(Updated February 2021)
IR35 ‘off payroll’ rules
In March 2020, because of the Coronavirus pandemic, the Government confirmed the IR35 private sector reforms will be DELAYED by 1 year until 6th April 2021 – brief information here.
On 29th October 2018, the Chancellor announced that all medium and large sized businesses in the private sector who employ Limited Company Contractors, will become responsible for assessing the Contractors ’employment status’ from 6th April 2020 – where the Contractor works through their own Limited Company (or through other ‘intermediaries’, such as an agency. It was confirmed in October 2020 that Contractors employed through a PAYE Umbrella company are exempt from these rules).
The background to this is (you can see our previous IR35 post about the Public Sector here):
- Since April 6th 2017, the IR35 ’employment’ status for Contractors with Limited Companies who work in the Public Sector has been determined by the client (the Employer), not the contractor. This change happened because HMRC is convinced that a large proportion of contractors are “disguised employees” (i.e. they would be employees if they were not employed as Ltd Co. Contractors). This change means the responsibility for enforcing IR35 in the public sector shifts away from the HMRC and the Contractor, and moves onto the end client i.e. the public sector body.
- Contractors with Limited Companies are also known as PSC’s (Personal Service Company).
- Therefore, the client (employer) needs to assess each Contractors’ working practices and if they believe that the underlying relationship between the Client and the Contractor providing the services is one of ’employment’ (rather than self-employment) then IR35 applies. This means that the contractors company will be taxed at source by the Client (through PAYE), exactly as if they were an employee (and employee and employer NIC’s need to be paid as well by the Client).
- This means that the client becomes liable if they make the wrong IR35 status determination.
- However, the contractors’ employment status does not change if the Client finds them ‘inside’ IR35, 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). But, 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, and which can be used be either Client and/or Contractor – 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 further down ……
So, what’s happening in the Private Sector from April 2021?
In the Government’s Budget Guidance of 29th October 2018 (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.
(Organisations are called ‘clients’ as they are clients of the services provided by the Contractor).
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 2021).
After the announcement there followed a debate about what a ‘small’, ‘medium and large’ business actually meant, and initially the Government gave no guidance on this.
However, on 11th July 2019, the Government published the draft legislation, which clarified this point. Secondary legislation to enforce this was published at the end of January 2020.
So, 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’:
- an annual turnover of not more than £10.2 million (this is income generated from the trade of the business)
- a balance sheet total of not more than £5.1 million (this is the total amount of assets of the business before any deductions0
- 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, whether they are full or part-time; 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).
If your company is ‘small’ then you are outside of this reform, i.e. not affected – so the Limited Company Contractors you employ will continue to make their own ’employment status’ determination, and the Client (you) will not have to.
This could obviously cause a major headache for business that move in and out of being a ‘small’ business…
Businesses that are not companies, such as partnerships and unincorporated bodies, will be ‘small’ for these purposes if their turnover does not exceed £10.2million. Businesses 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).
Just to repeat – if the Client business is ‘small’, the Contractor’s Limited Company is still potentially in scope of the off-payroll working rules but the Contractor needs to make the decision about their status themselves (and also account for any tax and NICs that become payable) and the Employer does not need to.
The Public Sector are also affected by this new legislation (see below).
What will happen now and what do Client Companies need to do?:
- The Government updated their Employment Status Manual in September 2020 which you can see here – it’s an important document and I’ve added links from relevant pages throughout this guide!
- Contractors will, from April 2021, have to know how big their client is (number of employees or turnover/ balance sheet) when deciding whether to accept a contract with them.
- However, initially, the legislation did 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’!). However, in September 2020 the Employment Status manual was updated to say a Consultant has the right to formally request confirmation from the end Client of their size. More information is here and there is a template here for businesses to use in response. The client has 45 days to respond to this request from the Contractor.
- Contractors have been concerned that medium/large sized organisations are being overcautious to avoid any IR35 risks and will therefore ‘blanket’ all Contractors as ’employees’ (as has happened widely in the public sector and is being suggested openly by many large private sector companies, especially in the banking 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 consultant’s status.
- If Companies do not take ‘reasonable care‘ then they will be responsible for the deduction of tax and NIC’s from the Contractors payments.
