The extended off-payroll worker rules, referred to here as the “new IR35 rules”, will come into effect on 6 April this year.
In this blog we provide a series of questions and answers about the new IR35 rules. This is aimed at clarifying any lingering concerns which employers may have about how the rules work and to highlight further preparations that may be required.
1. What are the new IR35 rules and why are they being introduced?
Put simply, the purpose of the new IR35 rules is to reduce the number of off-payroll workers, (referred to here as “contractors”) who treat themselves as being self-employed by taxing them as employees. This is achieved by placing the responsibility for determining the employment status of a contractor with the organisation receiving the contractor’s services. This has been the case in the public sector since 2017.
If your organisation (referred to here as the “client”) receives services from individuals who are not on your payroll and who work through an ‘intermediary’ (see question 4), then the new IR35 rules may apply. Your organisation will then be required to make a “status determination” (see question 7) of the contractors and (either your organisation or another entity in the contractual chain) may need to withhold employment taxes from payments made for the services provided by these individuals and also pay employers’ national insurance.
2. Which “clients” are affected?
The new IR35 rules apply to organisations which are:
- in the private sector (separate rules apply to public sector organisations);
- medium or large in size (ie not small, see definition of “small” below); and
- “connected” to the UK (see below).
A company (or an LLP) is “small” if it satisfies two or more of the following requirements:
- its annual turnover is not more than £10.2 million
- its balance sheet total is not more than £5.1 million
- it has not more than 50 employees
For a group company to be a small company, the small business test must be applied to the group as a whole. There are rules to aggregate the turnover of connected persons, so for complex structures external advice may be needed to confirm the position.
A client organisation will have a “UK connection” if, immediately before the beginning of the relevant tax year, the entity is either UK tax resident or has a permanent establishment in the UK.
3. Which contractors are affected?
The IR35 rules do not apply if the individual in question would not have been subject to UK employment taxes had they been an employee. This means that in most cases only contractors who are either resident in the UK or who perform their services in the UK can be within the new IR35 rules. The jurisdiction of the contractor's intermediary company is not a relevant factor.
4. What is an intermediary?
The IR35 rules are targeted at working arrangements which involve intermediaries acting as the contractor’s personal entity. Most often this will be a company which the contractor controls, often referred to as a “personal service company” or “PSC” for short.
Accordingly, the new IR35 rules apply if the intermediary is a company in which the contractor (or his/her associates, or together with his/her associates) has a “material interest”. A “material interest” is a 5 per cent ordinary shareholding in the company. A material interest can also be measured by reference to rights to dividends or to assets on a winding up.
A second type of intermediary company caught under the rules is a company from which the contractor has received (or has the right to receive) a “chain payment”. A “chain payment” is the amount paid for the services which the contractor has provided to the client. This definition was inadvertently drawn too widely, and consequently the Government announced that changes will made in the 2021 Finance Act to make it clear that where PAYE is already applied to a contractor’s earnings, the new IR35 rules will not apply.
5. What if we hire our contractors via an employment agency?
The new IR35 rules do not apply where the agency employs the contractor and operates PAYE on earnings paid to the contractor. However, if the agency contracts with the contractor's intermediary (eg his or her personal service company) rather than with the contractor directly, then the new IR35 rules can still apply.
6. What if we outsource operations to a service provider?
The new IR35 rules apply where a contractor personally performs (or is under an obligation personally to perform) services for a “client”. Where your organisation contracts with a service provider for a fully outsourced service, typically it is not entering into a contract for the supply of a particular contractor. Your organisation is therefore not the “client” for the purposes of the new IR35 rules. In an outsourced arrangement, the service provider is the client and it is, therefore, the service provider that must apply the new IR35 rules. In determining whether an arrangement is an outsourced service or not care must be taken, and reference to HMRC’s guidance on this point is recommended.
