Businesses in the United Kingdom which engage contractors through intermediaries should prepare now for changes to the “IR35” rules that will take effect in April 2021.
These changes, delayed from April 2020 due to the coronavirus (COVID-19) pandemic, require businesses which engage contractors through intermediaries (such as personal services companies) to determine whether they need to withhold and account for income tax and national insurance contributions through the pay-as-you-earn (PAYE) system in respect of payments for contractors’ services.
THE OFF-PAYROLL WORKING RULES
The UK’s off-payroll working rules (commonly referred to as “IR35”) address the perceived unfair tax advantages enjoyed by persons who provide services through third-party intermediaries (often, but not always, their own limited company) and who would, but for the existence of the intermediary, be treated for tax purposes as employees of the person engaging their services (referred to here as “clients”). By operating through an intermediary, these individuals may be able to structure their affairs to pay less income tax and national insurance contributions (NICs) when compared to a person providing comparable services as a direct employee of the client.
In broad terms the IR35 rules required the intermediary to operate PAYE and account for income tax and national insurance in respect of payments received for the services of the contractor. However, the rules did not historically require the client to operate PAYE, instead putting the responsibility on the intermediary.
In April 2017 these rules were reformed, requiring organisations in the public sector to assess whether payments made to intermediaries should be made subject to income tax and national insurance contributions, and if so operate PAYE in respect of those payments. This reform was due to be extended to the private sector with effect from April 2020, but this was deferred to April 2021 because of the COVID-19 pandemic. However, the UK government has recently confirmed that the reforms will go ahead, which means that businesses that already have or intend to engage contractors need to consider whether the new rules affect them.
THE POSITION FROM 6 APRIL 2021
From 6 April 2021, large and medium sized businesses engaging contractors through an intermediary need to make a status determination as to whether the contractor should be treated as an employee for income tax and national insurance purposes. If yes, PAYE will generally need to be operated in respect of payments made to an intermediary for that contractor’s services. For these purposes, large and medium sized businesses are those which have two or more of the following:
- turnover in excess of £10.2m;
- balance sheet assets exceeding £5.1m; and
- more than 50 employees.
For affected businesses, this will mean the following:
- The client must make a status determination as to whether the off-payroll working rules apply to an arrangement with an intermediary. The client must then communicate that decision (with reasons) to the individual and any agency or other organisation through which the individual and the intermediary has been engaged.
- If the off-payroll working rules apply, the person who makes a payment to the intermediary (referred to as the “fee-payer”) must operate PAYE and account for any income tax and national insurance contributions in respect of those payments. In practice the fee-payer could be either the client (if it pays the intermediary directly) or it could be an agency, if the client pays fees to an agency, which in turn pays the intermediary.
- If the client (or any other person sitting in the contractual chain between the client and the intermediary) fails to comply with its obligations under the off-payroll working rules (including making and notifying a status determination) it may be treated as the fee-payer for the purposes of the rules. This may make the client and other noncompliant persons liable for all amounts that should have been accounted for through PAYE, and any NICs, as well as possible interest and penalty charges.
A business should not be in scope of these rules if it enters into a contract for a fully contracted out service with a service provider. Whether or not a business contracts for a fully contracted out service is highly fact-specific. Relevant factors include (a) the nature of the service provider’s business; (b) the nature of the service provider’s contract with the business customer; and (c) the relationship between the individual, the service provider, and the business customer. This exemption is especially relevant for those businesses that outsource certain services to third parties from time to time.
RECENT CHANGES TO THE RULES
What constitutes an “intermediary” is very broad, and is interpreted by HM Revenue & Customs (HMRC) as meaning “any person who makes arrangements for an individual to work for a third party or pay for work done for a third party.” It had been thought that this wide definition would lead to unintended consequences, potentially catching some secondment arrangements and also employment agencies and umbrella companies which provide the services of workers to other businesses but which operate PAYE in respect of those workers’ remuneration. However, in a recent technical change to the rules the position has been made clearer.
WHAT SHOULD AFFECTED BUSINESSES BE DOING NOW?
Businesses will be required to take reasonable care in determining the status of contractors under the new off-payroll working rules. This means that it may not be acceptable for a client to make a blanket determination that all contractors are affected by the new rules without specifically considering the facts of each case, a point which HMRC has confirmed in its guidance on the new rules. This means that businesses which are or may be affected by the rules need to take steps to assess whether the new rules apply to their contractors.
To prepare for the rules businesses should take the following actions.
- Businesses should conduct an audit of their contractors, identifying arrangements which are at risk of the new rules applying to them. Potentially, this may include all contractor arrangements where the business contracts with a third party other than the worker actually performing services.
- At-risk arrangements should be reviewed to determine whether or not they are in-scope of the new rules. Among other things, businesses should consider whether the contractor providing the services would be viewed as an employee in the absence of the intermediary, and differences in how contractors operate as opposed to employees.
- Contractual arrangements should reflect the reality of how contractors actually work. For example, although a contract may not specify a place of work, contractors may be expected to work from a specific location which is relevant to the status determination.
- Contracts should be updated to ensure that businesses have the ability to make deductions on account of tax when required, and that they are able to obtain information from intermediaries and contractors to make status determinations and operate the rules.
- Businesses should develop internal policies to ensure that status determinations are made on time and are communicated through the contractual chain.
To deal with these arrangements some businesses may decide to simply transfer all contractors on to the payroll and treat them as employees. It is important to remember that there will be some significant benefits for individuals transferring from contractor to employee status. Unlike contractors, employees are entitled to minimum notice periods, protection against unfair dismissal, the right to request flexible working, time off for emergencies, and Statutory Redundancy Pay. Before doing this businesses should obtain specialist advice to fully understand the implications and manage any potential risks.