Off-payroll working in the private sector - reforms to IR35 have now come into force

Off-payroll working in the private sector - reforms to IR35 see a shift of responsibility

Following a delay of a year in light of the COVID-19 pandemic, organisations which hire contractors via intermediaries will need to make sure they are up to speed with changes to the way these contractors are taxed which came into effect on 6 April 2021.

Similar changes were made to off-payroll working in the public sector in April 2017 and this now brings the private sector into alignment.

What’s changed?

In short, the new rules shift the responsibility for determining how the contractor’s fee should be taxed from the contractor and their PSC to the end-user (‘client’). In the event that the rules apply, the client or, if intermediary agencies are involved, the agency as fee-payer, will then be responsible for deducting tax and other payments at source. Clients which fall within the definition of ‘small company’ are exempt from the changes. HMRC guidance has confirmed that, where the client is overseas and has no UK connection, the new rules do not apply.

What has changed since March 2020?

The new rules introduced by the Act broadly reflect the draft legislation save that:

• contractors and the first agency in any chain are able to request confirmation of the client’s size so as to confirm whether it is exempt, the client must respond to this request within 45 days
• the definition of a relevant intermediary has been widened to include any company intermediary from which the contractor has a right to receive payment for services provided to the client. HMRC has confirmed that this change was not intended to capture umbrella and other arrangements where PAYE is already being operated and in which the contractor has no material interest.

HMRC has published updated guidance relating to off-payroll working in the Employment Status Manual to help employers and contractors to navigate the new rules. The updated guidance includes explanations of the rules in plain English and practical examples.

Why the change in tax treatment?

One of the intentions behind IR35 was to ensure that individuals who provided their services through a PSC, but who otherwise are difficult to distinguish from directly engaged employees, would have to pay the income tax and national insurance contributions (NICs) which would have been payable had they been engaged, as an employee, directly by their client. Currently, in the private sector, responsibility for determining status and for accounting for income tax and NICs lies with the PSC. The government has long been concerned that there is widespread non-compliance with IR35 and the consequent shift in responsibility from PSC to client is designed to address this.

What do the changes mean for contractors?

Contractors in a labour supply chain, operating through a PSC or another form of relevant intermediary, will receive a status determination from the client together with reasons for the determination at the start of the contract. If the client determined that the contractor should be taxed as if they were employed, the client (or intermediary agency if involved) would deduct income tax and employee NICs from the fee payable.

What do the changes mean for clients?

Clients are now obliged to:

• determine the contractor’s status for tax in relation to an engagement
• notify the contractor of the status determination and the reasons for that determination
• if they are the fee-payer, deduct income tax and employee NICs from the payment and account for them to HMRC in the event that IR35 applies, and account for employers' NICs
• set up a process for dealing with challenges to their status determinations
• respond to requests from contractors to clarify whether they meet the 'small company' exemption.

Note: where the client is using a third party (usually an employment agency) to provide labour, the client must also notify the agency of the status determination and their reasons for reaching that determination. If income tax and NICs are to be deducted, it will usually be the agency (or the fee-payer in the event that there is more than one agency in the supply chain) which will be liable to make the deductions rather than the client. However, ultimate liability for accounting for tax and NICs on the fee paid will lie with the client if HMRC cannot recover from the fee-payer or contracting agency.

If the contractor in question is subject to PAYE and NICs as an employee of an agency or umbrella company already accounting for PAYE, then HMRC have confirmed that such arrangements fall outside the new rules.

Why are these changes significant?

Additional costs

The changes may result in additional costs in the form of employers' NICs. In addition, fee payments taxed under the new rules may count when calculating the Apprenticeship Levy. Clients may well see an increase in fees to make up for any shortfalls in contractors’ net income as a result.

Increased administrative and compliance burden

The changes, inevitably, create a significant administrative and compliance burden for clients which is likely to be particularly challenging for those who rely on large numbers of contractors working via PSCs. For example, clients will not only need to make status determinations at the start of a contract, but will also need to monitor contracts on an ongoing basis to identify changes in circumstance which may alter the status determination.

Equally the requirement to notify the contractor of the determination directly is also likely to be problematic as many clients who use intermediary agencies will not know the identity of the contractor or how to contact them before they arrive on site. If the client is the fee payer they may also not have the information required to process the payroll, for example, NI number, date of birth, address etc.

The client will be required to have a status disagreement process in place to deal with disputes from contractors and fee-payers and will need to respond within 45 days. It will also have to reply within 45 days to requests from contractors for confirmation of whether they meet the 'small company' exemption.

Whilst there are a number of different ways HMRC can seek to enforce compliance, HMRC have announced that it will not require businesses to pay penalties for inaccuracies in complying with these new rules relating in the first 12 months, regardless of when the inaccuracies are identified, unless there is evidence of deliberate non-compliance. The aim is to support businesses and HMRC has confirmed they will help businesses with correcting mistakes.

The waiving of penalties for the first 12 months does only apply to businesses, which took reasonable care to apply the off-payroll working rules, this includes making mistakes in status determination assessments. However, those businesses which HMRC considers deliberately have not complied may be named and shamed and any arrangements it considered to be artificial or contrived would be challenged.

How should clients who use self-employed contractors respond?

• identify individuals who are currently engaged via a PSC or relevant intermediary either directly or via an agency
• review any such existing contracts to identify which arrangements are likely to be caught – HMRC has revised its online tool known as CEST, and published accompanying guidance. When a client uses CEST, HMRC will stand by the outcome provided the answers are in accordance with the guidelines and not contrived to achieve a particular result
• calculate the additional cost of employers' NICs (and the effect on the Apprenticeship Levy if applicable)
• review the engagement of individuals via PSCs and determine an appropriate strategy moving forwards
• be aware of the practical issues around notification of status determinations, provision of reasons and be alert to the requirement to adhere to the 'status disagreement process' or answer a query as to the small company exemption
• given the low cost benefit of using PSCs, companies may consider engaging workers directly instead. However, workers engaged directly would benefit from additional employment benefits, such as national minimum wage, paid annual leave and protection from unlawful deductions from wages. If the individual was to be viewed as an employee this would bring with it significant additional rights and protections.

What should contractors be doing?

• ensure that you are aware of the changes and understand the basis on which you are currently contracting, the likely status determination that will be made by the client in relation to the assignment and the consequent tax obligations where fees are to be paid from April 2021.
• consider whether it might be in your interests to seek to change your working arrangements with the client. For example many clients are reviewing their resourcing requirements with a view to offering opportunities for contractors to be taken on as workers, or in some instances, permanent employees. Additional employment rights will attach if so but fees may decrease.

How Burges Salmon can help

Our readiness review service offers:

• an audit of your existing intermediary arrangements
• a review and risk analysis
• advice to help identify the right resourcing strategy for your organisation.

Standalone advice on the issues raised in this briefing is also available.

Disclaimer

This briefing gives general information only and is not intended to be an exhaustive statement of the law. Although we have taken care over the information, you should not rely on it as legal advice. We do not accept any liability to anyone who does rely on its content.