To employ or not to employ? Tax is the question

Insight

09.12.2019

April 2020 will mark the arrival of changes to the IR35 rules (also known as the “intermediaries” or “off-payroll” legislation) for the private sector, capturing many independent schools within its remit. The draft legislation which will bring the changes into effect is expected to be passed by the new Parliament.

The new rules will put the onus on your school (unless you are exempt – more on which below) as a private employer, to decide whether any workers (and I use that term here and elsewhere in the widest sense of someone who works for you) who provide services to you via an intermediary are "deemed employees" of the school under the IR35 rules for tax purposes. If they are, the school will need to account for employment taxes on payments the school makes to the intermediary.

Those working for you who provide services via an intermediary (commonly a Personal Service Company, “PSC”) could include, for example, sports coaches, music teachers, drama instructors, marketing or IT professionals.

State schools and academies have been subject to equivalent rules since April 2017 when the IR35 changes came in for the public sector.

This briefing sets out what the current position is, what is changing and what steps you should be taking to prepare for and respond to the changes.

The status quo

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 akin to an employee (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 of the intermediary.

The key changes – April 2020

The Government decided that too many individuals say they are outside IR35 when they should in fact be within it and that the public purse is suffering as a result. In an attempt to remedy this, from 6 April 2020 (assuming the legislation is passed):

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 individual’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.

Is your school exempt from the likely changes?

Before considering what steps you should be taking to respond to this proposed change, you should first confirm whether your school is subject to the new rules.

The new rules will not apply to you if the school is defined under the legislation as a "small" business. You will be a small business if your school is established as a company and meets 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 group as a whole and connected companies (for example, is your nursery or prep school connected to the secondary school or part of the same company group?). Non-corporates (for example unincorporated associations or charities without a corporate structure) need only satisfy the turnover test ((i) above) 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.

Audit your workforce

If and when the new rules come into effect, you will need to be ready to issue a Status Determination Statement (SDS) for each individual who is working for the school through an intermediary. This should include both 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 the school, and also those who you conclude are self-employed for tax purposes.

HMRC has provided the CEST tool (Check Employment Status for Tax tool), to assist with the process of identifying deemed employees. 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 has been widely criticized for being too simplistic and inconclusive in more complex cases. As a result, the CEST tool has been enhanced and a new version was recently released on 25 November 2019. HMRC has also issued more detailed guidance which includes advice on how to answer some of the CEST questions. Until HMRC’s approach to the CEST tool has been more widely probed in the courts, our view is that other than in the most straightforward cases, it should be used only as a starting point and with caution.

When determining employment status for the purposes of the IR35 rules, the usual employment status tests are relevant. These tests come with the disclaimer that none of the factors are, in themselves, determinative and there is sadly no simple checklist available. 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 and feature in the CEST tool (this list is not exhaustive):

there is no substitution clause, or the substitution clause is rarely used or gives the school significant control over who can be a substitute;
the school has control over what services the worker provides and how they provide them;
the school decides where and when the work is done;
the worker doesn’t have to provide significant equipment in order to complete the work;
the worker is paid a set termly or yearly amount;
the school offers benefits to the worker, for example access to the gym, a parking space;
the worker interacts with the parents and pupils of the school or holds themselves out to be working for the school (rather than as an independent).

The Status Determination Statement

The SDS must include the reasons for the decision made and “reasonable care” must be used in preparing it. HMRC has warned that organisations should not make blanket determinations – eg decide to treat everyone as deemed employees for ease. 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 you and the worker, it is the person in the chain immediately before the PSC who is responsible for accounting for the employment taxes due. For example, where an agency supplies the worker to you (and the worker contracts with the agency via their PSC), the agency would be responsible, and the SDS should be passed down the chain from the client to the agency so as to alert the agency to 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

You should start identifying those who supply their services through PSCs and are at risk of deemed employment tax status, and you may wish to start consulting with such individuals about the proposed IR35 regime. (If you do the latter, be mindful when you do that the legislation has not yet passed.) In due course, you may wish to consider renegotiating the commercial terms of your arrangements with some individuals in order to pre-empt a challenge to an employment tax status determination. For others it may be preferable (again in due course) to offer an employment contract. (See further below on the potential impact of status for tax purposes on status for employment law purposes.)

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 with your determination.

Implement the changes

Once your decisions have been made on status then, from April 2020, the most prudent step is to prepare SDSs for all workers who supply their services through an intermediary regardless of whether you consider them to be deemed employees. Those who you determine to be deemed employees should be notified that they will go on the payroll. You will need to pay the employer national insurance contributions to HMRC and take into account the deemed employment payment (ie the money paid to the worker for their services) when paying corporation tax.

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.

When planning for and implementing IR35, very careful consideration will need to be given – particularly when dealing with existing arrangements - to the status of individuals for employment law purposes, as well as for tax purposes. It is in theory possible for someone to be deemed to be an employee for tax purposes but a worker or a self-employed for employment law purposes, but in practice there is considerable overlap in the tests applied to determine tax and employment law status. Before sending an SDS or communicating with individuals providing services through a PSC, you will need to be mindful of the potential impact of such communications on the employment law position.

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. This is all the more reason to take care when assessing the status of your current workforce and the likely status of relationships you enter into in the future.

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.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.