Are you concerned about the new IR35 rules and how they may affect your business or subject to an HMRC investigation? Tara Edwards explains what you need to look out for.
The extended off-payroll workers rules now often referred to as the new IR35 rules came into effect on 6th April 2021. They are intended to reduce the number of off-payroll workers (‘contractors’) who treat themselves as being self-employed by taxing them as employees.
This is achieved by placing responsibility for determining the employment status of the contractor with the organisation receiving the contractor’s services. If your organisation receives services from individuals who are not on your payroll and who work through an intermediary then the new IR35 rules may apply.
Who do the Rules Apply to?
The new IR35 rules apply to organisations which are in the private sector, medium or large in size and connected to the UK.
A company (or an LLP) is small if it satisfies two or more of the following requirements:
- It’s annual turnover is not more than £10.2m;
- It’s balance sheet total is not more than £5.1m;
- It has no more than 50 employees.
For a group company to be a small company the small business test must be applied to the group as a whole. There are rules to aggregate the turnover of connected persons, so for complex structures external advice may be needed to confirm the position.
An organisation will have a UK connection if immediately before the beginning of the relevant tax year the entity is either UK tax resident or has a permanent establishment in the UK.
Only contractors who are either resident in the UK or perform their services in the UK can be caught by the new IR35 rules. The jurisdiction of the contractor’s intermediary company is not a relevant factor. The IR35 rules are targeted at working arrangements which involve intermediaries acting as the contractor’s personal entity.
Personal Service Companies
Personal service companies are the most common intermediary through which businesses engage with contractors. A contractor would only be caught by the new IR35 legislation if he or she owns the material interest in the personal services company.
Material interest
Material interest is defined as beneficial ownership of or the ability to control more than 5% of the ordinary share capital of the company;
- An entitlement to receive more than 5% of any distributions that may be made by the company; or
- An entitlement to receive more than 5% of the assets on winding up.
This can cause problems in that it is often difficult to independently identify corporate ownership structures.
Companies House can confirm whether an individual owns over 50% in the corporate entity. It will not however identify ownership between 5% and 50% of the intermediary. It will also not identify whether the contractor is entitled to distributions or assets on winding up. It is therefore essential that the engager of the contractor’s services request detailed information and evidence of ownership structure, often coupled with contractual indemnities. The new rules apply if the intermediary is a company in which the contractor (or his associates or together with his associates) have a material interest. A material interest is a 5% ordinary shareholding in the company.
A second type of intermediary company caught under the rules is a company from which the contractor has received (or has the right to receive) a ‘chain payment’. A chain payment is the amount paid for the services which the contractor has provided to the client. The legislation makes it clear that where PAYE is already applied to a contractor’s earnings the new IR35 rules will not apply.
The new IR35 rules do not apply where the agency employs the contractor and operates PAYE on earnings paid to the contractor. However if the agency contracts with the contractor’s intermediary, ie personal service company, rather than with the contractor directly then the new IR35 rules can still apply.
The new IR35 rules apply where a contractor personally performs (or is under an obligation personally to perform) services for an engager. Where your organisation contracts with a service provider for a fully outsourced service typically it is not entering into a contract for the supply of a particular contractor. Your organisation is not therefore the ‘client’ for the purposes of the new IR35 rules. In an outsourced arrangement the service provider is the client and it is therefore the service provider that must apply the new IR35 rules. Advice should be taken on whether this is an outsourced service.
If the contractor and personal service company fall within the scope of the rules then you must examine whether the contractor would have been an employee or your organisation had it not been for the existence of the intermediary. This is known as a ‘status determination’. If it is decided that the contractor would have been an employee they are referred to as being ‘deemed employed’ by the client.
Who’s responsibility is it to determine employment status of contractor?
It is up to the engager to determine whether the IR35 legislation applies. HMRC will seek underpaid Income Tax and NIC from the engaging entity. Engagers must ensure that where they are relying on the representations made by contractors that they have processes in place to validate the information provided, requesting detailed back up documentation from the contractor and checking the data as much as possible against Companies House.
The obligation to determine the contractor’s employment status and the preparation of the status determination statement falls on the engager of the services of a contractor. If these obligations are not complied with the engager becomes liable for any underpaid Income Tax and NIC as well as interest and penalties.
Determining who the engager is may have its own complexities where there are multiple agencies and outsourced services. Where the outsourced service primarily relates to the provision of specific individuals (possibly naming them) there is a risk that it may not be an outsourced service.
