(Updated July 2019) In a not-unexpected move on 29th October 2018, the Chancellor announced that all medium and large sized businesses in the private sector who employ Contractors will become responsible for assessing the Contractors ’employment status’ – where the individual works through their own Limited Company (or through other ‘intermediaries’) – from 6th April 2020.
Although this fundamental change was originally expected to be implemented in April 2019, many felt this change should be delayed further to April 2021 to allow the private sector to prepare for the change, with the current Brexit uncertainties ongoing for businesses of all sizes.
The background to this is (you can see our previous IR35 post about the Public Sector here):
Since April 6th 2017, the IR35 status for Public Sector Contractors with Limited Companies (or Contractors working through other ‘intermediaries’) has been determined by the client (the Employer), not the contractor. The client becomes liable if they make the wrong IR35 determination. This is because HMRC is convinced that a large proportion of contractors are “disguised employees”. This change means the responsibility for enforcing IR35 in the public sector shifts away from the HMRC and the Contractor and onto the end client i.e. the public sector body.
Therefore, the client (employer) therefore needs to assess the Contractors’ working practices and if they believe that the underlying relationship between the Client and the Contractor providing the services if one of ’employment’ then IR35 applies. This means that the contractors company will be taxed at source by the Client (through PAYE), exactly as if it were an employee (and employee and employer NIC’s need to be paid as well by the Client).
However, the contractors’ employment status does not change, so they will not receive the rights and benefits that go with full ’employee’ employment (e.g. holiday pay, SSP, unfair dismissal/redundancy rights etc). To complicate this, there has already been a successful claim from an affected Contractor in the public sector, for holiday pay, which you can read here.
The HRMC provide a ‘Check employment status for tax’ (CEST) tool which is designed to test whether an engagement is inside or outside IR35, which you can see here – https://www.gov.uk/guidance/check-employment-status-for-tax
However, this CEST tool has been widely criticised in the Public Sector for asking incomplete questions and for giving ‘incorrect’ status decisions – see more information on CEST (July 2019) later on……
In the Government’s Budget Guidance of 29th October 2018, which you can see here, and which we’ve reproduced in full below, the Government says that “The reform will not apply to the smallest 1.5 million businesses”, which means that this will only apply to Contractors working with large or medium sized clients.
So, if you are the Client and your business is classed as ‘medium or large’ this change will affect you, and when you employ someone who has their own limited Company, you will be responsible for determining if the Contractor can legitimately work for you as a Limited Company or must be taxed as an employee (from 6th April 2020).
After the announcement there followed a debate about what ‘small’, ‘medium and large’ business actually meant, and initially the Government gave no guidance on which organisations would be affected, apart from to say there would be “A further consultation on the detailed operation of the reform will be published in the coming months. This consultation will inform the draft Finance Bill legislation, which is expected to be published in Summer 2019”.
On 11th July 2019, the Government published the draft legislation.
It is now clear that the definition of a ‘small’ company will be determined by the existing Companies Act statutory definition.
So where the ‘client’ company satisfies 2 of more of the following requirements they will be deemed as ‘small’ and outside of this reform (i.e. not affected – so the Contractor will continue to make his/her ’employment status’ determination, and the Client will not have to):
- an annual turnover of not more than £10.2 million
- a balance sheet total of not more than £5.1 million
- and a number of employees of not more than 50 (averaged over the year; only PAYE employees are counted who have a Contract of Service with their Employer; using the definition that is set out in section 382 of the Companies Act) .
- All Businesses will be ‘small’ in their first year (and will remain ‘small’ until they meet two of the above criteria).
These thresholds are tested for the most recent financial year that ended at least 9 months before the start of the current tax year. This could obviously cause a major headache for business that move in and out of being a ‘small’ business. Business that are not companies, such as partnerships and unincorporated bodies) will be ‘small’ for these purposes if their turnover does not exceed £10.2million. Business who are subsidiaries of a larger company will not qualify as a small company if they are part of a larger group (that is classed as a ‘medium’ or ‘large’ company).
