The UK government’s plans to make changes to off-payroll working rules will be effective from 6 April 2020. The reform will affect any contractors working through a Personal Service Company in providing services to a large and medium-sized end client, whether directly or arranged through an agency, says David Sheppard.
Off payroll working rules were imposed on the public sector to increase tax revenues from IR35 assessments
Since 2000, where an individual contractor serves an end client through an intermediary, such as a personal service company (PSC), then the intermediary must undertake what is known as an “IR35” assessment. The assessment aims to determine, for tax purposes, whether a hypothetical direct contractual relationship between the end-client and individual contractor would amount to that of employer-employee, or client-contractor.
If the assessment finds that a hypothetical employer-employee relationship would exist, the arrangement falls “inside IR35” and the end-client is required to make PAYE deductions for income tax and national insurance from any payment of the intermediary’s fees. But HMRC found that delegating the assessment to the intermediary had resulted in lost tax revenues, estimated in 2017-18 to be £700m, and projected to increase to £1.2bn by 2022-23.
To improve tax revenues, the Off Payroll Working Rules were introduced for the public sector in April 2017. Under these new rules, public sector bodies – such as NHS bodies, schools, universities, local authorities and government departments – are required to undertake the IR35 assessment when engaging contractors through intermediaries, in the place of the intermediary.
If the public sector body undertakes the assessment and incorrectly finds that there was no deemed employment, then it would be liable for any unpaid tax and national insurance, together with any penalties and interest. Public sector bodies have therefore treated their new obligations with great caution and tend to find deemed employment, or elected to simply directly employ former contractors. As a result, within 12 months of April 2017, HMRC reported an additional £550m in income tax and national insurance receipts, and 58,000 new individuals were subject to PAYE deductions.
Inspired by this success, the Government announced in its Autumn 2018 Budget that from 6 April 2020 the Off Payroll Working Rules will extend to the private sector, and apply to end-clients who are “medium” or “large” businesses. “Small” businesses in the private sector – defined as meeting two of the following three criteria, namely having an annual turnover not more than £10.2m, a balance sheet (i.e net assets) total of not more than £5.1m, and 50 or fewer employees on average – will remain outside the new Off Payroll Working Rules, and continue to fall under the 2000 IR35 regime.
Now extended to the private sector, these rules bring new obligations for “medium” and “large” end-clients
From next month, medium or large end-clients engaging with a contractor through a PSC, or with an agency which sources and supplies the services of a PSC, will need to undertake an assessment in respect of services provided on and after 6 April 2020.
To help them, HMRC has launched an online “check on employment status for tax” (CEST) tool, which considers various judgments of the tax courts and tribunals to assess if an individual is an employee or self-employed for tax purposes. Most arrangements will either be clear cases of employment or self-employment, and will be confirmed by the CEST tool. But genuine borderline cases may prove more difficult to assess, because the test for employment status is highly fact sensitive and a finely balanced arrangement could fall either way. For such cases, end-clients should seek specialist tax advice.
Once it concludes its assessment, the end-client must issue a status determination statement, confirming and justifying the outcome. It must provide this statement to the PSC, individual contractor, and agency if applicable, at the latest before the first payment for services provided on or after 6 April 2020.
If the assessment finds that the hypothetical relationship between the end-client and individual contractor would be that of employer-employee, the “fee payer”, being the entity in the supply chain immediately responsible for paying the PSC, will be obliged to make PAYE deductions from any payments to the PSC, provided they have received the status determination statement. If the end-client is the fee payer, then it will need to ensure it makes the appropriate PAYE deductions when paying the PSC’s invoices.
If the end-client fails to take reasonable care and incorrectly assesses that PAYE deductions should not be made from any payment to the PSC, HMRC can charge a penalty and interest as well as recovering the unpaid tax and national insurance.
Concerned end-clients should not wait until 6 April 2020 to prepare
As 6 April 2020 fast approaches, medium and large end-clients need to carry out an audit of their supply chains with contractors engaged outside of their payroll, and identify where the Off Payroll Working Rules will apply potentially.
They would be prudent to start the assessments well ahead of the cut-off date for pre-existing arrangements, and in advance of signing terms for new contractor services commencing on or after 6 April 2020, as the tax status will have an impact on fees and contractual terms.
Where a contractor is likely to be assessed as a deemed employee, end-clients need to weigh up the various commercial pros and cons of engaging that contractor directly as an employee, rather than through a PSC, and making off payroll PAYE deductions. While engaging individuals as employees will mean less flexible labour and more workplace protections, it has the advantage of greater control and supervision, simplifies payroll processes, and minimises any risk of failing to make appropriate PAYE deductions. Every situation and the relative bargaining positions of the end-client and contractor will be different.
Both contractors and end-clients should also review their template terms and conditions, as the heightened tax risk means that the party with the stronger bargaining positions will seek appropriate warranties and indemnities from the other in managing this risk.
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We know this will be a daunting time for both end-clients and contractors, as long-established working arrangements will be changing. Our experienced employment and immigration team is well placed to help you navigate through the new rules and best protect your position, and we regularly advise both employers and contractors.