The off -payroll working rules, known more commonly as IR35, were introduced in 2000. Their purpose is to stop independent contractors who operate through an intermediary gaining unfair income tax and national insurance advantages when, in essence, they would be classed as an employee if they were contracted directly.
Although the legislation has been around for close to two decades, HMRC has claimed that levels of non-compliance have been high, with only 10% of those who should be applying the rules doing so.
To combat this, HMRC introduced reforms to the public sector in 2017, which shifted the responsibility of determining whether IR35 applies from the worker’s intermediary to the public sector body or agency paying the worker’s intermediary.
Despite mixed reviews of the effectiveness of the public sector reforms, Budget 2018 announced an extension of the off-payroll working reforms to the private sector, with the new rules applying from April 2020.
From 6 April 2020, medium and large private sector organisations will be responsible for assessing the employment status of individuals who provide services to them through an intermediary, typically a Personal Service Company (PSC).
Where an individual is considered to be a disguised employee within the scope of IR35, the entity that pays the contractor’s intermediary (the “fee-payer”) will be responsible for withholding tax and National Insurance Contributions (NICs). Typically, the fee-payer is likely to be the client or an agency.
It’s worth noting that, while the reforms essentially change who the responsible party is for determining IR35 status (shifting responsibility for determination on from the contractor’s PSC to the end client) the underlying IR35 legislation has not changed as a result of these reforms.
While medium and large-sized organisations, agencies, and contractors that operate through a PSC will have to consider the implications of the new legislation, small organisations are exempt from the new rules.
The draft legislation uses the Companies Act definition of small, where an entity is considered small if two or more of the following conditions are met:
- Annual turnover not more than £10.2 million;
- Balance sheet total not more than £5.1 million;
- Not more than 50 employees. Unincorporated organisations will be consideredsmall where turnover does not exceed £10.2 million. Where an organisation is exempt from applying the new rules, the existing IR35 procedure will apply (i.e. it will remain the responsibility of the PSC to make an IR35 determination).
As part of the reforms, medium and large organisations should provide a worker with a Status Determination Statement (SDS) which outlines both the decision reached by the organisation as to the worker’s employment status as well as the reasons behind the decision.
The client should also pass on the SDS to the agency or other organisation the worker contracts with until the SDS reaches the party immediately above the worker’s intermediary, who is classed as the fee-payer or deemed employer. A fee-payer must be resident in the UK or have a place of business in the UK.
Crucially, if a party in the labour supply chain fails to pass the SDS to the next relevant party, then that entity will become the fee-payer.
A fee-payer is responsible for calculating the deemed direct payment, which accounts for employment taxes and NIC associated with the contract.
The fee-payer should withhold the relevant employment taxes and employee NIC from the payment to the worker’s PSC and also pay employer NIC. These amounts should then be reported to HMRC through the Real Time Information (RTI) system.
Notably, the employment allowance cannot be used against deemed employee payments.
If a worker or deemed employer disagrees with an SDS, a client-led appeal process is available. As the legislation stands, clients will have 45 days to respond to a worker or deemed employer where a status determination has been challenged, either to inform them that the client’s initial determination has been reviewed and is deemed correct or to issue a new SDS.
The draft legislation has been subject to a fair amount of criticism, with major accountancy and tax bodies, including the ICAEW and CIOT, highlighting issues with the draft legislation and accompanying guidance, such as:
Lack of clarity over status determinations
As small organisations are exempt from the new rules, the responsibility for making status determinations remains with the worker.
However, as small organisations are not required to notify contractors that they are small, this could cause confusion for workers, who may not be aware that the onus remains with them to determine the IR35 status of an engagement.
Additionally, the client-led disagreement process over an SDS determination has been criticised, with both the CIOT and ICAEW highlighting that the legislation does not place any time limit on when a worker or deemed employer can object to an SDS determination.
This means, in theory, years could pass before any objection is raised, which could lead to increased uncertainty for clients.
It’s no secret that the IR35 legislation can be difficult to navigate at the best of times, as an IR35 determination is often subjective and dependent on the specific circumstances of a contractor’s engagement with a client.
HMRC’s recent high-profile IR35 cases in the courts, such as Lorraine Kelly, have only further highlighted the complexity of this area of legislation.
To assist relevant stakeholders, HMRC introduced a Check Employment Status for Tax (CEST) tool that workers, engagers, and agencies can use to see whether HMRC considers an engagement to fall within the scope of IR35.
As HMRC has stated that it will stand by the results given by CEST unless the information provided isn’t accurate, it is likely to be relied on by many organisations when making a status determination.
However, CEST in its current form is flawed and does not consider fundamental tests when determining employment status, including the Mutuality of Obligation (MOO). What’s more, in a significant minority of cases CEST cannot even make an employment status determination.
HMRC has stated that an improved CEST should be available for use later in 2019, but, without seeing the new tool, it’s hard to say whether it will be reliable enough when assessing contracts impacted by the April 2020 changes.
The power to transfer PAYE liabilities
One of the more controversial aspects of the draft legislation is section 688AA, which would, by means of secondary legislation, permit HMRC to recover PAYE liabilities from other entities in the labour supply chain in cases of non-compliance.
This could create a situation where, even if a client or agency had taken all reasonable steps to comply with the new rules, they could still face a PAYE liability if non-compliance is found elsewhere in the chain.
A few concerns have been raised about how the changes may impact contractors negatively, with some doubts paralleling criticisms levied against the public sector reforms.
In response to the government’s consultation the private sector reforms, concerns were raised that medium and large organisations may make blanket judgments over the IR35 status of a contractor, effectively deeming all their contractors to be disguised employees. There have been reports of such practices in the public sector since the 2017 reforms, although HMRC has denied that this is the case.
Whether predictions of blanket determinations come to fruition for private sector contracts remains to be seen. According to Deloitte’s 2019 pulse survey results, only 20% of organisations responded that they “believe they will assess 80-100% of identified PSCs as deemed employed” while 19% of respondents believed “they will find that only 0-20% are deemed employed.”
Even if blanket determinations were adopted by organisations, there are some safeguards available to contractors.
For example, a contractor can challenge the SDS, following the process outlined above. There is also provision in the legislation for an SDS to be disregarded if it is found that the client has not taken “reasonable care” (although crucially, the guidance does not provide a definition of reasonable care).
The LITRGalso expressed concern that low-paid workers, who may only be working through a limited company at the instruction of an engager, may be forced out of working through such structures as a result of the changes and be “encouraged into other dubious arrangements that help engagers protect their profitability.”