed such that the contractor’s work is no longer considered ‘Deemed Employment’. This may not always be feasible or realistic.
It is worth noting that an individual may be an employee for tax purposes, but not for employment law purposes. The test under employment law and tax law are not uniform.
How should my organisation prepare for the changes?
Dealing with the roll out of IR35 to the private sector is no small task and there are several preparatory steps you can take now to ensure that your organisation is ready for 6 April 2021:
- Train – Provide training to the parts of your organisation that engage contractors to ensure they are familiar with the new requirements.
- Audit – Identify how many PSCs (or other intermediaries) your organisation engages with and which ones may be employees for the purposes of IR35.
- Engage – Communicate with your contractors, explain that changes are being introduced and that there will need to be an exchange of information and a review of working practices.
- Gather information – Establish a process for receiving the information you require from your contractors, e.g. a working practices questionnaire. This will need to be issued to, and completed by, your contractors as well as the manager engaging the contractor (often with HR input).
- Analyse – Analyse the information provided and determine whether the contractor is within IR35. Provide a Status Determination Statement setting out the reasons for your conclusion.
- Resolve – Prepare and publish a Status Disagreement Process.
- Develop – Develop a system for recording and keeping status determinations under review.
- Adapt – Review your current systems (e.g. payroll, contracts) to ensure that they are fit for purpose under the new regime.
Do you have any top tips?
The IR35 rules are not straightforward and businesses will be facing a steep learning curve come April. However, here are our top tips on how to stay compliant with the IR35 rules:
- Take care when determining an individual’s status. If your organisation makes a mistake, it is less likely that HMRC will take an aggressive stance if it can be shown that reasonable care was taken in making and issuing the SDS. This can include seeking legal advice on complex cases.
- Know the limits of the tools you are using. HMRC has acknowledged that the CEST Tool does not always provide the correct answer, therefore, the risks need to be weighed up as to whether a more thorough examination is required by the circumstances.
- Avoid blanket determinations. Not only will it be difficult to demonstrate that there was reasonable care in making the determination, it can be particularly damaging to morale and can hinder recruitment efforts.
- Don’t leave it too late. Plenty of notice has been given to organisations and HMRC is likely to expect many businesses to have already done significant inroads in the preparation process last year, prior to the government’s announcement that the changes would be postponed. We can expect them to hit the ground running when it comes to compliance.
How can Bates Wells help?
Here at Bates Wells we have a strong team of experienced IR35 experts who are already helping organisations understand and prepare for the changes ahead of April 2020. We are happy to assist with all stages of the compliance process including:
- preparing a Status Disagreement Policy;
- designing a working practices questionnaire;
- performing status reviews;
- preparing a Status Determination Statement;
- monitoring status determination;
- reviewing contractor agreements; and
- talking through potential changes to your contractor arrangements.
We also offer an in-depth webinar (‘An essential Guide to IR35: What does your organisation need to know?”) and supporting materials such as an employment status checklist and a template SDS. To learn more about having the webinar delivered for your team, please email [email protected]
Our previous webinars on IR35 include:
- An essential guide to IR35 (February 2020)
- IR35 – The Thorny Issues (with tax specialists Marianne Tutin and Colm Kelly from Devereux Chambers).
To access an audio recording of these webinars, please email [email protected] (note: the content in these webinars is correct as of February 2020).
This information is necessarily of a general nature and doesn’t constitute legal advice. This is not a substitute for formal legal advice, given in the context of full information under an engagement with Bates Wells.
All content on this page is correct as of January 25, 2021.