- All Companies need to check whether they are covered by the new rules.
- The new rules apply from when both the Contractor’s work is done and relevant payment is made to the Contractor, on or after 6th April 2021.
- Medium and Large Companies should start planning and auditing all their Contractors employed on PSC’s now (including those that come via employment agencies) and ensure their current contracts are IR35 compliant. The following problems are pretty likely;
* that Companies will incur costs in the planning and work involved in identifying all their Contractors (and determining if the new rules will apply to them),
* Companies may potentially face a shrinking Contractor talent pool and reduced flexibility; and higher costs of hiring Contractors (as Contractors raise their rates and/or Clients see their tax/NIC payments increasing)
* possibly, later legal challenges from Contractors (if they do not agree with their ‘status’ and/or demand ’employment’ rights and benefits).
- The new rules only apply to UK tax resident workers – they will not apply to people who are non-UK resident and perform their services outside the UK. The rules also apply to off-shore companies, registered outside the UK, who employ workers in the UK (who are registered in the UK and work in the UK).
- The rules will apply to non-executive Directors who work through their own PSC.
- From April 2021, Client Companies who need to make a determination on the employment status of each individual Contractor (because they are a ‘medium’ or ‘large’ Company), will need to make a ‘status decision’ and communicate this in writing to the party who they contract with (the Limited Company) and to the individual Contractor themselves.
- This will be called a ‘Status Determination Statement‘ (SDS), and is a statutory requirement. The Client Company must give a reason for the status determination they have made. The SDS must be given on or before the first pay date after 6th April 2021. In the event the Client does not communicate the SDS in time they would bear the tax and NIC liability if the Contractor is later deemed an employee. More information on SDS is here.
- An SDS should be re-done regularly for regular Contractors in case the relationship develops away from its original form, or if for example, payment arrangements change. Failure to do this would be a lack of ‘reasonable care’.
- Existing Contractors will need a SDS decision before April 2021 (including those working via an Agency; and including those who are already inside IR35). All Contractor PSC’s need an SDS done, even if they are found not to be an employee. If you believe a current Contractor will fall within the new rules you should tell them in advance and negotiate changes to the contract to ensure you can deduct tax and NIC’s at source.
- In a situation where the individual/Contractor disagrees with the client’s status determination (SDS) 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, so Client companies will need to provide their own resolution process. More details here.
- Client Companies will have 45 days in which to respond to contractors who are concerned about their status determination. The response must tell the Contractor whether the original SDS decision is correct or if it needs to change. However, Contractors have no statutory right to ‘appeal’ this decision (!). If the client does not comply with the Status Disagreement process they are responsible for the deduction of the Contractor’s tax and NIC’s.
- Where the Client Company determines that the IR35 rules apply and the Contractor is effectively an employee/covered by this legislation then the Client Company must deduct income tax and Employee NIC’s (13.8%) from the Consultancy fee and account this to HMRC (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. So if you pay VAT for the Contractor’s services then VAT should continue to be paid directly to the Contractor (but it is ignored when calculating the tax and NIC’s due on the fee).
- The Status Determination Statement and Status Disagreement process must also now be done in the public sector from 6th April 2021.
- You do not need to auto-enrol any Contractor into your workplace pension scheme, if they fall inside the new IR35 rules (as things stand at the moment).
- 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. HMRC have said it will not look at historic information unless there is a reason to suspect fraud or criminal activity.
- Some commentators believe the ‘immunity’ for small businesses may only be temporary (so it will apply to all private businesses in the future).
- There are complicated rules around ‘supply chains‘ where the contractor provides services to a client, but the actual end-user of those services may be further down the chain – more details are here.
How do you determine a Contractor’s employment status (to provide a ‘Status Determination Statement’)?
IR35 will generally apply if the Contractor is under an obligation to provide services personally to the client company and they would otherwise be viewed as an employee of the clients business.
