The new IR35 (“off payroll”) rules, affecting consultants engaged via personal service companies (“PSCs”), are due to come into force on 6 April (having already been postponed for a year in large part due to the Covid-19 pandemic). Where these rules apply, they will significantly increase the administrative and compliance burden on businesses which engage consultants via PSCs. What steps should firms take to address the compliance challenges created by the new regime?
- Consultancy arrangements – a recap
- What is changing?
- Who do the changes impact and who is exempt?
- How will the reforms to IR35 impact your business?
- How to prepare for 6 April
1. Consultancy arrangements – a recap
Consultancy arrangements are a versatile way of engaging and retaining staff, particularly for large projects requiring extra capacity or expertise, and for senior staff who have taken a step back from a full-time role as a precursor to retirement.
Consultants will often operate via their own PSCs, so that the PSC acts as an intermediary between the individual (whose services the PSC provides) and the ultimate client.
Traditionally, one characteristic of this three-party structure has been that less tax and/or national insurance contributions (“NICs”) would be payable to HMRC as compared to a typical employer-employee relationship, in which the employer is required to make income tax and employee NICs deductions from salary via Pay As You Earn (“PAYE”), and also pay employer NICs. These could represent a significant extra cost for firms engaging employees.
Because of this, rules were introduced in 2000 to ensure that, in situations where the individual consultant would have been an employee of the end-user client were it not for the existence of the PSC in between, the PSC was required to make deductions for income tax and employee NICs and pay employer NICs on the fees received by the PSC for the consultant’s services.
However, as described below, the new off-payroll regime represents a fundamental change to the rules. It will place the burden of assessing whether the individual would be an employee, but for the PSC acting as an intermediary, and (in many cases) in accounting to HMRC for the relevant income tax and NICs onto the end-user of the consultant’s services (and not the PSC).
The changes do not affect two-party consultancy arrangements (i.e. where an individual contracts directly with the business receiving his or her services) as, in that case, the end-user of the services already takes the risk of the individual being deemed an employee of the end-user for tax purposes. But it should not be forgotten that these types of relationship are also susceptible to inadvertently giving rise to an employer-employee relationship or the individual obtaining “worker” status (as was the case in the recent Uber case, which we discuss here).
2. What is changing?
As mentioned above, under the current IR35 rules, where a consultant is engaged via an intermediary (such as the consultant’s own personal service company), the intermediary is responsible for determining the consultant’s deemed employment status for tax purposes and, where appropriate, accounting to HMRC for PAYE and NICs.
The Government believes that only 10% of PSCs have been applying the current IR35 rules correctly. The off-payroll reforms are intended to increase compliance by making the end-client responsible for determining the consultant’s deemed employment status and, where appropriate, making PAYE deductions and paying employer NICs on the consultancy fees. The Government estimates that over 66,000 businesses will be impacted by the new rules.
3. Who do the changes impact and who is exempt?
The reforms to IR35 will apply to all large and medium-sized entities (including companies, partnerships and LLPs) which engage consultants through PSCs. Only companies, LLPs and unincorporated organisations that are regarded as “small” will not be caught by the new rules.
For these purposes, a company or LLP is “small” if it satisfies at least two of the following conditions:
- annual turnover of up to £10.2m
- total assets (as shown in the entity’s balance sheet) of up to £5.1m
- fewer than 50 employees
It should be noted, however, that whatever the size of your business, the reforms to the off-payroll rules are part of a wider package of measures to crack down on perceived unlawful tax avoidance, and firms should expect an increased level of scrutiny over the tax treatment of staffing arrangements.
Following a change to the law in September 2017, all businesses (whatever their size) that fail to take adequate steps to ensure their staffing arrangements do not permit the facilitation of tax evasion by third parties in their supply chain are also at risk of being subjected to criminal penalties.
