From 6 April 2021 changes to the IR35 rules will come into effect with the introduction of the off-payroll working rules (referred to as IR35 for the purposes of this alert). These changes mean that where a medium or large non-public sector business (which includes charities) contracts with a worker through an intermediary (such as a personal service company "PSC") in the UK, that business (the "client") must determine whether the worker is ‘inside’ of IR35 or not. Essentially, what the business is asking, and what HMRC will ask if they investigate an engagement, is:
were it not for the contract between the intermediary and the client (or agency, if the worker contracts with an agency through an intermediary), would there be a contract of employment for tax purposes?
Where the worker is inside IR35, payments to the intermediary will be subject to employee taxes and National Insurance under PAYE. It will be for the party paying the intermediary, which may be the client or it may be an agency or another intermediary, to deduct and account for these taxes. However, if, for whatever reason, they cannot, then liability for payment can flow up the chain of contracting parties, ultimately stopping with the client that is the end user of the worker's services.
Critically, the responsibility for assessing whether the worker is inside or outside IR35 will now fall on the private sector clients. Getting this assessment wrong could be costly and we have set out below some of the most common questions we have seen being raised about the roll-out of IR35 to the private sector.
1. Is the CEST tool reliable?
The Check Employment Status for Tax ("CEST") service is an online questionnaire to help "determine how work being done should be dealt with for tax purposes". HMRC recommends that the CEST tool is used, although it is not compulsory.
HMRC have said they will stand by a CEST result, provided the information inputted is accurate and it is used in accordance with their guidance.
The tool is, however, frequently unable to come to a decision (in around 20% of cases) and, therefore, this has raised concerns. If there is any doubt about the outcome of the CEST result, legal advice should be sought.
In addition, if there are subsequent changes to the relevant contractual or working arrangements, the information provided may cease to be accurate, in which case HMRC will not stand by the original CEST result and a new check should be performed.
We recommend that records are kept of CEST checks carried out and supporting evidence for the information used to complete the checks.
2. Is the reform retrospective?
HMRC has said there will be no ‘targeted campaigns’ into previous tax years and so the amended IR35 rules will not be retrospective (although the expanded rules already apply to public sector organisations).
3. Can you take what a contractor says at face value, e.g. about working for others/financial risk?
There is no legal obligation to look behind what your contractors say to you about their other arrangements. However, clients are required to use reasonable care when making assessments and so it would be wise to do so and, in some cases, ask for evidence to try and ensure all the facts are obtained before making a status determination. Clients should ensure that their contractual arrangements are consistent with the intended status and may wish to consider seeking representations and undertakings from the intermediary/worker to support the information relevant to the status determination.
4. Are all arrangements entered into with intermediaries caught?
No. Although arrangements with all types of intermediaries (e.g. companies, partnerships, individuals) can fall within scope of the amended IR35 rules, it is worth noting that, for the individual who provides services to be treated as receiving earnings from employment as a result of the new rules, that individual must (except where the intermediary is an individual) have a material interest in the intermediary which engages them for the off-payroll working rules to apply to impose a requirement to deduct and account for income tax and National Insurance in respect of the relevant engagement.
4a. What about arrangements that fall within the agency rules: are they caught?
Agencies and other employment intermediaries can qualify as intermediaries for the purposes of the new rules; however, where workers are supplied via an arrangement that is subject to the agency rules1 those rules have priority over the off-payroll working rules. It is, therefore, important for the client to check what the situation is and which rules apply in each case.
4b. What about managed service companies: are they caught?
Workers supplied through a managed service company (a "MSC") that operates PAYE on the payments to workers under the MSC rules2 are unaffected by the new rules, unless that MSC is also a personal service company. It is, therefore, important for the client to check what the situation is and which rules apply in each case.
5. Are sole traders exempt?
If the worker is not operating through an intermediary, then IR35 does not apply, but it is advisable to check whether this is the case. For direct engagements, the client should still consider whether the worker ought to be considered an employee of the client for tax purposes, in which case the client may nevertheless have an obligation to deduct and account for income tax and National Insurance via PAYE.
6. Am I protected if I have an indemnity?
Whilst having an indemnity in your contract is helpful, there is no guarantee of recovery. It is also important to remember that, under the Social Security Contributions and Benefits Act 1992, it is not possible to indemnify for employer's National Insurance contributions.
7. What about where the contractor and their PSC are based outside the UK?
When assessing whether IR35 applies to a worker, as well as whether they have a PSC, it is important to establish where they are located. IR35 will not apply if the worker is not a UK resident and performs all services outside the UK and, therefore, does not have a liability to tax or National Insurance contributions, but the end user will need to make sure they are satisfied the rules do not apply. Particular care should be taken in cases where workers may perform some services inside the UK and some services outside the UK.
8. The client is overseas – will IR35 apply?
There is a general exemption for clients who are overseas with no UK connection. A UK connection is found to exist for a tax year where a person is resident in the UK or has a permanent establishment in the UK immediately before the beginning of the tax year. This should be considered carefully, as clients who would otherwise not have a UK connection will need to assess whether the proposed arrangement may result in them being treated as having a permanent establishment in the UK.
It is important to remember that whether IR35 applies will depend on whether the worker providing services through an intermediary is based in the UK or otherwise provides services there.
9. The worker has challenged the status determination. What are the next steps?
If the client receives a challenge to their status determination, they will have 45 days to consider the representations made, and either notify the worker that: a) they stand by their original conclusion; or b) they have decided to issue a new status determination statement, setting out reasons for the different conclusion, whilst also withdrawing the previous determination. During the 45 days period, the original determination will continue to apply.
The same process must be followed when the fee payer, such as an agency, challenges the status declaration.
10. If the worker is found to be an employee for tax purposes, will they be automatically entitled to holiday pay and other employee rights?
The IR35 regime is separate to the employment rules on worker status. That said, the tax and employment tests for determining employment status are intrinsically linked. It seems likely that, where an individual is found to be an employee for tax purposes, they will likely be considered an employee for employment law purposes, or at least a ‘worker’ and so eligible to holiday pay and payment of the national minimum wage.