Next year HMRC will require private employers to have the same conversation with their workers that the laws of dating appear to require of new couples about five dates in - the infamous ‘define the relationship’ discussion (or ‘DTR’ for short) - “Are we ‘together’ now or is this just a casual thing…?”
And not unlike those sitting down to agree the right label for their blossoming romance, employers and those who provide services to them want to know: what their status is, what their respective obligations and entitlements are, and who pays what taxes and when. But also like the laws of love, the rules and guidance for employers are far from decisive and the ‘status question’ can seem an intimidating and loaded one.
We’re talking of course about the planned changes to the IR35 rules (also known as ‘off payroll’ or ‘intermediaries’ legislation) due to come in next April 2020 for the private sector. In simple terms, where the new rules apply, they will put the onus on private employers to decide whether the individuals who provide services to them are ‘deemed employees’ for tax purposes and, if they are, to deduct employment taxes from the payments made to them.
Following the publication this month of the outcome of the Government’s consultation and the draft legislation for off-payroll working, this blog recaps what these changes are and what steps employers should take, as well as highlights some continuing areas of uncertainty on which it is hoped further guidance may cast light in due course.
The status quo
As it stands, individuals who supply services indirectly (ie via a Personal Service Company (PSC)) to a private company are responsible for deciding what taxes they should pay. If the individual is, despite the lack of an employment contract, in fact working in a way that is similar to an employee or a worker who provides personal service (eg there is mutuality of obligation, no option to provide a substitute, and limited freedom for them to do the work as they wish etc.), then he/she is likely to fall within the IR35 regime. This means tax and national insurance should be paid by the intermediary on their behalf as if they were an employee.
The key changes – April 2020
The Government has decided that too many individuals say they are outside IR35 when they should in fact be within it. If unaddressed, it is estimated this will deprive the public purse of an estimated £1.3 billion over the next 5 years.
To tackle this, from 6 April 2020:
- where ‘deemed employment status’ applies
- and a payment is made by a medium or large private business (the client organisation) to an intermediary (normally a PSC) to supply the worker’s services
- then relevant payments made to the intermediary will be subject to deduction of payroll taxes and employer NICs will be payable, and
- there will also be obligations on the client organisation regarding notification and dealing with any objections from the worker.
So, what does all this mean, and what should you be doing now to prepare for these changes?
1. Decide whether the new rules apply
The new rules will not apply to ‘small’ businesses. You will be a small business if you meet two of the following criteria:
- annual turnover not more than £10.2m
- balance sheet total not more than £5.1m,
- number of employees not more than 50.
When companies assess their size they must consider the group as a whole and connected companies. The tests also cover LLPs, but non-corporates need only satisfy the turnover test in order to be considered small. It is important to remember that your size may change and so you should keep these criteria under review - your position at the end of your accounting period before the tax year will determine whether IR35 applies for the tax year to come.
2. Define the relationship
When the new rules come into effect, private sector organisations will need to be ready to make a Status Determination Statement (SDS) for each contractor working through intermediaries whom they consider to be a ‘deemed employee’ under the IR35 rules.
The SDS must include the reasons for the decision made and ‘reasonable care’ must be used in preparing it. The usual employment status tests apply and although HMRC has provided the CEST tool (check employment status for tax tool) its results are not binding on HMRC and it has been widely criticised as being unhelpfully simplistic and accurate only in the most straightforward cases.
A new and improved CEST is expected, but for now it should be used only as a starting point and with caution. Careful thought should be given to the reality of the working relationship with those you contract with. For example, although there may be a substitution clause in the contract, has it ever and will it ever be used?
HMRC has warned that organisations should not make blanket determinations – eg decide to treat everyone as “deemed employees”. However, for larger workforces with cohorts working on identical terms and in the same way, where an individual assessment of each worker would be excessively burdensome, it seems likely that a collective assessment of status may be justifiable.
You, as the client organisation, must pass the SDS to both the party you contract with (ie the PSC or an agency) and the worker.
Where there is a chain of entities between the client and the worker, it is the last person in the chain before the intermediary (the PSC) to receive the SDS who is responsible for accounting for the employment taxes due. In the event of a compliance breach, HMRC will still have discretion to require any party in the chain to account for employment taxes (although there are exceptions where the fraudulent information has been provided by the intermediary or worker).
3. Engage with the workforce
You should start identifying and consulting with those in your workforce who supply their services through PSCs and are at risk of deemed employment status. It may be best to renegotiate the commercial terms of your arrangements with some individuals in order to pre-empt a challenge to an employment status determination. For others it may be preferable to offer an employment contract.
Once in force, the new rules provide for a process through which workers or the person paying the PSC can challenge an SDS and you will have 45 days to respond to this and either reconfirm the SDS with reasons or issue a revised one. At this stage, it is not clear what the next steps would be if the worker remains dissatisfied.
4. Implement the changes
Once your decisions have been made on status then, from April 2020, SDSs should be prepared for affected workers and they should be notified that they will go on the payroll.
5. Think ahead
Ensure that when planning and structuring future arrangements you factor in the new IR35 rules, including agreeing with workers what their status will be and what the tax implications of that are.
It is important to note that the employment rights of individuals affected by IR35 will not be impacted by the new rules. So, even if it is decided that someone is a “deemed employee” for tax purposes, it will not automatically follow that they will be an employee or worker for employment purposes.
Having said that, you may be aware that the government’s consultation on employment status is ongoing, and one of the questions they are considering is whether to align the status test for tax and employment. If this approach is taken, those ‘deemed employees’ under the IR35 regime are likely to be entitled to the rights connected to being an employee or worker. This is all the more reason to take care when assessing the status of your current workforce and considering the relationships you have with future workers.
The draft legislation which will need to be passed to bring the new rules into effect is still being consulted on and it is expected that HMRC will issue more guidance in light of that – it is not clear when the guidance will come but potentially in the Autumn - we will keep you posted. In the meantime, good luck with those ‘defining the relationship’ conversations…!
With thanks to Charlotte Black from our Tax team for helping to prepare this piece.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, July 2019