As expected, the government announced in the Budget last week that it will extend to the private sector the reforms it has implemented in the public sector to off-payroll working rules (known as IR35).
This extension is the latest development in the ongoing scrutiny by both the courts and HMRC of the contractor element of the workforce. Introduced in 2000, very broadly the IR35 rules were intended to ensure that individuals working through an intermediary (usually, but not necessarily, a personal service company), who would have been regarded as employees if engaged directly by the client, pay broadly the same income tax and National Insurance contributions ("NICs") as if they were employed. Importantly, in the private sector it is currently for the intermediary to determine whether the rules apply and to pay tax accordingly. This means that the tax risk currently lies with the intermediary rather than with the client.
Scope of reform
From April 2020 the responsibility to determine whether IR35 applies and, if it does, to pay tax and NICs on the sums paid to the intermediary for the individual's services, will generally be that of the engaging business. The government has announced that the reforms will not apply to 1.5 million small businesses, using criteria similar to those used in the Companies Act (which contains tests based on turnover, balance sheet and employee headcount). The government plans to consult on further details of the reforms in 2019.
While the government is keen to emphasise that it is not introducing a new tax liability and that this reform does not affect the (genuinely) self-employed, only changing who is liable to account for the PAYE and NICs, this does potentially place a significant tax liability on businesses that engage contractors through intermediaries. The government has stated that evidence suggests that currently only 10% of intermediaries that should be applying IR35 do so.
It is important to remember that this tax liability risk is one that businesses who engage contractors on a self-employed basis through a direct agreement with the individual (i.e. without an intermediary) will already be taking. Your approach to that risk, if it already exists in your business, may influence your approach to this new potential liability.
If your business is affected, we recommend taking steps now to ensure it has the procedures in place to be compliant by April 2020 and has budgeted for any additional costs.
- Carry out an "audit" of your contracting arrangementsFirstly, we recommend undertaking an "audit" of the arrangements under which your business engages contractors through an intermediary, including whether these are expected to change in the near term. This scoping exercise will inform your business's approach to preparing for the reforms. For example, a different approach may be appropriate for a business engaging a small number of contractors under output-focused short-term contracts, compared to one whose contractors provide services for regular working hours where the business heavily supervises their work.This audit should include a consideration of which contractors engaged through an intermediary currently fall within IR35 (regardless of whether the intermediary is currently accounting for tax and NICs). The government has created a tool for this purpose (Check for Employment Status Test, "CEST"), and businesses who fill out this tool correctly and receive a response that the contractor is genuinely self-employed should be able to rely on this if HMRC questions their determination of a contractor's tax status. However, determining employment status with any certainty does remain legally complex and concerns about the CEST tool have been raised (particularly those cases where CEST does not give a definitive "employed" or "self-employed" result). Whilst the government has stated that HMRC will seek to improve the CEST tool and employment status guidance, it is inevitable that, in some areas, there will continue to be unclear cases.If a chain of intermediaries and contractors is used to provide a contractor's services, your business may not be the entity required to consider tax status and/or withhold income tax and employee NICs and pay employer’s NICs. We are happy to advise you in relation to such arrangements.
- Determine an approach for your businessThe above scoping exercise will inform the approach your business takes to prepare for the reforms. There are two broad elements of this:Contractor status. Post-April 2020, what will be the status of your contractors engaged through an intermediary? There are a number of potential outcomes, including:
- The contractor is considered self-employed and income tax and employee NICs are not deducted, and employer's NICs not paid. To the extent that your current contracting arrangements do not already achieve this result, you may wish to consider amending the respective obligations of contractors and the business so that it is truly engaging people on a self-employed basis. Bear in mind however that HMRC looks at the reality of the situation rather than just the contract so any such changes do need to be carried out in practice. For example, including a right of the contractor to send another in their place will be ignored by HMRC if it is clear that the client would not accept such a substitution. Some businesses will find that amending contractors' working practices too significantly will not be commercially acceptable, so will need to consider an alternative option;
- IR35 is considered to apply so the business deducts income tax and employee NICs from fees paid to the intermediary company, and pays employer's NICs. In these circumstances, you should be prepared for contractors to demand either (i) that their fees are grossed up, or (ii) that they are engaged as employees or workers, which will bring extra costs (see below). It is also possible that contractors who are having taxes deducted bring employment law claims based on a contention that they are employees or workers for employment law purposes;
- Current and future contractors are engaged as employees or workers, e.g. on fixed-term arrangements. This will cause extra costs in relation to paid holiday, pension contributions and benefits as well as increased statutory employment protection and potentially additional business support costs.
Many businesses engage contractors under a variety of arrangements and for a range of purposes, so a mixture of the above may be necessary. The government has stated that it is aware of concerns that businesses may use blanket decisions as to IR35 status across groups of workers. The government intends to explore options for the consequences of businesses failing to use reasonable care in making their decisions.
Organisational procedures. Who will be responsible for ensuring that contractor engagements through intermediaries are entered into on the right basis in future? Some businesses will feel more comfortable delegating this process to procurement or those making the decisions to engage contractors, with a directive to use the government's CEST tool and possibly additional internal guidance. Others may want HR or Legal to sign off on any contracts deviating from past practice, or contracts above a certain value. For large businesses, which retain contractors in different ways, an internal code of practice or decision tree is likely to be invaluable.
- Budget for the new arrangements
This may include additional fee/ payroll costs and internal compliance costs, and should be kept under review as discussions and negotiations with contractors progress.
- Train those internally who need to know about the reforms
The training needed and its recipients will depend on who is responsible for contractor arrangements in future, but it is important to ensure that those responsible for engaging contractors are aware of the basics of the regime and who to contact internally with any queries or before entering into new arrangements.
- Speak to your contractors whose position is changing and negotiate any required amendments to arrangements
As set out above, you may find that contractors demand additional money or employment law rights, and businesses need enough time to settle these issues before 6 April 2020. Engagements may have long notice periods for termination and it is best to have the option to terminate before 6 April 2020 if necessary.
If this is an issue that affects your business, please contact your usual employment team contact to discuss the possible scenarios and practical steps to take.