4. How will the reforms to IR35 impact your business?
If your organisation is a large or medium-sized business and engages consultants through intermediaries, once the new rules come into force in April 2021, as the “client” of the consultancy services, your organisation will need to:
- determine each consultant’s deemed employment status. To prevent “blanket determinations”, the legislation provides that a determination will be invalid if the client fails to take “reasonable care” in reaching its conclusions
- notify the consultant of the determination and the reasons relied on for the determination. If the consultant disagrees with the determination, the client must provide a dispute resolution process that allows the consultant to challenge the determination.
Where it is determined that the new rules apply, and your business is responsible for paying the consultancy fee directly to the PSC, then it must:
- deduct income tax and employee NICs from the consultancy fee and account to HMRC for these amounts; and
- pay employer NICs (and apprenticeship levy if applicable) on top of the consultancy fee.
If the fee is paid to the PSC via an agency, then the agency (as the “fee-payer” for these purposes) must operate the PAYE deductions and account for them, as well as the employer NICs (and any apprenticeship levy if applicable), to HMRC.
As well as increasing the administrative and compliance burden on organisations, the new rules are also likely to result in increased costs that will need to be factored into business plans and pricing models (not least the costs of employer NICs (and apprenticeship levy if applicable) – payable at a rate of 13.8% – for “consultants” who are deemed to be employees for tax purposes and updating the payroll to operate PAYE in respect of such individuals).
Organisations which fail to comply with the new rules are at risk of financial penalties or unpaid tax and NICs. In addition, organisations that cannot demonstrate that they have “reasonable prevention procedures” in place to prevent the facilitation of tax evasion in their supply chains also risk criminal penalties, which can include unlimited fines, confiscation orders and serious crime prevention orders.
The consequences of non-compliance with IR35 and/or a criminal conviction for failure to prevent tax evasion are likely to extend far beyond the immediate financial penalty. It may require disclosure to professional regulators both in the UK and overseas and prevent the organisation from securing and retaining business. It is also likely to trigger increased scrutiny from HMRC in respect of the organisation’s overall tax compliance and result in adverse publicity and significant reputational damage.
5. How to prepare for 6 April
Many public sector organisations vastly underestimated the time and resources required to comply with the new rules when similar changes were introduced in the public sector in 2017.
Indeed, many large businesses (including Barclays, Lloyds, RBS and HSBC) announced that they would simply no longer engage consultants at all. Whilst this is one possible response to the challenges posed by the new rules, it is not necessarily the right one in all cases.
We expect many businesses will want to find a way to retain access to consultancy arrangements. Should they wish to do so, firms should (if they have not already done so) start planning for the reforms now.
We recommend the following steps are taken:
A. Carry out an audit of your firm’s consultant population
The first step is to identify potential risk areas by carrying out a critical review of existing consultancy arrangements to identify any individuals that are at high risk of being deemed to be employees for tax purposes.
Organisations can do this internally by using the Government’s free online “CEST” (Check Employment Status for Tax) tool (although there remains much criticism of this tool, despite previous attempts to improve it) or contact Fox Williams for support.
B. Analyse the results of the audit
Identify high-risk cases where action should be taken without delay.
Flag cases that require careful monitoring (e.g. where there are indications that deemed employment status may change).
Identify improvements to contractual documentation and working practices to manage risks going forward.
C. Prepare an action plan
The audit will help you prioritise the follow-up actions required to manage the firm’s exposure. Steps may include:
- Talking to your consultants about the changes in the rules and how this may impact on them
- Terminating high risk consultancy arrangements (which clearly needs to be handled carefully to minimise commercial and legal risks)
- Taking steps to “break the chain” of accrued employment liabilities where former consultants are re-engaged as employees
- Putting in place arrangements to monitor and assess deemed employment status on an ongoing basis
- Ensuring the firm has reasonable procedures, including due diligence processes, reporting procedures and staff training, to protect it against liability for facilitation of tax evasion by its consultants
- Reviewing and (where necessary) improving the firm’s contractual documentation to protect the firm’s interests.
If you have any questions about these issues in relation to your own organisation, please contact a member of the team or speak with your usual Fox Williams contact.