Laura Livingstone Partner, Head of Employment
IR35 and the Off Payroll Working Rules
The IR35 rules were first introduced in 2000 in order to tackle a perceived tax avoidance scheme whereby individuals sought to save employee income tax and national insurance contributions by supplying their services through an intermediary and paying themselves in dividends.
Under the IR35 rules where an individual (the Worker) is engaged by a company (the End User) through an qualifying intermediary (often called a Personal Service Company (PSC) and if, but for the PSC, that individual would have been deemed an employee of the End User, then the IR35 rules will apply.
Changes to IR35 were due to come into effect on 6 April 2020, however in light of COVID19, the government has ruled that incoming IR35 regulations will not come into effect until 6 April 2021.
Currently, private sector End Users are not required to determine whether IR35 applies, this obligation falls on the PSCs. If a Worker is caught under the IR35 Rules, the PSC is required to pay income tax and national insurance contributions (NICs) on their “deemed employment income”.
The Draft Legislation (Off-Payroll Working Rules)
From 6 April 2021, under the draft Off-Payroll Working Rules, the position will change for all private companies (save for those which are “small”) and will mirror the current rules for the public sector which came in in 2017. The responsibility for making IR35 status assessments will shift from the PSC to the End User. Any End Users engaging a Worker will have to determine whether the IR35 rules apply. Where the rules apply, the End User will be required to account to HMRC for income tax, NICs and the apprenticeship levy (if relevant).
A private company is considered “small” if it satisfies two or more of the following requirements:
- Its annual turnover is not more than £10.2 million.
- Its balance sheet total is not more than £5.1 million.
- It has no more than 50 employees.
This is a relatively low bar, and it is plain that the intention of the legislation is for it to apply to the majority of UK companies.
Determining whether IR35 applies
From 6 April 2021, since the End User will be responsible for determining the employment status of any workers, and they must carry out a status determination.
There are various factors which indicate that a Worker might have deemed employment status. These include:
- Control – What degree of control does the End User have over what, where, when and how the Worker carries out work?
- Right of Substitution – Is the Worker obliged to provide their services personally, or can they send a substitute?
- Mutuality of obligation – Does the Worker have an obligation to provide their work or skill?
The IR35 status determination is complex, and it is important that none of all the relevant factors are considered in isolation, and are instead viewed on the whole.
To assist companies to determine whether the IR35 rules apply, the HMRC have developed the 'check employment status for tax' (CEST) tool. Users are required to answer a series of questions about the Worker and the relationship between the Worker and the End User and the CEST tool will either conclude that:
- an employee is in deemed employment, in which case the party which pays the PSC must make payroll deductions and account for NICs; or
- an employee is not in deemed employment, in which case the rules do not apply and no employment tax liabilities will arise for the End User; or
- the tool is unable to make a status determination, in which case companies will have to undertake their own status determination and gather key documentation and make enquiries from the PSC.
Whilst the CEST tool has been widely criticised for being overly simplistic, the benefit of using the tool is that HMRC will be bound by determination outcome (unless it has been obtained fraudulently). The downside is if the determination is uncertain because then the responsibility falls on the End User to make sufficient enquiries to further satisfy HMRC.
New duties and procedures
1. Reasonable care
The draft legislation introduces an obligation on End Users to use “Reasonable Care” when making the status determination. It is unclear what the precise standard required is in order to meet this, but it is assumed that use of the CEST tool or multi-faceted approach (if necessary) which considers the Worker’s employment will meet this requirement. Companies can no longer just rely upon the relevant PSC to inform the End User that the Off-Payroll Working Rules will apply or that they have satisfied them, even if they have for years in the past.
2. Status Determination Statement
The End User should provide the Worker (and if applicable any other company in the chain between the Worker and the End User) with the “Status Determination Statement”. This statement should contain the outcome of the status determination as well as the reasoning for that decision. Failure to do this will mean that the End User is treated as the party responsible for the employment tax liabilities even if another entity is nominated as the Fee Payer.
In more complex supply chains where numerous parties are often involved between the End User and the PSC, each subsequent party after the End User in the supply chain will then need to pass on the 'status determination statement' to the party they themselves have contracted with until the same reaches the party who is directly contracting with the PSC, i.e. the Fee Payer.
3. Client-led status disagreement process
The draft legislation envisages that a PSC may make representations to an End User if they think that the original status determination was incorrect. End Users will be required to consider any representations made by an individual Worker and must, within 45 days, inform the parties whether or not they have decided the original conclusion will be reversed (and their reasons for this). Significantly, failure by the End User to respond to the 45 day time period means that the employment tax liabilities will become the responsibility of the End User regardless of whether they are the Fee Payer.
Putting in place a client-led status disagreement process will inevitably require significant preparation and End Users are encouraged to consider doing so in advance of April 2021. The government’s announcement to delay IR35 until April 2021 will no doubt come as a relief.
As a starting point, all large and medium companies should:
- Review any existing off-payroll engagements to determine which are likely to fall within the scope of the reforms. This may be a lengthy and time consuming exercise and organisations are encouraged to undertake this review sooner rather than later.
- Prepare to undertake status determinations for existing and new contracts. Organisations should take advantage of this period before the scheme is in force by setting up a robust system for undertaking the status determinations.
- End Users should consider including warranties and indemnities in their supply contracts to ensure that PSCs, and all those in the supply chain have properly communicated any status determinations from the End User and any notification of a PSC by the Worker.
- Plan for and prepare a robust client-led status disagreement process. Organisations will need to be able to efficiently respond to any representations made by Workers in relation to their status determinations.