7. What is a “status determination”?
If your organisation is within the scope of the new IR35 rules and both the contractor and the intermediary fall within the ambit of the rules, then you must examine whether the contractor would have been an employee of your organisation had it not been for the existence of the intermediary. This is known as a “status determination”. If it is decided that the contractor would have been an employee, they are referred to as being “deemed employed” by the client.
To establish whether a contractor is “deemed employed”, the contracts and also the “on the ground” working arrangements between the parties must be analysed. Where an agency is involved this will entail understanding the terms of the contract between the agency and the contractor’s intermediary. Each case will depend on its own facts.
In order to assist with the status determination process, the Government encourages the use of its on-line tool: Check Employment Status for Tax (the “CEST test”). This interactive questionnaire is a good starting point to ascertain whether a contractor is a deemed employee under the new IR35 rules. However, in many instances, particularly where the CEST tool gives an inconclusive or unanticipated result, it will be advisable to seek the advice of an employment specialist.
NB. If the contractor is an office holder of the client organisation (eg a director) then they will automatically be a “deemed employee”.
8. What should a Status Determination Statement say?
Under the new IR35 rules the client (the recipient of the contractor’s services) is obliged to provide a status determination statement (an “SDS”) to the contractor and to the entity with which the client contracts (eg the recruitment agency). If the client fails to do so, and the contractor is working through an intermediary, the client will automatically be treated as the “deemed employer” and will be obliged to account for PAYE.
There is no prescribed format for the SDS. If the CEST test has been used HMRC will accept the results of the test, which contains all the questions and answers supplied to be a valid SDS, however alternative formats will be accepted.
The client must take “reasonable care” in making the status determination. If this is not done, then again, the client will automatically be treated as the “deemed employer”. HMRC consider that “reasonable care” means a client should act in a way that would be expected of a prudent and reasonable person in the client’s position. Although HMRC recognises that organisations will vary in size and capability, they expect each client to carry out a complete and thorough determination and to preserve sufficient records to show how the decision was reached.
The SDS must be issued before payments on or after 6 April 2021 are made.
9. What happens if there is a disagreement over the status determination?
A contractor (or another party in the chain who pays the intermediary) can appeal the status determination in writing or orally. If this happens, the client must respond within 45 days and either confirm the original determination with its reasons or, having used “reasonable care”, reverse the original decision.
10. Does a “deemed employee” gain employment rights and benefits?
No, if a contractor is classified as a “deemed employee” for the purposes of the new IR35 rules this does not in itself confer any employee rights on the individual. Thus, for example, the contractor’s intermediary will remain responsible for the payment of such benefits as Statutory Sick Pay and for the operation of pensions auto-enrolment. That is not to say that a working relationship which closely resembles employment cannot be reclassified, and in cases of doubt the advice of an employment specialist should be sought.
11. Will my organisation be required to administer PAYE and if so on what amount?
If, having applied the new IR35 rules, the client organisation becomes a “deemed employer” then it will be responsible for deducting income tax and national insurance contributions and accounting for these to HMRC, together with employer NICs and, if relevant, apprenticeship levies. In cases where there is a chain of entities between the client organisation and the contractor’s intermediary, it will usually be the entity that pays the intermediary (rather than the client) that will be the deemed employer and responsible for the payments of tax.
PAYE must be operated on the amount of the payment made by the deemed employer. This will usually be the fee invoiced by the intermediary, net of VAT. The deemed employer may also, if it so chooses, deduct expenses that would be tax-free if paid to an employee (such as free/subsidised meals provided on their premises).
12. If our contractors will be "deemed employed" are there other options?
It may be possible to terminate existing contracts with contractors and enter into new contracts with a reduced fee, to reflect the fact that the client organisation will now assume responsibility for employer’s NICs.
Alternatively, the contractor may be willing to abandon their intermediary entity and provide their services to the client via an umbrella company or agency.
A third option would be for the client organisation to offer the contractor a fixed term contract of employment.
If you require further information about anything covered in this blog, please contact Charlotte Black, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, February 2021