IR35 tax changes put employment status in the spotlight again
Written in collaboration with David Williams-Richardson, partner in the Employer Solutions team at RSM UK
This will mean contractors who supply their services via a personal service company (PSC), either directly or through an agency or other intermediary to an end user client, could face increased taxes to mirror the tax position of traditional employees. Similarly the end user of the services will face an increased administrative burden and potentially the added cost of employer NIC (currently 13.8%) where an arrangement is within the IR35 regime.
Understanding the legal status of people working for an organisation is critical in establishing whether the upcoming changes to IR35 apply.
What is IR35?
IR35 is a particular part of the Finance Act 2000 which is designed to prevent people from paying a lower rate of tax and NIC by setting up a personal service company as a payment vehicle to disguise employment, thereby paying less tax.
The amended IR35 legislation will shift responsibility for assessing whether or not the IR35 legislation applies from the individual contractor, or their PSC, to the end user. Where it is concluded that the rules do apply, then the fee payer paying the PSC will need to operate PAYE/NIC including the additional cost of 'employer' NIC.
"The proposed new rules from 6 April 2020 will increase the potential cost for end-users who are engaging off payroll workers via intermediaries such as PSC as well as significantly adding to the administrative burden. Not only will the end user need to identify all arrangements with PSCs, they will also need to make a status determination and issue a status determination statement setting out whether or not the rules apply and their reasons for reaching that conclusion. A status dispute process will also need to be put in place. Where the rules do apply, the fee payer will need to operate PAYE/NIC deductions, including the additional cost of 'employer' NIC at 13.8%. Changes will also need to be made to systems, processes and procedures in order to be compliant and there are now less than 9 months left before 6 April 2020.
It is also important to appreciate that the 'end user' client will still have the obligation to review the arrangements and issue a status determination statement even where the worker is sourced via a third party such as a recruitment agency. The only exception to this is if the recruitment agency can give assurances that they are operating PAYE/NIC on payments to the PSC.
The new rules will however only apply to end users who are medium or large businesses. Small businesses, as defined by the Companies Act (broadly those with two or more of turnover of not more than £10.2m, balance sheet total of not more than £5.1m or less than 50 employees) will not need to apply the rules and the PSC will continue to be required to self assess as to whether or not IR35 applies. These small company rules are complex though, particularly for groups, and we recommend that end users seek professional advice before concluding that they are outside the rules.
Where IR35 does apply from 6 April 2020, organisations will have to consider the practicalities and additional cost of compliance. It is important to remember that these rules will apply to payments on and after 6 April 2020, so the cost of existing arrangements that continue after 6 April 2020 and which are within the new rules could increase significantly.
A real challenge for many of the businesses we are working with is how to ensure that their internal accounting, HR and payroll systems can deal with the requirements of the new rules. There is now limited time to set up and test interfaces between systems and this will be crucial in order to meet compliance obligations.
Contractors operating via PSCs will also need to ensure that they understand the implications of the changes and their right to dispute status determinations made by their end clients.
Due to the complexity of the new rules and the increase in the risk profile where mistakes are made it is recommended that organisations take independent tax advice to ensure that they are ready for the changes."
Why is understanding employment status relevant?
In broad terms, IR35 will apply if:
- An individual personally performs services for a client.
- Those services are provided under arrangements involving an intermediary such as a PSC.
- The circumstances are such that if the arrangements had been made directly between the individual and the client, the individual would have been regarded as employed by the client for tax and national insurance contribution purposes.
It is the third condition which means organisations will have to consider employment status.
What adds additional confusion is that the IR35 rules only relate to tax and not employment law. From a tax perspective someone can only be employed or self-employed. Yet in an employment law context someone can be an employee, worker or self-employed and this has different ramifications in the Employment Tribunal. In particular, employees benefit from a range of statutory rights in comparison to workers or those that are self-employed.
Employment status factors
HMRC has provided guidance on the factors that it considers to be the most important in determining an individual's employment status. Whilst each case will vary on its individual facts, the below are some of the important factors:
- Personal service. In order for the contractor to be an employee, they must be obliged to provide their services personally. If they are able to provide a substitute to do the work, this may point away from an employment relationship.
- Mutuality of obligation. There must be an obligation on the part of the contactor to provide their work and the end-user to pay for that service. Where someone is genuinely employed they will be obliged to work and they will expect to be paid. Those who are self-employed often cannot expect regular work.
- Control. To be an employee there must be a degree of control over them, for example the way they perform their services.
- Equipment. Someone self-employed would be expected to provide their own equipment.
- Financial risk. Those who incur or risk their own money are likely to be self-employed. In nature employees do not have the same financial risk, they will expect to get paid every month and will be reimbursed for expenses.
- Integration. If a contractor is integrated into the organisation they are more likely to be an employee.
In contrast, if the parties label the contractor as self-employed when in reality that is not the case, the label will be ignored by HMRC.
Whilst these changes won't be implemented until April 2020 we would recommend that organisations start their preparations now by:
- reviewing which PSCs are engaged (including those sourced via agencies) and assess whether the reality of the engagement may be more akin to an employment relationship
- using HMRC's online status guidance tool which is a good starting point as part of the employment status assessment process
- taking independent tax advice on whether IR35 applies to the contractors you engage and the practical steps that you will need to take to meet your obligations under the new rules
- reviewing the contracts you have with the contractors you engage, or implement a contract if one isn't in place to govern the relationship. This contract should set out the relationship to reduce the risk of IR35 but the provisions must accurately reflect the reality of the contractual relationship.