It is currently expected there will be no further delay to the planned implementation of the IR35 legislation in April 2021, which will bring significant changes for in-scope businesses which engage contractors who operate through an intermediary. The implementation has already been delayed for 12 months because of Covid-19 and is likely to be welcomed by the Government and HM Treasury hoping to increase compliance and increase tax and National Insurance receipts. Although further postponement and additional (hopefully minor) changes should not be ruled out entirely, we recommend that employers assume implementation will proceed as planned.
From a practical perspective, it will be particularly important to understand that in-scope businesses will no longer be able to engage a contractor via their personal service company (“PSC”) and pay their fee on a gross basis without a careful (documented) assessment of whether this is appropriate, or whether the business should make deductions from the fee for tax and National Insurance contributions. Given this, the significant nature of the other changes and HMRC’s belief that “disguised employment” remains a serious problem with many purported contractor arrangements (and which it is keen to rectify), Chris Warwick-Evans (Associate) considers below the key aspects of the new regime and what the options are for employers to ensure they get the expertise they need whilst ensuring the business is compliant.
In brief, what’s changing?
From April 2021, medium and large “end-users” (i.e. the client/recipient of the services provided by the contractor) in the private sector will be required to determine the employment status of their contractors who operate through an intermediary (usually a PSC), for tax purposes. This will require the end-user to ascertain whether the contractor would be an employee (or office holder) for tax purposes if they were hired directly by the end-user (without a PSC) or whether they are genuinely self-employed. Previously, this determination would have typically been made by the PSC rather than the end-user.
Status determination
The end-user will be required to take “reasonable care” when making its assessment and set out its conclusion (with reasons) in a Status Determination Statement (“SDS”) and comply with the record keeping and notification requirements. Failure to take reasonable care when making the assessment or failure to comply with the SDS notification requirements will risk exposing the end-user to liability for income tax and National Insurance contributions if the fee should have been paid after deductions (rather than paid gross).
HMRC has refined its online “Check Employment Status for Tax” (CEST) tool which can be used as the basis for the SDS in many cases, and HMRC has indicated it will stand by the result issued to an end-user unless the information inputted was not accurate.
End-users should also bear in mind that blanket status determinations for all contractors performing similar roles is a high-risk approach and unlikely to be compatible with the requirement to take reasonable care.
The end-user must also have a procedure in place in the event the contractor (or intermediary) disagrees with the status determination and wishes to challenge it. If the nature of the contractor arrangement changes or there is a new engagement, the SDS will need to be rerun to reflect this, and also periodically, though we await further guidance in this regard.
Is the contractor genuinely self-employed?
If the contractor is not found to be genuinely self-employed, IR35 will apply, and the fee payer (typically the end-user client) will be required to operate payroll, make deductions for income tax and employee’s National Insurance contributions and pay employer’s National Insurance contributions and apprenticeship levy costs on the fees paid for the services. If a UK agency supplies the contractor via a PSC, the agency will be the “fee payer” and will be liable to make these deductions/payments where appropriate.
Alternatively, if the worker is held to be genuinely self-employed it is permissible for the end user (or agency) to continue to pay the fee on a gross basis.
Is your business in scope?
The changes are expected to be effective from 6 April 2021 and will apply to medium and large private sector end-users (not based wholly overseas) which meet two or more of the following conditions:
- Annual turnover exceeds £10.2 million
- The balance sheet total exceeds £5.1 million
- The number of employees exceeds 50
A modified test applies to small companies which are part of a larger group. Small end-user businesses will not be affected by the changes and the obligation to determine contractor status and account for tax and National Insurance contributions (if appropriate) will remain with the PSC (or other relevant intermediary).
Steps to consider taking now
- As a priority, if the hiring business has not already done so, it should conduct a “contractor audit” to identify contractors engaged via a PSC (or other intermediary) where any contracts continue or are due to start after the April 2021 implementation date.
- Ensure the end-user’s internal business functions are live to the changes and the business agrees a coherent approach. For some end-users this will require input from payroll, HR, procurement, compliance and legal, in addition to input from external advisors. If changes to internal systems (such as on-boarding and payroll) will be required, this should be promptly addressed if it has not been already.
- It is also worth considering how the end-user will communicate the changes to contractors (if it has not already done so). Many contractors are likely to be anxious given take-home pay is likely to reduce for those contractors who will be subject to PAYE and National Insurance contributions by the end-user/agency and there will also be an impact on their cash flow.
