IR35 and changes in private sector contracting arrangements
Contractors are widely used in the oil and gas sector to ensure flexibility of resource, cost control and engagement of highly skilled individuals for technical workstreams.
The arrangements with contractors may be direct between the contractor and end user or involve an intermediary company which supplies the contractor to the end user. The use of the latter arrangement has been subject to HMRC scrutiny and IR35 legislation was introduced in 1999 to combat potential tax avoidance by workers supplying their services to end users through an intermediary, such as a Personal Service Company (“PSC”).
If, but for the intermediary, the worker would be an employee of the end user, then IR35 will apply.
Currently in private sector arrangements, the PSC (or other intermediary) is required to determine whether IR35 applies and the end user is not involved in this decision.
If caught by IR35:
- The worker has to pay income tax and National Insurance Contributions (“NIC”) as if they were employed on the “deemed employment income”;
- Employer and employee’s national insurance contributions are payable by the worker’s PSC;
- The PSC needs to have a PAYE scheme.
IR35 determination is complex but will often involve three core principles to determine employment status:
- Control – what degree of control does the end user have over what, how, when and where the worker completes the work?
- Substitution – is personal service by the worker required or can the worker send a substitute in their place?
- Mutuality of obligation – this is a concept where the end user is obliged to offer work, and the worker is obligated to accept it.
Changes in legislation
From 6 April 2017, IR35 reforms were introduced impacting the public sector. IR35 status for contractors is now determined by the end user on a project-by-project basis. Many end users in the public sector have taken a risk-averse approach and decided to apply IR35 as the default position in contracting arrangements and taxed the PSC as if it were an employee. Whilst the PSC may be taxed on an employment basis, the worker providing the services does not receive any statutory employment rights or benefits.
From 6 April 2020 IR35 reforms already implemented in the public sector will be replicated for the private sector.
An exemption from the IR35 changes is expected to be applied to small organisations which are likely to be determined as those with less than 50 employees.
The changes will shift the responsibility for making IR35 status assessments from the intermediary to the end user who pays the intermediary. They will need to decide whether the IR35 rules apply to an engagement with individuals who work through their own limited company. Where it is determined that the rules apply, they will be required to account to HMRC for PAYE, NIC and the apprenticeship levy (if relevant), for the PSC’s tax liability.
The CEST test
The CEST (Check Employment Status for Tax) online tool was introduced in March 2017 by HMRC ahead of the introduction of the IR35 changes in the public sector requiring the end user to account to HMRC. The tool can be used to check the employment status of PSCs. However, it has a reliability rate of 85% and so is not always conclusive. Companies should therefore ensure they collate key information to determine PSC status in the event of a dispute.
In order for the CEST tool to produce an accurate result, the following information will need to be understood:
- The worker’s responsibilities;
- Who decides the work to be done;
- Who decides when, where and how the work needs to be done;
- How the worker is paid;
- If there are any benefits or expense reimbursements involved in the contract engagement.
Three possible results will be returned from using CEST which may assist the end user with its decision on the responsibility to account to HMRC:
- The intermediaries legislation requiring the end user to account to HMRC applies;
- The intermediaries legislation requiring the end user to account to HMRC does not apply;
- Unable to determine.
As can be seen from the “unable to determine” result the onus will remain on the end user to make the final determination.
Arrangements with contractors using intermediaries should be reviewed to ensure all parties understand the status of the arrangements, responsibilities and manage the impact of the new IR35 private sector rules. The following should be included in any such review:
- Does the contract allow the end user to deduct tax and NIC?
- Is there a right of worker substitution?
- What indemnities relating to tax are included in the contracts?
- Does the PSC have its own terms of business?
- Does the PSC’s commercial arrangements suggest it is a sustainable genuine business, for example logo, corporate letterhead, website, published insights, separate phone number?
- What services does the PSC provide to other clients?
- Does the contract allow flexibility about “how” the work is to be performed?
- Are there tight and specific task specifications in the contract?
Significant financial consequences of being caught by existing IR35 rules have been demonstrated in a number of high-profile cases where the tax tribunal has made rulings for substantial backdated tax to be paid by workers who utilised an intermediary.
As the end user will now be required to account for the intermediary’s tax, an additional administrative burden is imposed on the end user as well as a financial risk in the event HMRC seek to recover unpaid tax from the end user responsible for the collection of tax.
Preparation is therefore now key in ensuring that the arrangements in place are those that the parties had intended.
This article was co-authored by Jonathan Young, second year trainee solicitor.
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