Welcome to our January edition of Owner Managed Business update.
IR35 compliance update
The intermediaries legislation (more commonly known as 'IR35') applies where an individual worker provides services to an end client through an intermediary, such as personal service company (PSC), partnership or agency, in circumstances where the individual would otherwise be regarded for tax purposes as an employee or an office-holder of the client.
The basic premise behind IR35 is to ensure that the worker's income tax and NICs liability is broadly equivalent to that of an employee and to impose a PAYE and NICs obligation on the intermediary (ie the PSC). Sounds simple enough, but in reality and even ignoring the proposed changes due in April 2020, the IR35 regime is problematic as it is often unclear whether arrangements are within or outside the IR35 regime resulting in uncertainty for taxpayers.
As a number of high profile TV presenters (such as Lorraine Kelly) have come to discover, there is a significant risk of HMRC investigation and potential dispute, which can be invasive, burdensome and costly.
Given this backdrop, the proposed changes to the IR35 rules have not gone down well with those operating in the sectors where engagement via PSCs is prevalent (such as the banking, IT/tech, media, construction and healthcare sectors). All businesses, with the exception of small companies (as defined by reference to the Companies Act 2006), are going to have to take responsibility for assessing if off-payroll contractors should be on the payroll or risk substantial tax liabilities and penalties for non-compliance.
A 'small company' for these purposes will be any company that meets any two of the following three criteria: (i) an annual turnover not exceeding £10.2m; (ii) a balance sheet total not exceeding £5.1m or (iii) an average, over a year, of no more than 50 employees. Whilst it may be that an owner managed business operating as a company may fall within such a definition, care will be required where there are other companies in the group as the test will be applied across the group.
Lobbying of Government resulted in the pre-general election announcement by the Chancellor that the IR35 rule changes would be reviewed. In January, this review was confirmed by HM Treasury but the tone was very much of ensuring a smooth transition of the changes rather than them being abolished or altered. So as Nathan Williams, Tax Partner at Trowers & Hamlins says, "at best, we might be looking at a delay as to when the new rules are brought in and/or a possible extension of the small company exemption".
Assessing whether IR35 applies is not always straightforward. Someone who is genuinely self-employed will not fall within IR35, but it is this which is not always easy to determine. Both the contract in place, and the reality of the situation, will be relevant, because HMRC and the Tax Tribunals will look behind the contractual arrangement. The documentation therefore cannot simply be a tick box exercise.
In the spring of 2019, the television presenter Lorraine Kelly defeated HMRC when she successfully appealed a tax bill of £1.2 million, arguing that she was not an employee of ITV. Kelly was hired by ITV via a limited company (effectively her PSC) and was not on the payroll. However, HMRC argued she was effectively an employee of ITV (ie a deemed employee under the IR35 rules) with the PSC therefore liable to account for PAYE income tax and NICs on her earnings, rather than the significantly lower rates of corporation tax payable by the PSC if she were self-employed.
Kelly won the case by proving that she had more control over the work she performed than if she were an employee: one of the key factors in determining employment status.
Under the proposed changes, companies in the private sector that engage individuals as consultants or contractors via an intermediary will have to take responsibility for deciding whether the individual should be deemed an employee for tax purposes. If they fail to get it right, under the changes it is the client that will be obligated to account for the employment taxes, rather than the PSC. "It is this change in passing the tax risks to the end client instead of the PSC that has caused most concern, together with the tax compliance burdens that come with it", says Williams. The changes bring the private sector in line with the public sector, where public sector bodies have had to take responsibility for IR35 compliance of contractors since 2017.
At the moment, in the private sector it is the PSC's responsibility to establish whether the arrangements represent an employment relationship for tax purposes. The PSC pays corporation tax instead of income tax where it determines that the IR35 rules do not apply.
