Introduced in 2000, the IR35 rules were intended to ensure that individuals working through an “intermediary” (usually, but not necessarily, a personal service company), who due to the way they were working and the nature of their work, would have been regarded as employees if engaged directly by the end user (the “client”), pay broadly the same income tax and National Insurance contributions ("NICs") as if they were employed. In the private sector, it is currently for the intermediary to determine whether the rules apply and, if so, to account for income tax and NICs accordingly. This means that the tax risk lies with the intermediary rather than with the client.
In April 2017, the government amended the IR35 legislation for individuals providing services to a public sector client through an intermediary. The changes meant that the public sector client, rather than the intermediary, became responsible for deciding whether IR35 applies (assisted by an online tool known as CEST) and, if so, for accounting to HMRC for tax and NICs.
Private sector reforms
From April 2020, the public sector reforms will be extended to the private sector. This change is expected to raise £1.1bn for the Exchequer in its first year.
These reforms mean the client will be responsible for determining whether IR35 applies and, in some circumstances, accounting for tax and NICs on the sums paid to the intermediary for the worker’s services.
1.5 million “small businesses”, assessed based on turnover, balance sheet and employee headcount, won’t be affected by the reforms and will remain subject to the current rules.
The consultation on the draft provisions of the Finance Bill that will implement the changes for the private sector closed on 5 September 2019, but we do not expect the provisions to change significantly now before being finalised.
Who will now determine employment status and how?
From April 2020, in the private sector the obligation will be on the client to decide whether or not the worker providing services through the intermediary (and perhaps via a longer supply chain) would be regarded as its employee for income tax purposes if they were engaged directly by the client. To make such a determination, the client will need to consider the reality of all aspects of the working arrangements, not just how it is documented.
Whilst not required under the draft legislation, HMRC is encouraging clients to use the CEST tool (which is expected to be updated this Autumn) to assist in the decision-making process. HMRC is not compelled to stand by any result given by CEST, but it has said that it will do so unless a compliance check finds the information provided by the client when using the CEST tool is not accurate.
Having made its determination, the client will then need to pass a status determination statement (“SDS”) to:
- the individual worker; and
- where the worker is supplied through a more complex supply chain and there are other entities between the client and the intermediary (for example one or more agencies), the entity immediately below the client in that supply chain.
Broadly, the SDS must state whether the client has concluded that the individual should be treated as its employee for income tax purposes or not, and the reasons for that conclusion.
The obligation to provide the SDS, and the consequences that flow from this, noted below, will also apply to the public sector from April 2020.
Who bears the income tax/NICs liability?
The obligation to deduct and account for income tax and NICs in accordance with the determination in the SDS will sit with the entity that pays the intermediary for the services provided by the worker (“fee payer”).
Where the client contracts with the intermediary directly, the client will also be the fee payer. In a chain of suppliers, the fee payer will be the entity that pays the intermediary.
Can the status determination be disputed?
The client will need to create its own process to resolve any disputes in relation to its status determinations, with minimum requirements for this being set out in the draft legislation.
Where the conclusion in the SDS is disputed by the worker or deemed employer (usually this will be the fee payer), the client must respond within 45 days:
- confirming it is satisfied that the SDS is correct, giving reasons for this; or
- withdrawing the SDS and replacing it with a new one with a different determination.
When will/could the client be responsible for the income tax/NICs liability?
There are several situations in which the client will or could be responsible for some or all of the income tax/NICs liability, including:
- where it is the fee payer and:
- it has determined that, without the intermediary, the relationship between it and the worker would be one of employment; or
- it has determined that the relationship is that of independent contractor and therefore falls outside of IR35, but HMRC successfully challenges its determination;
- where it is not the fee payer and:
- it has determined that without the intermediary, the relationship between it and the worker would be one of employment, but:
- the fee payer fails to account for all of part of the income tax/NICs due; or
- the client has failed to:
- provide an SDS in accordance with the legislation (including taking “reasonable care” when doing so);
- respond to a dispute within the prescribed timescales and provide the requisite information; or
- withdraw the SDS and notify the worker and any other relevant entities of this when it has ceased to be treated as a medium or large business for that tax year.
- it has determined that the relationship is that of independent contractor and therefore falls outside of IR35, but HMRC successfully challenges its determination.
It will be interesting to see the approach HMRC takes to recovering income tax/NICs liability from entities in the supply chain other than the fee payer. HMRC is due to publish guidance and education tools which should provide more clarity on when liability might attach to the client.
What can organisations do now to prepare?
In our update last year, we encouraged organisations to carry out an audit of their existing arrangements with contractors, and to consider how, and to what extent, they are affected by the reforms. The results of such an audit should inform discussions about how affected organisations can plan for the implementation of the new rules from April 2020. This is likely to include:
- Due diligence - it will be important for a client to be aware when a worker is providing services through an intermediary. This may not be immediately evident where the worker is supplied through an agency. In arrangements with agencies and other suppliers, organisations may wish to include an obligation to inform the client where a worker is providing services through an intermediary and other information it may require to carry out a status determination;
- Making the determination - determining employment status (with assistance from the CEST tool) and providing the SDS in accordance with the legislation should happen before the start of the engagement. Clients should consider:
- requesting information from the worker and any other party in the supply chain relevant to making the determination (this could relate not just to the work done for the client, but the way in which the worker operates more generally any services they provide to other clients);
- gathering evidence to demonstrate it has taken “reasonable care” in making that determination; and
- recording the supply of the SDS to the worker and any entity between it and the intermediary;
- Further guidance and training - for key internal stakeholders on when the new rules may apply and the relevant processes for determining employment status and making and disseminating the SDS;
- Contractual negotiations - where the client determines that a worker, or workers, fall within the new regime, it may be necessary to negotiate new terms or new arrangements with the intermediary or any agency sitting in between. It may even be necessary to find new contractors altogether where agreement with existing contractors cannot be reached. Therefore clients will need to ensure they have built sufficient time into the project planning stage to address any challenges to status determinations and the consequences that flow from these;
- Budgeting - in practice, it is likely that any agency sitting between the client and the intermediary will seek to pass on to the client any increased costs incurred, given the negative effect that these costs will otherwise have on profit margins. Clients will need to budget for any such additional costs or otherwise allow for consideration of alternative staffing approaches (such as fixed-term employment or managed service provision);
- Knowing and relying on suppliers – clients will need to carry out appropriate due diligence on any agencies or third-party suppliers to assess the potential risk of default on fee payer obligations or other eventualities that could result in a contingent liability passing to the client. Indemnity protection is also likely to be sought by the client to ensure any income tax and NICs liability falling to it that should otherwise be borne by the fee payer can be recovered in appropriate circumstances;
- Dealing with disputes – challenges to a client’s status determination will need to be dealt with promptly, not only to comply with the prescribed timescales, but also from a commercial perspective. A standard dispute process will assist in ensuring consistency of approach across the business and that prescribed timescales are adhered to;
- Keeping it under review – all parties are likely to want to keep arrangements under review. A material change in the way services are provided during the engagement could result in a change in the status determination and impact the costs that flow from that requiring a review of the arrangements with the intermediary or agency.
Join us for our webinar - we will be discussing preparing for the IR35 reforms in more detail at our forthcoming webinar on Tuesday 1 October at 1.15pm – click here to register.