On 6 April 2020, it is expected that changes to the IR35 rules, also known as the ‘intermediaries’ or ‘off-payroll’ legislation, will take effect. Despite the delay to the Budget (as a consequence of the General Election) the new rules are scheduled for inclusion in the 2019-20 Finance Bill.
Under the revised law, the onus will be on private businesses of a certain size (see below), to decide whether any individuals (‘workers’) who provide their services via an intermediary - commonly a personal service company (referred to as a ‘PSC’), are ‘deemed employees’ for tax purposes. If they are, then employment taxes must be paid on the fees paid by the engager business to the intermediary.
Workers who provide services via an intermediary can be in any role and work in any business sector. Many professionals working through PSC’s are information technology or business consultants, but others include those in the hospitality and construction industries. Broadly speaking, a PSC will be an ‘intermediary’ in relation to an individual if he or she (including associates) has a minimum of a 5% interest in the PSC’s shares.
This briefing sets out what the current legal position is, what is changing and what steps employers should take to prepare for and respond to the changes.
At the moment, workers who supply services indirectly (ie via a PSC) to a private company are responsible for deciding what taxes they should pay. If the worker 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 a personal service (eg there is mutuality of obligation to provide and be provided with work, no or limited ability for the worker to provide a substitute, and little freedom for them to carry out the work in their own way), then he/she is likely to fall within the IR35 regime. This means tax and national insurance should be paid by the intermediary on the worker’s behalf as if they were an employee of the intermediary.
The key changes – April 2020
In the Government’s view, too many individuals say they are outside IR35 when they are in fact within it and the public purse is suffering from reduced income tax and Employer NIC receipts. In an attempt to remedy this, from 6 April 2020 (assuming the legislation is passed) where:
- deemed employment status applies;
- a payment is made by a medium or large private business (the client business) to an intermediary (normally a PSC) in respect of the supply of the worker’s services
then payments made to the intermediary will be subject to deduction of payroll taxes and Employer NICs will be payable. There will also be obligations on the client business regarding notification and dealing with any objections from the worker.
Is your business exempted?
Before considering what steps you should be taking to respond to this change, you should first confirm whether your business is subject to the new rules.
The new rules will not apply to you if the business is ‘small’. For a company, a small business is one which meets at least two of the following criteria:
(i) annual turnover not more than £10.2m
(ii) balance sheet total not more than £5.1m
(iii) number of employees not more than 50.
When you assess size, you must consider the corporate group as a whole and connected companies. Non-corporates need only satisfy the turnover test in order to be considered small. It is important to remember that your business’ size may change and so you should keep these criteria under review - your position at the end of your accounting period in the previous tax year will determine whether IR35 applies for the tax year to come. In some circumstances businesses which qualify as ‘big’ for the first time will have a year’s grace period.
Who is a ‘deemed employee’ under IR35?
When determining employment status for the purposes of the IR35 rules, the usual employment status indicators remain relevant. None of the indicators are in themselves, determinative, so a checklist approach is not possible. Careful thought should be given to the reality of the working relationship with those you contract with. The following factors are commonly considered indicative of employment status (this list is not exhaustive):
- there is no substitution clause, or the substitution clause is rarely used or gives the business significant control over who can be a substitute;
- the business has control over what services the worker provides and how they provide them;
- the business decides where and when the work is done;
- the worker does not have to provide their own equipment in order to complete the work;
- the worker is paid a set monthly or yearly amount;
- the business offers benefits to the worker, for example gym membership, health insurance or retail discounts;
- the worker interacts with the customers of the business or holds themselves out to be working for the business (rather than as an independent).
HMRC has provided the CEST tool (Check Employment Status for Tax tool), to assist with the process of identifying ‘deemed employees’. CEST includes questions on all of the above criteria. Although HMRC state that they will accept the results of the CEST tool, this is caveated and ultimately the CEST results will not bind HMRC. The CEST tool was widely criticized for being too simplistic which led to it often being inconclusive. As a result, CEST has been enhanced and a new version was released on 25 November 2019. HMRC has also recently issued more detailed guidance which includes advice on how to answer some of the CEST questions. Until HMRC’s approach to CEST has been more widely probed in the courts, in nuanced cases, CEST should be used as a starting point and with caution.
The Status Determination Statement
When the new rules come into effect, you will need to be ready to issue a Status Determination Statement for each individual who is working for the business through an intermediary. This should include those who you consider to be deemed employees under the IR35 rules (ie they would be an employee for tax purposes if they contracted directly with your business) and also those who you conclude are self-employed for tax purposes.
The Status Determination Statement (‘SDS’) must include the reasons for the employment status decision which you have made and ‘reasonable care’ must be used in preparing it. HMRC has warned that businesses should not make blanket determinations – eg decide to treat everyone as ’deemed employees’ for ease.
The rules provide for a process through which workers or the person paying the PSC can challenge an SDS and the engager organisation (the ‘client’) 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 with the determination.
As the client, you 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 your business and the worker, it is the last person in the chain before the intermediary who is responsible for accounting for the employment taxes due. For example, where an agency provides a worker to your business (and the worker contracts with the agency via their PSC), the agency would be responsible and the SDS should be passed from your business to the agency in order to alert the agency of their liability.
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).
Engage with the workforce
Once you have identified those supplying services through PSCs who are at risk of deemed employment status, consider consulting with them about the effect of the new IR35 regime (although keep in mind that the changes are not yet law). It may be best to renegotiate the commercial terms of your arrangements in order to pre-empt a challenge to an employment status determination. Alternatively, it might be preferable to offer an employment contract. In either case, you will want to factor in the added expense to the business of the Employer NICs. Some existing consultancy contracts could simply be left to expire. See below on the potential impact of these actions on employment status.
Implement the changes
At any time after the rules become law, but in any event before 6 April 2020, the most prudent step is to prepare a Status Determination Statement (SDS) for all workers who supply their services to your business through an intermediary. In some instances, this will be as simple as printing off the results of the CEST test, but often more will be required and you may need legal advice. Those who are ‘deemed employees’ will go onto the payroll. You will have to account for the ‘deemed employment payment’ as employment expenditure and budget for Employer NICs. Any VAT being charged on the payments to the intermediary is likely to remain payable.
The IR35 regime should be factored into all your future staffing decisions. For new hires, it would be wise to agree in advance what the status of a worker will be and the consequent tax implications. When dealing with existing contractors you should have regard to their status under employment law and perhaps discuss with your employment adviser before entering into discussions. For example, it is possible for someone to be deemed an employee for tax purposes but a worker or a self-employed for employment law purposes. The last Government ran a consultation on employment status and considered whether to align the status test for tax and for employment so we expect the law in this area to continue to evolve.
On 7th January 2020 a government review was announced, tasked with finding ways to ‘smooth implementation’ of the new rules. The review will conclude mid-February and we will report on its findings.
If you require further information about anything covered in this briefing note, 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, January 2020