As of April 2020, the complexity of the rules and their application will remain but with the difficulty of determining the employment status now resting with the private sector client. “What we saw in the public sector was a lot of clients saying they didn’t want to take any risks so they made the decision upfront to treat off-payroll contractors as employees for tax purposes going forward,” says Williams. “For an individual, that means becoming subject to tax at source, which results in a cashflow disadvantage and higher tax costs, neither of which are balanced against any corresponding increase in the individual's employment rights". Those contractors which are on the other end of any similar decision made by their end client will obviously be impacted. Some commentators say that it is this inconsistency that results in unfairness for the individual: they are taxed as an employee but have little legal standing as an employee.
In some industries, the challenges of assessing the compliance risk across a workforce can be daunting. “We are dealing with clients in the construction industry where there are layers upon layers of sub-contractors, with multiple supply chains, so the individuals that are providing services via personal service companies may not even be aware of the end client,” says Williams. “The client has to inform the individual of the status determination they have made (and this will have to flow down the labour chain), and whether they are deemed employed or not, so it is all becoming much more complicated than it used to be". This is arguably borne out by the recent announcements of some of the big high street banks to move all contractors on to payroll so that they avoid having to deal with the IR35 process.
The advice for businesses in the private sector that engage workers via PSCs or other intermediaries is to start preparing for the changes now, if not already commenced. That means conducting a thorough assessment of the contractor population and the scale of the impact of any changes, and then assessing whether the individuals concerned should be deemed employees for tax purposes and so fall within IR35. Similarly, for those individuals who operate via PSCs or other intermediaries, they will need to be aware of the processes involved and what, if any, opportunity they have to input in to the assessment and determinations made by their end client. For those who operate with small companies, they will need to ensure that their arrangements continue to fall outside the IR35 rules as the tax compliance burden will remain with them and their PSC.
The next step is to review contracts to ensure that they are fit for purpose, ensuring contracts for those who fall outside of IR35 genuinely reflect the self-employed relationship, or updating contracts where IR35 applies. Where there are contractors that need to move onto PAYE, employers will need to be mindful of increased costs to the business as well as potential cashflow implications for those workers. For tax purposes, it only matters whether someone is self-employed or a deemed employee. For employment purposes there are three types of employment status: employees, who have the whole host of rights; workers, who have some rights; and the truly self-employed. Where contractors are moved onto PAYE, it is possible that they will assert they are employees in the general sense.
Imogen Reseigh, senior associate in the employment practice at Trowers & Hamlins, says: “We are suggesting to clients that they effectively audit their workforce, ascertaining what contracts they have in place as well as how those contractors are operating in practice. It's important that businesses really get to grips with the implications of IR35 applying and who this will affect.”
She adds: “The test for whether or not someone is an employee for tax purposes and so falls within IR35 is not exactly the same for whether or not they are an employee (or a worker) for employment purposes. So, it is possible to put all contractors onto payroll without making them employees, but you might find contractors that fall within IR35 asking to be considered employees and you should also consider if they are in reality.”
One group that will be particularly challenged by the new IR35 reforms is non-executive directors, who often provide consulting services to the companies on whose boards they sit, and to others. They therefore provide consulting services and are impacted by the IR35 rules, while their fees for carrying out the role of director are subject to income tax and national insurance.
“In the NED sector it’s very common for people to be engaged via personal service companies,” says Williams. “You then have a challenge of how you remunerate a director via payroll for some part of their role and via that company for their consulting work. You are not necessarily going to be tax compliant unless you split out what you provide as a director and what you provide as an external adviser, and even then, your client company may not want to run the risk of tax non-compliance following the IR35 changes.”
The complexities are evident and this is an issue that many companies and their consultants/contractors are going to have to get to grips with quickly to be ready for April 2020. “We have known for some time that IR35 would likely be extended to the private sector, and if organisations are not preparing already they should start doing so imminently" says Reseigh. “Some organisations will have lots of contractors engaged in different parts of the business, on different contracts. Getting ready for IR35 is a process and a challenge that will involve lots of parts of the business, for example, HR, finance, internal communications, and organisations will need to put processes in place for making IR35 determinations and dealing with disputes. IR35 requires each part of the business to be aligned and preparing together".
Now is the time for anyone impacted to get ready for the change that is coming.
