IR35: Changes to off-payroll working in the private sector
With effect from April 2020, the requirement to ensure working practises are compliant with 'IR35', also known as the 'off-payroll working rules', is shifting to the end user.
This change will affect private sector businesses who use consultants/contractors where those consultants/contractors operate through intermediaries, such as personal service companies ("Relevant Contractors").
This change follows an identical change (already implemented with effect from April 2017) for organisations in the public sector that use Relevant Contractors.
Under the new rules, private sector businesses that use Relevant Contractors will also be responsible for identifying and ensuring 'IR35 compliant' working practices.
In certain circumstances, the private sector business may also be responsible for applying PAYE and employer's NICs to payments to Relevant Contractors.
Businesses engaging large numbers of consultants/contractors should start reviewing their working practises now to avoid unexpected disputes with HMRC and sizeable tax demands for uncollected PAYE.
What is IR35?
'IR35' was a press release from the Inland Revenue (now part of HM Revenue and Customs) issued on 9 March 1999 which stated:
"The Chancellor announced today that changes are to be introduced to counter avoidance in the area of personal service provision. This move underlines the Government's commitment to achieving a tax system under which everyone pays their fair share.
There has for some time been general concern about the hiring of individuals through their own service companies so that they can exploit the fiscal advantages offered by a corporate structure. It is possible for someone to leave work as an employee on a Friday, only to return the following Monday to do exactly the same job as an indirectly engaged 'consultant' paying substantially reduced tax and national insurance."
The legislation and rules that followed are known as 'IR35'.
IR35, therefore, is HMRC's attempt to tackle individuals working for end users through intermediaries / personal service companies ("PSCs") where the motive for that working arrangement is lower tax payments (and in particular employer's NICs, which is by far the biggest single tax cost to many businesses) rather than a genuine intent to be self-employed.
IR35 compliance must be considered in all circumstances where there is: (1) an individual; (2) the individual personally performs services for a client/end user (or is obliged to do so); and (3) services are provided under arrangements involving an "intermediary" (collectively referred to in this article as PSCs).
If these conditions are met then an assessment is carried out as to whether the circumstances are such that if the arrangements had been directly between the individual and the client/end user, the individual would have been regarded as "employed" by the client/end user for income tax purposes.
HMRC will look at the relationship between the individual worker and the end user and assess whether, absent the PSC, the relationship would be most properly characterised as an employment relationship. In doing so HMRC looks at the requirement for personal service (i.e., the right of substitution), mutuality of obligation (i.e., the requirement to provide and receive work), the degree of control between worker and end user, and various other aspects of the relationship.
Joe Blogs provides services to Huge PLC. Joe Blogs contracts with Huge PLC to provide services through Joe Blogs Limited, a limited company owned by Joe Blogs. Joe Blogs is the sole Director of Joe Blogs Limited.
Joe Blogs has provided services to Huge PLC for many years. Huge PLC manufactures widgets; Joe Blogs is a quality control specialist. Joe Blogs wears a Huge PLC uniform, reports to a senior employee of Huge PLC, and is in all material respects integrated in to Huge PLC. Huge PLC is Joe Blogs Limited's only client.
Joe Blogs Limited invoices Huge PLC; Joe Blogs receives a small salary from Joe Blogs Limited but most of the money paid to Joes Blogs Limited by Huge PLC passes out to Joe Blogs as dividends.
In this example, Joe Blogs Limited is the PSC. Huge PLC is the 'end user' and Joe Blogs is the individual working. Applying a notional assessment of the relationship between Joe Blogs and Huge PLC absent Joe Blogs Limited, it is likely that Joe Blogs would be considered, for tax purposes, to be an employee of Huge PLC.
The arrangement described would be likely to be found to fall foul of IR35 legislation and, as matters stand, Joe Blogs Limited would be required to account for the Income Tax and Employer and Employee National Insurance Contributions that would have been payable had Joe Blogs been an employee of Huge PLC.
What is changing?
In the Autumn 2018 Budget, the government announced that the responsibility for IR35 compliance would shift from PSCs (such as Joe Blogs Limited) to private sector end users (such as Huge PLC) from April 2020.
As set out in the example above, at the moment IR35 compliance lays with the PSCs. It is the PSCs who will be the subject of a HMRC enquiry and any demand for tax due.
Under the new rules, this will shift. It will be the responsibility of the client / end user (in the example above, Huge PLC) to assess whether or not IR35 applies and, if it does (and in certain circumstances), ensure that PAYE is applied to payments sent to the PSC (in the example above Joe Blogs Limited).
What steps should be taken?
The changes are being introduced to make life easier for HMRC. At the moment, HMRC is required to pursue the individual workers and their PSCs. HMRC is, as a result, pursuing numerous individuals for relatively modest amounts of tax.
These changes mean that HMRC can pursue large employers (engaging multiple PSCs) to recover the same tax- for a fraction of the recovery (and administrative) cost to HMRC. Yield-seeking compliance activity by HMRC is expected to be stepped up in light of these changes with more and more enquiries into working practices by HMRC.
We recommend that large and medium sized employers with numerous contractors get their house in order now, before the change in rules. This should involve:
A careful analysis of current working practises. Businesses will need to identify who they are currently contracting with and on what basis. A risk-based approach should be adopted and changes made to amend working relationships where necessary. As part of this process, businesses should have their contracts with contractors reviewed. But companies need to understand that a carefully drafted contract is not the solution to avoiding problems in this area unless it also reflects the reality of the situation.
Businesses can engage with CEST; the government's online checking system. CEST has been the subject of widespread criticism and we encourage you to approach it with caution. In particular, CEST has been criticised for giving undue weight to certain aspects when assessing whether an employment relationship exists (such as the right of substitution) and, in a large number of cases, failing to give a result at all.
Businesses should review their payroll systems, booking systems and other processes to ensure they have the capacity to apply PAYE to contractor pay where necessary.
Further, the tax implications cannot be considered in isolation. Businesses will also need to consider any changes made from an employment law perspective. Attention should be given in particular to employee and workers' rights, equal pay and employee protections, but there are other implications.
If businesses opt to move workers on to payroll, they will need to consider:
their staff budgets including in pitch situations. There will be an associated PAYE cost (such as employer's NIC). This increased costs needs to be incorporated in to budgets.
the size of their HR team. Will the current team be able to cope with additional employees?
In preparing for these changes, the private sector can learn from the public sector (which has already undergone these changes). Keep your eyes peeled for our forthcoming article on lessons to be learned from the public sector experience of these changes!
For further information please contact our IR35 team (above) or follow our Employment Law Blog.
You can also register here for our forthcoming event discussing these issues.
The event is taking place on 2 April 2019 (3:30pm until 5:30pm) at Fieldfisher's London office.
The event, which is free of charge, is a roundtable discussion on IR35 and employment status issues in the private sector. The collaborative discussion will focus on how the forthcoming changes to off-payroll working in the private sector will impact your business and to knowledge share solutions being adopted.