What seems clear at the moment is:
- Contractors will, from April 2020, have to know how big their client is (number of employees or turnover/balance sheet) when deciding whether to accept a contract with them, as that may determine their tax status.
- However, July 2019’s draft legislation does not require Client Companies to declare if their size makes them exempt from the rules (i.e. Companies don’t have to say if they are ‘small’!). Which could make it difficult for Contractors to know if they should consider IR35 for the contract.
- Contractors will be concerned that medium/large sized organisations may be overcautious and avoid any risks and ‘blanket’ all Contractors as ’employees’ (as has happened widely in the public sector and is being discussed openly in the private sector). However, the legislation tries to prevent businesses making a ‘blanket determination’ of all its Contractors at the same time; the legislation says that a determination will be invalid if the organisation fails to take “reasonable care” in reaching its conclusions about each consultants’ status. (Organisations are called “clients”, as they are clients of the services provided by the Contractor).
- Medium and Large Companies should start planning and auditing their Contractors now (including those that come via employment agencies); and they will incur costs in the planning and work involved in identifying all their Contractors (and determining if the new rules will apply to them), potentially face a shrinking talent pool and reduced flexibility, and/or higher costs of hiring Contractors (Contractors raising rates and/or tax/NIC payments increasing) and possible later legal challenges from Contractors (if they do not agree with their ‘status’). Companies who are going to be covered by the new rules should also ensure their contracts are IR35 compliant now.
- From April 2020 Client Companies who need to make a determination on the employment status of each individual Contractor (because they are a ‘medium’ or ‘large’ Company), should make a status decision and communicate this in writing to the party who they contract with (the Limited Company) and the individual Contractor themselves – this will be called a ‘Status Determination Statement’. The Client Company must give a reason for their status determination. This must take place before the time of the first payment under the contract. In the event the Client does not communicate in time they would bear the tax liability.
- In a situation where the individual/Contractor disagrees with the client’s status determination it will be for the 2 parties to resolve this and the Client must provide a dispute resolution process to allow this status challenge – this will be a statutory requirement and will be called a ‘Status Disagreement process’. However there is no formal resolution process provided by the legislation/HMRC. Client Companies will have 45 days in which to respond to contractors who are concerned about their status determination.
- Where the Client Company determines that the IR35 rules apply (and they normally pay the consultancy fee directly to the personal service company) then the Client Company must deduct income tax and Employee NIC’s (13.8%) from the Consultancy fee and account to HMRC for them (through the PAYE system), and also pay Employers NIC’s on the Consultancy fees. If the fee is normally paid to the personal service company via an agency, then the agency must operate the PAYE/NIC deductions and account to HMRC for them. This is called a ‘deemed payment’. The legislation sets out how the deemed payment is calculated – it excludes amounts in respect of VAT and the direct cost of materials.
- Where a Personal Service Company is found to be inside IR35 they will lose the ability to claim 5% of their turnover as an allowable deduction to cover the cost of operating their PSC.
- Where Client Companies fail to comply with the new IR35 rules they are at risk of financial penalties and/or unpaid tax and NIC bills. There is also the possibility of a criminal conviction for failure to prevent tax evasion.
- Some commentators believe the ‘immunity’ for small businesses may only be temporary (so it will apply to all private businesses in the future).
How do you determine a Contractor’s employment status?
IR35 will apply if the contractor is under an obligation to provide services personally to the client company and they would be viewed as an employee of the clients business. There are several competing factors to be balanced, some of which come from case law and HMRC have a guide (its Employment Status Manual) summarising the factors it considers to be most relevant to determine whether an ’employment’ relationship exists. HMRC considers the key factor is ‘mutuality of obligation’; other factors are the genuine right to substitution; the extent to which the Contractor bears financial risks for their own business; and control. You can read more details about status here.