Careful consideration of mixed service contracts and bespoke payment agency arrangements, for example where it is commission based, should be carefully analysed. The engager when analysing these arrangements needs to consider whether the contractor’s services are similar to those of employees. If this is the case then this may not be an outsourced service. HMRC have given guidance on this point stating that where the service provided by the worker sits squarely with the nature of the business this indicates this is not an outsourced service. It is essential that businesses and their suppliers agree where the responsibility lies for undertaking employment status assessments.
Engagements with small companies fall outside the scope of the new IR35 rules
All decisions and their rationale should be documented in case of HMRC enquiry. Periodic reviews should be undertaken since arrangements may change over time. Procedures need to be put in place to ensure this occurs. Contracts should be revisited to ensure they reflect the true nature of the engagements.
It is clear that a determination by the engager that a contractor is employed under the IR35 legislation will not be welcomed by the contractor because their remuneration would be subject to Income Tax and NIC deductions.
Contractors have historically challenged their employment status determinations, completing HMRC’s check of employment status tool, leading to dispute resolution. The new legislation states that the engager is required to consider these challenges within 45 days of receipt and to provide a statement either confirming the original decision with supporting reasons or to amend the original decision, unless there was a corresponding day rate increase. They would leave.
VAT and Contractors’ Invoices
Regardless whether the contractor’s invoice is subject to a further payment of PAYE and NIC, the VAT element is still payable to HMRC. Procedures need to be in place to identify these invoices so that only the amount due to the contractor under the IR35 rules is paid and the VAT element processed through the ultimate engager’s VAT Return.
Employment Rights
These changes do not entitle the contractors to employment rights. This has been specifically stated by the Government. However, since the contractor will be treated as an employee there is a risk that they will request holiday pay, sick pay and other employment benefits.
Conclusions
Engagers should review whether their contractors come within IR35 and a procedure set up for deadlines for the acceptance of new engagement terms. It will be necessary to review all supply chains to ascertain whether those suppliers use contractors.
Due diligence of supply chains because of the transfer of liability provisions within the new legislation. Underpaid Income Tax and NIC can transfer to the first agency in the contractual chain but if not collected by them to the end engager itself. Contracts need to be reviewed to ensure there are adequate indemnities and obviously the liquidity of the agency ascertained.
Umbrella companies have been used as a substitute for personal service companies to eradicate the need of undertaking employment status assessments, however, contractors may not agree to do so and the engager’s costs could escalate.
There are however further risks if the umbrella company is not registered in the UK. HMRC is focusing on non-compliant umbrella companies and so there is still a risk that the Income Tax and NIC could pass to the ultimate engager.
To determine the status of the contracts the ‘on the ground’ working arrangements between the parties must be analysed. Where an agency is involved this will entail understanding the terms of the contract between the agency and the contractor’s intermediary. If the contractor is an office holder of the client organisation they will automatically be a ‘deemed employee’.
The new IR35 rules put an obligation on the client to provide a status determination statement to the contractor and to the intermediary (eg the recruitment agency). If the client fails to do so and the contractor is working through an intermediary the client will automatically be treated as the ‘deemed employer’ and will be obliged to account for PAYE.
There is no prescribed format for the status determination statement. If the CEST test has been used HMRC will accept the results of the test. The client must take ‘reasonable care’ in the making of the status determination otherwise they will automatically be treated as the ‘deemed employer’. The status determination statement must be issued before the payments on or after 6 April 2021 are made. The statement can be appealed in writing or orally.
Where there is a chain of entities between the client organisation and the contractor’s intermediary, it will usually be the entity that pays the intermediary (rather than the client) that will be the ‘deemed employer’ and responsible for the payment of tax.
PAYE must be deducted from the amount of the payment made by the ‘deemed employer’. This will usually be a fee invoice by the intermediary, net of VAT. The ‘deemed employer’ may also, if it chooses, deduct expenses that would be tax free if paid to an employee such as free subsidised meals provided on their premises.
It may be possible to terminate existing contracts with contractors and enter new contracts with a reduced fee to reflect the fact that the client organisation will now assume responsibility for employer’s NIC. Alternatively the contractor may be willing to abandon their intermediary entity and provide the services to the client via an umbrella company or agency.
A third option would be for the client organisation to offer the contractor a fixed term contract of employment. This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances. If you would like to discuss your tax situation please call us on 020 7481 2422 or you can email enquiries@wellerslawgroup.com.
