The extended off-payroll worker rules, referred to here as the “new IR35 rules”, will come into effect on 6 April this year.
The following Q&A’s are aimed to help schools check that they are fully prepared and to clarify any lingering concerns.
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 – ie the school. This has been the case for the public sector since 2017 (including maintained schools).
If your school (referred to in the new IR35 rules as the “client”) receives services from individuals who are not on the school’s payroll and who work through an “intermediary” (see Question 4), then the new IR35 rules may apply. If so, your school must conduct a “status determination” of the contractors and, depending on the results, the school (or another entity in the contractual chain), must withhold employment taxes from payments made for the services of these individuals and pay employers’ national insurance contributions (NICs).
1. Which schools 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 (UK tax resident or with a UK permanent establishment).
Your school will be “small” (and therefore not impacted by the new IR35 rules) 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
If your school is part of a group of schools 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.
2. Which contractors are affected?
In a school setting, contractors can include individuals working in a variety of roles, for example: peripatetic music teachers, sports coaches, IT or PR professionals.
The IR35 rules apply if the individual in question would have been subject to UK employment taxes if they had 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 are affected. The jurisdiction of the contractor's intermediary company is not a relevant factor.
The next step is to consider the contractor’s intermediary (see Question 3) and then to assess whether the contractor is “deemed employed” (see Question 6).
3. 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 falling within 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.
4. What if the school hires 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 and the school should liaise with both the agency and the contractor to clarify the position and take the necessary steps to ensure compliance with the rules.
5. What if the school outsources 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 school contracts with a service provider for a fully outsourced service (eg catering), typically it is not entering into a contract for the supply of a particular contractor. In this situation, the school is not the “client” for the purposes of the new IR35 rules. In an outsourced arrangement, the service provider (eg catering company) is the client and it is, therefore the service provider that must apply the new IR35 rules. If there is uncertainty as to whether or not a service is an outsourced service, reference to HMRC’s guidance is recommended.
6. What is a “status determination”?
If your school 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 school 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”.
To establish whether a contractor is “deemed employed”, the contract between the school and the contractor should be examined. In addition, the “on the ground” working arrangements between the parties must be analysed. Where an agency is involved this will also entail understanding the terms of the contract between the agency and the contractor’s intermediary. Each case will depend on its own facts.
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 unexpected result, it is advisable to seek advice.
NB If the contractor is an office holder of the client organisation (eg a director) then they will automatically be a “deemed employee”.
7. What should a Status Determination Statement say?
Under the new IR35 rules the client (ie the school) is obliged to provide a status determination statement (an “SDS”) to the contractor and to the entity with which the client contracts (eg the intermediary company or recruitment agency). If the school fails to do so, and the contractor is working through an intermediary, the school will automatically be treated as the “deemed employer” and will be obliged to account for PAYE and pay employers’ NICs.
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, although other formats will be accepted.
The school must take “reasonable care” in making the status determination. If this is not done then again, the school will automatically be treated as the “deemed employer”. HMRC consider that “reasonable care” means acting in a way that would be expected of a prudent and reasonable person in the school’s position. Although HMRC recognises that client 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.
8. What happens if there is a disagreement over the status determination?
A contractor (or the party in the chain who pays the intermediary) can appeal the status determination in writing or orally. If this happens, the school must respond within 45 days and either confirm the original determination with its reasons, or, having used “reasonable care”, reverse the original decision.
9. 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.
10. Will my school be required to administer PAYE and if so on what amount?
If, having applied the new IR35 rules, the school becomes a “deemed employer” then it will be responsible for deducting income tax and NICs and accounting for these to HMRC together with employer NICs and, if relevant apprenticeship levies. In cases where there is a chain of entities, it will usually be the entity that pays the intermediary (rather than the school) 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).
11. If my school’s contractors will be “deemed employed” what are the options?
Possible courses of action are set out below. Schools should consider their options on a case-by-case basis, weighing up the pros and cons, both from an employment and a tax perspective, seeking advice where necessary. The right option will very much depend on the school’s particular circumstances.
One possibility is for the school to maintain the status quo, ensure that it complies with the IR35 administrative procedures and accept the increased tax burden of paying employers’ NICs.
If the school is unable to accommodate the increased cost, it may be possible for the school to terminate existing contracts with contractors and enter into new contracts with a reduced fee, to reflect the fact that the school will now assume responsibility for employers’ NICs.
Alternatively, the contractor may be willing to abandon their intermediary entity and provide their services to the school either directly, or via an umbrella company or agency.
If the school engages the contractor directly as an independent contractor the terms of the contract and the working arrangements cannot remain as before and must be reflective of genuine self-employment. It may not be possible to achieve this if the requirements of the school cannot be met this way.
If the school engages the contractor via an umbrella company or agency, although these parties would then bear the employers’ NIC cost they will likely seek to pass the cost on to the school.
A final option would be for the school to offer the contractor a contract of employment.
If you require further information about anything covered in this briefing, 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, March 2021