HMRC’s CEST tool can be used to check Contractors status now, although it has been heavily criticised, or some companies may prefer to take legal advice or contact IR35 Contract Review firms. The Government responded to their first Consultation by acknowleding that the HMRC needs to improve its CEST tool (see information here) so it is effective in the private sector. In July 2019 the Government acknowledged that status determinations can be difficult! And made promises of more detailed guidance from the HMRC and a new and improved CEST tool before April 2020. So using CEST now may not be a reliable indicator of the result if you will repeat the status check using CEST at a later date (assuming changes are actually made!!).
However, the CEST Tool is not mentioned in the draft IR35 legislation, which means that there will be no statutory obligation to use it.
We understand that the draft IR35 legislation should be finalised by November 2019, although many commentators hope it will never become law! – We’ll update this post and our affected Clients as more news comes in (last updated July 2019).
(The full text of the Budget Statement)
Increasing compliance with the off-payroll working rules in the private sector (“IR35”)
- To increase compliance with the existing off-payroll working rules (known as IR35) in the private sector, businesses will become responsible for assessing an individual’s employment status. The reform does not apply to the self-employed or introduce a new tax. It brings the private sector in line with the public sector.
- The government has listened to stakeholder views during the consultation. The reform will not apply to the smallest 1.5 million businesses, and large and medium businesses will have longer to adjust, with the changes being introduced in April 2020.
1. It is fair that two individuals working in the same way pay broadly the same income tax and National Insurance contributions (NICs), even if one of them works through a company. The off-payroll working rules were introduced in 2000 and require that individuals who work like employees, but through companies, pay similar taxes to other employees.
2. Contractors who do not comply with the rules pay significantly less income tax and NICs than an equivalent employee. HMRC estimates the cost of non-compliance to the exchequer will reach £1.3 billion a year by 2023-24.
3. The reform will bring the private sector in line with the public sector, where evidence suggests compliance has improved since the reform was introduced in 2017. HMRC estimates the reform has raised £550 million in income tax and NICs in its first year.
4. The off-payroll working rules only affect people working like employees and through a company. They do not apply to the self-employed.
What does the reform mean for businesses?
5. From 6 April 2020, medium and large businesses will need to decide whether the rules apply to an engagement with individuals who work through their own company.
6. Where it is determined that the rules do apply, the business, agency, or third party paying the worker’s company will need to deduct income tax and employee NICs and pay employer NICs.
7. The government has listened to business and will build on learnings from the introduction of the reform to the public sector. As a result:
• medium and large businesses will have until April 2020 to implement the changes
• the existing rules will continue to apply to the 1.5 million smallest businesses.
8. HMRC has developed the Check Employment Status for Tax (CEST) service to help businesses determine whether the off-payroll working rules apply. HMRC will continue to work with stakeholders to improve further CEST and guidance before the reform comes into effect.
Responding to the consultation
9. Since the introduction of the public sector reform, and during the consultation, the government has listened to the views of stakeholders. On that basis, it can confirm:
• the reform is not retrospective – as it has in the public sector HMRC will focus its efforts on ensuring businesses comply with the reform rather than focusing on historic cases
• HMRC will not carry out targeted campaigns into previous years when individuals start paying employment taxes under IR35 for the first time following the reform and businesses’ decisions about whether their workers are within the rules will not automatically trigger an enquiry into earlier years
• the reform will not stop anyone working through a company if that suits them, and does not apply to the self-employed
• HMRC will provide extensive support and guidance to help businesses implement the offpayroll working rules to ensure they apply them correctly, and will ensure the guidance is appropriate to the needs of the private sector, which are more diverse than those of the public sector
• HMRC continues to work with stakeholders to identify improvements to CEST and wider guidance to ensure it meets the needs of the private sector – enhancements will be tested with stakeholders, operational and legal experts before the reform is implemented
• the government has monitored the public sector reform, including by engaging with the sector during consultation and evidence shows that compliance is increasing without impacting market flexibility. The government will continue to monitor tax receipts as data becomes available.
10. A further consultation on the detailed operation of the reform will be published in the coming months. This consultation will inform the draft Finance Bill legislation, which is expected to be published in Summer 2019.