- In the event of a HMRC investigation, we would expect the SDS to be closely scrutinised, so it will be time well spent for end-users to carefully consider now (if they have not already done so) how they will run the status determination process to make accurate and consistent determinations.
- In our experience some end-users have found status determination surprisingly time consuming. Even if CEST is used as the basis of the status determination, it requires a good understanding of how each contractor arrangement works in practice (not simply what is documented), which not all HR or operations staff may immediately possess. To this effect, end-users should identify now (if they have not already done so), which staff are best placed to assist with the status determination process regardless of whether CEST will be used. Some end-users have also received unexpected status determinations by using CEST, so we recommend allowing for sufficient time to deal with such issues if they arise.
- End-users should also ensure they are familiar with the requirements as to how, when and to whom the SDS should be communicated. End-users should also ensure that intermediaries which supply contractors are familiar with their obligations under the new regime.
- End users should also consider at this stage how any status determination appeals will be managed, such as who the decision makers will be.
- This is also an opportune moment to review contractor agreements, and we can help with this. In particular, it will be important to ensure that there are appropriate warranties and indemnities protecting the end-user from claims for tax or National Insurance contributions, and giving the end-user the right to deduct income tax and National Insurance contributions from the fee if appropriate. It goes without saying that we would expect contractor agreements to be consistent with responses entered into CEST, and we would expect HMRC to query any discrepancy in the event of an investigation. It is also worth considering whether there is value in including details of how disputes as to status determination will be managed in light of the new requirements.
Options to consider
Employment? End-users may decide to hire their contractors as employees and enter into employment contracts with them, which will sidestep the obligations and risks of the IR35 regime. Although this will be the simplest approach in some circumstances, those with employee status will be entitled to additional statutory employment law protections so this is not without risk and there will be additional employer costs such as holiday pay and employer pension contributions. Given take home pay is likely to be reduced as a result of changing status from contractor to employee, there is also likely to be pressure to mitigate this by increasing the level of remuneration by the business, and if agreed, this will also have a cost implication. Businesses will also be faced with the additional cost of employee benefits. Alternatively, it may be possible to contract directly (i.e. without a PSC or intermediary) with the individual as a worker or on a self-employed basis.
Change the nature of the relationship? Given the new rules do not apply where the individual is genuinely self-employed, for borderline or ambiguous cases it may be possible to “re-set” how the contractor arrangements work (crucially, in practice as well as in the paperwork) so the nature of the relationship can be properly described as self-employment. This is not necessarily an easy or risk-free approach as the changes would need to be practicable, properly embedded and rigorously applied to avoid relapse of the new arrangements.
Re-negotiate the fee? Where a contractor is subject to the new regime, the cost to the end-user of hiring them will be significantly increased (for example, as a result of the requirement to pay employer’s National Insurance contributions and the apprenticeship levy costs), and there will be significant costs of ensuring the business is compliant more generally. Although this will ultimately be a commercial decision and depend on the bargaining power of the parties, it may be possible to renegotiate the fee to mitigate against the increased costs, though we expect some contractors will push back and in many cases this will not be possible.
Use an agency or other intermediary? If the end-user engages an agency or other intermediary to supply PSC contractors, generally speaking, the agency/intermediary will be responsible to account for income tax and National Insurance contributions where appropriate. Ultimately, this is unlikely to protect end-users from the increased costs of hiring in-scope contractors as we expect strong pressure from agencies to pass these costs back to the end-user. It is also worth noting that HMRC is able to pursue the end-user in some circumstances for unpaid income tax and National Insurance contributions in the event of the agency’s default. More practicably, many of the end-user responsibilities under the new regime could be delegated to the agency. However, given responsibility for non-compliance will remain with the end-user in many circumstances, it will be important to ensure sufficient indemnity protection is in place.
The new rules are significant changes as to how in-scope contractors should be engaged and paid and entail significant compliance obligations. There is also the risk of reputational damage for end-user clients in the event of non-compliance. Although we expect many end-user clients will by now be well prepared for the reforms, those who are not should start planning and implementing changes without delay where this is appropriate. Although plans made to prepare for the delayed 2020 implementation are likely to be helpful it will be important not to simply dust these off given inevitable changes to the use of contractors over the last year or so, and therefore the situation warrants careful appraisal with fresh eyes.