However, there are several competing factors to be considered when making a status determination, 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‘ (the client is required to provide the work, the worker is always required to perform the work). However, other important factors that need to be taken into account are:
- whether the Contractor has the genuine right to substitution (if they are unable to work they provide a substitute; has this ever happened? Can the client reject the substitute?);
- the extent to which the Contractor bears financial risks for their own business;
- the level of control exercised by the client over the workers hours and place of work; does the client direct how the work is done or it is highly specialised; can the client move the contractor to other projects?;
- Would you naturally consider them as an employee (ignoring their Ltd Company status) – also called integration – are they ‘part and parcel’ of the organisation? How involved is the Contractor in the client business and its management? Do they have rights to holiday, sick pay, pensions, bonuses, share options etc? Do they tell customers that they work for the client or for themselves?;
- The length of the engagement and the rights of parties to terminate the Contract; does the client impose restrictions on what other work the contractor can do? Does the contractor work solely (or mostly) for the same client?
- does the Contractor provide their own equipment and tools of the trade? (do they carry out business on their own account? Do they have financial risk for their own business?)
Ultimately it is the ‘overall’ picture presented by all the factors that is important when coming to a status decision. What written agreements say is important, however the ‘reality’ of the arrangements is more important than what is written.
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 (and there have been several cases where the Courts have made decisions that are opposite to those provided by the CEST tool). CEST was updated at the end of November 2019 and you can read more information about that here – but it is still being criticised and apparently it fails to test whether there is sufficient mutuality of obligation between the parties; and also fails to give any result in a minority of cases. In December 2020, Government figures revealed thatCEST was unable to make a determination of status in nearly 20% of cases.
We understand that there is no statutory obligation to use CEST. However, if all the information is entered into it correctly by the client company then HMRC are bound by its result. HMRC will not be bound by a CEST assessment that is done by the contractor themselves!
Where an end client issues a CEST report as a SDS, HMRC will deem this to mean that the client agrees with the CEST output. Inputting inaccurate information into CEST will be seen as a behaviour (by HMRC) that does not constitute ‘reasonable care’.
CEST may be a helpful starting point but some companies may prefer to take legal advice or contact a IR35 Contract Review firm (especially if CEST gives no status determination). Make sure any firm you use has been independently verified and their service carries insurance. Crunch Accounting provide this service – Crunch publish our Workline/employment law articles. (We are not recommending their service, as there are many others, and we cannot guarantee how accurate they are; we are just giving their details as an example).
For each Contractor – Client Companies must keep records of the SDS and any checklist/CEST report they have completed, including any other information behind the reasons for their status determination.
Companies who make inappropriate blanket-assessments that decide that all contracters (or a big chunk of them) are inside IR35 (which many well known companies appear to be doing) are not taking ‘reasonable care’!
Some large companies are just deciding they will no longer engage PSC’s; and by doing it they think they can avoid having to comply with the IR35 regulations. Technically they may not be doing anything wrong?, but will HMRC see this as an abuse of the new laws?!
What happens if a Contractor is ‘inside’ IR35. There are options:
- the Contractor remains as a PSC but their payments are subject to tax/NIC’s (and the Client has to pay employers’ NIC’s; this may involve the Contractor wanting to negotiate a £ rate rise to counteract the new tax deductions)
- the Contractor is re-engaged as a PAYE employee or worker
- the Contractor is re-engaged as a self-employed Sole Trader
- the Contractor and end client restructure their working practices so they genuinely fall ‘outside’ IR35
- the Contractor is re-engaged and works via another intermediary such as a tax-compliant Umbrella Company
- the Contractor leaves!
On 15th February 2021 HMRC reaffirmed there will be no penalties for inaccuracies in the first year of the expanded IR35 rules in a new policy briefing.
HMRC have committed to supporting those who are “trying to do the right thing” and to helping taxpayers meet their new responsibilities and correct their mistakes. It also confirms that it will not issue penalties for inaccuracies in the first 12 months of the regime, unless there is evidence of deliberate non-compliance. It also confirmed that it will not use information it receives under the expanded regime to open new compliance enquiries into returns for tax years before 2021/22, unless there is reason to suspect fraud or criminal behaviour.
We’ll update this post as more news comes in (last updated February 2021). If you need any help with this please contact us.
Please note that this information is intended for general guidance only; it represents our understanding of the relevant law and technical guidance as at February 2021.
(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.