In draft clauses for Finance Bill 2019-20, the government has confirmed that changes to the off-payroll working rules for the private sector will go ahead from April 2020.
The rules, based on the changes in the public sector in April 2017, will make all engagers (other than those in the private sector considered ‘small’) responsible for determining whether the IR35 rules apply to the contractors they hire and ensuring the necessary PAYE tax and National Insurance contributions (NICs) are paid.
In light of HM Revenue & Customs’ (HMRC’s) earlier statements on the estimated levels of tax lost through non-compliance under the existing legislation, it is not surprising that extensive lobbying for these changes to be delayed held little sway. Businesses – both contractors and those engaging them – now have a tight timescale to make sure that they are prepared for the changes.
The draft legislation also includes provisions to ensure that all parties in the labour supply chain are aware of the engager’s decision and the reasons for that decision, and will introduce a statutory (albeit incomplete) engager-led status disagreement process.
Scope of the reforms
The intermediaries legislation, more commonly known as IR35, was intended to prevent businesses and individuals avoiding the increased tax and NIC costs associated with employment by interposing an intermediary – generally a personal service company (PSC) – between an individual and the business they work for. The legislation is not intended to catch genuine self-employment, but the government has long been concerned that contractors are incorrectly categorising engagements as falling outside the IR35 rules, leading to a potentially substantial loss of tax and NIC.
Since April 2017, public sector bodies (as the ‘engager’) have been responsible for determining whether IR35 applies to an engagement. Where a contract is deemed to fall into IR35, the public sector body is responsible for deducting tax and NICs from payments to the contractor, unless there are other entities in the supply chain (in which case, in broad terms, the responsibility to make the deductions falls on the body making the payment to the PSC – known as the ‘fee payer’). For private sector contracts, the obligation to determine whether any contract falls within IR35 – and if so to make the necessary deductions – will, like in the public sector, fall on the engager for all payments from April 2020 (even where the contract was in place prior to this date) unless the engager meets the definition of a small business.
Where the engager meets the definition of a small business they will be exempt from the reforms, and where a contractor engages with a small business via their PSC, the PSC will retain responsibility for determining whether IR35 applies.
Defining small businesses
The existing Companies Act definitions will be used to determine whether a business is small for the purposes of this legislation. The test currently requires a company to satisfy two of the following three conditions:
- An annual turnover of not more than £10.2 million;
- A balance sheet of not more than £5.1 million; and
- Not more than 50 employees.
Of course, it is not only incorporated businesses which engage contractors, and the draft legislation has determined that the turnover test only will apply in determining whether non-incorporated businesses as considered small.
There are also specific rules for joint ventures and groups of companies (the small definition only applies if all parties meet the definition).
A business will need to assess whether it is ‘small’ at (or prior to) the beginning of each tax year. Responses to the consultation highlighted that it would be difficult for many businesses, particularly those with accounting dates close to the start of the tax year, to know if they met these tests for their previous accounting period in good time. Instead, the draft legislation confirms that companies will test against the last finalised set of accounts – that is, they will have at least nine months from their accounting year end to determine whether they are small for the coming tax year. The same nine-month period will apply to partnerships. Sole traders, however, will need to look at their turnover for the previous calendar year.
Changes to the current public sector rules
The consultation proposes a number of changes to the off-payrolling rules as they currently operate for the public sector, aimed at addressing some of the practical issues which have arisen.
The current public sector off-payrolling rules require engaging businesses to provide an employment status determination to the party they contract with – which may be an agency or other intermediary, instead of with the entity that pays the fees to the PSC (the fee payer) or the PSC directly. The new rules have been amended for both public and private sector engagers such that:
- The engager will have fee payer responsibilities until such time as they pass on a ‘status determination statement’ to the party they contract with and the contractor themselves.
- The last party in the chain to receive the determination is classified as the fee payer and takes fee payer responsibilities.
- For a status determination statement to be valid it has to also include the reasons why the determination was reached, and the engager must ensure reasonable care is taken in reaching the decision.
- Contractors/PSCs can challenge the determination and engagers are given 45 days to respond.
- If, on reviewing the position, the engager disagrees with the challenge, then they have to provide the worker with the reasons as to why they believe that the determination was correct.
- If the engager agrees that the determination was incorrect then they have to issue a new status determination.
There is still a concern that, where the contractor does not agree with the response received, there is no legislative right of appeal to HMRC and the contractor would need to make a general approach HMRC to ask them to get involved.
Further changes to the PAYE Regulations will allow HMRC to seek to recover PAYE and NICs from elsewhere in the supply chain where a party fails to meet its obligations. It is likely that engagers will need to show they have taken reasonable care and met all their obligations under the legislation where a tax default has occurred in the labour supply chain.
CEST and guidance
The implementation of the rules is totally reliant on engagers being able to correctly determine whether the IR35 rules will apply – by considering if the work would have been employment had the worker been engaged directly.
One of the main methods for determination for public sector contracts has been HMRC’s Check Employment Status for Tax (CEST) tool. We understand that there will be further updates to this before the end of 2019 and we hope that these changes will address some of the concerns around the current tool, its application to the private sector and the fact that it does not take account of whether there is mutuality of obligation between engager and contractor.
HMRC have lost five of the seven cases on IR35 taken to the tax tribunal since the start of 2018. The judgments in these cases have highlighted the potential complexity of making an accurate IR35 assessment. In less straightforward cases, such as those in the TV and radio industry, it requires a full assessment of a wide variety of factors, and it is likely to remain difficult to accurately reflect these in a tool designed to be straightforward for non-tax specialists to use. Even after the changes, CEST may, therefore, only provide a clear and reliable result in the most straightforward of cases.
HMRC guidance on the new rules is expected during summer 2019, but even before this is available, both contractors and engagers should begin to prepare for the changes. Feedback from the public sector implementation was that the five month lead period was insufficient in many cases for sufficient procedures to be adopted in time, especially in respect of preparing individual determinations where multiple workers are impacted.
For engaging businesses, this will mean that prior to 6 April 2020 they will need to have:
- Identified all individuals who may be impacted by the new rules.
- Determine whether or not a contract will fall within the IR35 rules.
- Put in place processes to ensure that these decisions are both made and communicated consistently going forwards.
- Engaged with all stakeholders, including individual contractors, about the tax and procedural changes going forwards.
- Reviewed their internal systems, such as payroll, finance and HR processes, to ensure that they can make the correct tax and NICs deduction from payments where required.
- Considered what processes need to be put in place to deal with the specific time limits for dispute resolution with the workers.
Contractors should also take this opportunity to consider whether an engager could reach a different conclusion on their status to their own.
If you would like any further information on this matter or wish to make a representation please contact your usual Saffery Champness partner.