The off-payroll working rules (also known as IR35) (the Rules) operate to prevent tax avoidance. The rules require an individual worker who provides services to a client through an intermediary, but who in reality has an employment relationship with the client, to pay broadly the same income tax and national insurance contributions (NICs) as an employee would have to pay. From April 2020 the way the Rules operate will change significantly.
For almost 20 years, the Rules have sought to ensure that the employment tax and NIC rules applied by treating an intermediary, such as a personal service company (PSC), as the employer of the worker, where the conditions of the Rules are satisfied.
Although in many cases, operating through an intermediary is perfectly legitimate, these structures continue to be used for tax avoidance by disguising genuine employment relationships. Non-compliance has been widespread and HMRC estimates that only 10% of those who should be applying the Rules do so properly.
To tackle this, the Rules were reformed in 2017 in respect of the public sector, so that responsibility for determining the tax status of the worker shifted to the public authority client engaging their services.
From April 2020, this reform will be extended to all medium and large organisations, in the private or public sector, who engage with individual workers or contractors through intermediaries. The burden of compliance with the Rules will shift to the client organisation.
The reforms will not apply to small organisations, in order to prevent a disproportionate administrative burden being placed on smaller businesses.
Shift of responsibility: the new Rules work by shifting responsibility for determining the tax status of the worker to the public or private sector client. The client will, in certain circumstances, be treated as the employer of the worker for the purposes of income tax and NICs, if it is the fee-payer in the supply chain.
Identifying the fee-payer: the fee-payer in the contractual supply chain is the entity responsible for deducting income tax and NICs from the supply invoice amount and passing them to HMRC.
Where there is a PSC in the chain, the fee-payer is the lowest party in the chain above the PSC. In many cases, this will be the client itself. In cases involving a chain of contracts through one or more intermediaries, including agencies, the fee-payer will be the person or entity who pays the personal service company (provided it is UK resident and, if a company, not one that the worker, or an associate of the worker, has control over or a material interest in).
The fee-payer is treated as making an employment related payment to the worker, to which income tax and NICs apply.
Status determinations: in each case, client organisations will need to take reasonable care to make a written determination of whether, in the context of the particular engagement, the individual worker is employed or self-employed for tax purposes.
The determination should be issued in writing directly to the worker, who has the right to ask for the reasons for the determination.
If the client is not the fee-payer, it should also issue the determination to the next entity in the supply chain as by doing so it can transfer liability for income tax and NICs to that entity.
Client organisations will be under a legal duty to consider whether the circumstances of the engagement are such that, if the services were provided under a contract directly between the client and the individual worker (rather than through a third party intermediary), the worker would be regarded for income tax purposes as an employee of the client or the holder of an office under the client (e.g. a director), or whether the worker is an office-holder who holds that office under the client and the services relate to that office.
Although in theory this will be a question of fact, the law in this area is notoriously difficult to apply. Some of the factors that the client will need to consider include:
- whether the worker is obliged to provide a personal service to the client (which would indicate they would be an employee) or is allowed to provide a substitute worker;
- the payment arrangements and worker’s time commitment;
- the degree of control that the client is entitled to exercise over the worker, such as over when, where and how tasks are to be performed;
- whether the worker uses or provides their own equipment to do the work;
- whether the worker takes on any financial risk and/or has the opportunity to make a profit;
- whether the worker is integrated into the client’s workforce and/or enjoys employee-type benefits.
However, no single factor is determinative. HMRC has an online tool called CEST to help decision makers, which it says it is enhancing ahead of the introduction of this reform.
As the new Rules require the client to take reasonable care in making the status determination, client organisations should consider each relationship on a case by case basis, rather than implementing a blanket approach (for example to attempt to reduce risk of non-compliance by determining that all workers are employees for tax purposes). They should also consider whether to rely solely on CEST or to add further layers of decision-making or analysis given that CEST does not produce guaranteed results.
Risk of failing to comply
If the client fails to issue a status determination with reasonable care, or at all, or fails to respond to a worker’s representations within 45 days, the client will be treated as the fee-payer and will be responsible for deducting income tax and NICs from the payments it makes in respect of the services, as if the worker is an employee of the client.
What if the worker disagrees with the status determination?
If the worker notifies the client that it disagrees with the status determination, the client must within 45 days either inform the worker that it has decided its conclusion was correct (giving reasons), or issue a new status determination if it concludes the original determination was incorrect.
Exemption for small organisations
A small organisation is (broadly) one which falls under the small companies regime for tax purposes. Organisations (and their advisers) are likely to already be aware whether they fall under this regime or not. To summarise, a “small” company meets two of the following conditions:
- its annual turnover does not exceed £10.2m;
- its balance sheet total is not more than £5.1m; and
- it has no more than 50 employees.
There are alternative conditions to determine whether unincorporated organisations are small. Specific advice should be taken where it is not clear whether the new rules will apply.
Next steps for medium and large client organisations
Analyse existing supply chains: it is important to understand how individual workers provide services to the client and which intermediaries are involved.
Client organisations might consider providing support to key individual workers in understanding how the new Rules might affect them and invite them to make representations in respect of their status ahead of the formal determination process.
Formalise a determination process: a consistent and reasonable approach will assist the client to defend any status determination to HMRC. Clients should consider developing a policy or process for making determinations. They should also consider developing a consistent approach to engaging with workers who challenge a determination.
Other policies and training: medium and large organisations who engage off-payroll workers may wish to put policies and procedures in place to make it clear how they will carry out the status determination process.
Organisations should also consider updating their policy on the corporate offence of failing to prevent the facilitation of tax evasion and providing staff training to make sure staff comply with the new rules and do not facilitate the evasion of tax.
Next steps for workers
Workers should engage with their clients early to assist them in making the status determination, and to avoid being caught by a blanket or overly-cautious approach.
Workers who disagree with the client’s status determination should respond promptly with representations as to why they disagree. Clients must consider and respond to a worker’s representations in the event they disagree with the status determination.
In cases where a worker’s historic position differs from a client’s status determination (which is likely to happen as HMRC estimates that only 10% of engagements are currently compliant), the worker may take some comfort from HMRC’s assertion that it will not carry out targeted campaigns into previous years. Nevertheless, workers should consider taking their own tax advice to ensure they are and have been compliant with the Rules.
How we can help
As ever, planning and communication will be the key to successfully managing this change.
Winckworth Sherwood’s Employment and Tax Teams are well placed to assist client organisations and individual workers operating in navigating the new off-payroll working rules whilst maintaining good working relationships and effective contracts.
Please contact us to discuss how we can help you.