In the UK Government’s latest Budget, delivered on 11 March 2020, it was announced that the changes to the off-payroll working rules (also known as IR35) previously announced at Budget 2018 would apply to the private sector from 6 April 2020. The rules require businesses that use the services of individuals in the UK that are provided through an intermediary to determine whether there is, in fact, a deemed employment relationship and, if so, to deduct income tax and National Insurance contributions accordingly. Following the rapidly changing developments caused by the outbreak of Covid-19, the UK Government announced on 17 March 2020 that the implementation of the new off-payroll working rules will now be deferred by a year, until 6 April 2021. A statement from Steve Barclay, chief secretary to the Treasury, confirmed: “This is a deferral in response to the ongoing spread of Covid-19, to help businesses and individuals. This is a deferral, not a cancellation, and the government remains committed to reintroducing this policy.”
This Client Alert covers the following:
The off-payroll working rules (the “Rules”) are a successor to the anti-avoidance legislation known as IR35. The IR35 rules were introduced in 2000 and were designed to tackle tax avoidance via the use of personal services companies. That is, arrangements in which individuals providing services to a client through an intermediary company or a personal services company (the “Intermediary”) are remunerated in the form of dividend income rather than employment income, notwithstanding the fact that there was an employment relationship between the individual and the client. The IR35 rules require the Intermediary to determine the employment status of the individual and to then pay income tax and employee’s and employer’s National Insurance contributions (“NICs”) through PAYE, if it is determined that the arrangement between the individual and the client was an employment relationship.
Whereas IR35 requires the Intermediary to determine the individual’s employment status and deduct employment taxes accordingly, the Rules will shift the burden onto the client receiving the services (the “End User”) and the company that pays for the individual’s services (the “Fee-Payer”). Where a deemed employment relationship exists, the Fee-Payer is treated as an employer for tax purposes and is required to deduct income tax and employee’s and employer’s NICs from the deemed earnings that the Fee-Payer pays to the Intermediary for the individuals’ services. In most cases, the End User and the Fee-Payer will be the same entity, although the Rules also include specific provisions governing complex labour supply chains to ensure that all parties in the supply chain have the necessary information in order to be able comply with their respective obligations under the Rules.
When calculating the deemed earnings to be paid to the Intermediary, the taxable amount will be the total payment for the individual’s services, net of VAT, net of the cost of materials used in the performance of services and incurred directly by the Intermediary, and (optionally) expenses that would be tax-free if paid to an employee. Employer’s NICs and any Apprenticeship Levy payment (if applicable) cannot be deducted from the deemed earnings and must be borne by the Fee-Payer.
The Rules were introduced in the public sector in 2017 and will apply to End Users that are medium and large companies in the private sector from April 2021. IR35 will continue to apply to small companies in the private sector once the Rules are introduced in April 2021. Broadly, a “small” company is a company that, in a financial year, satisfies two or more of the following requirements:
A medium or large company is any company that is not a small company. In addition, all private companies (including medium and large companies) will be deemed small for their first financial year. Public companies, however, cannot be small companies. The Rules will apply to any new contracts entered into between an End User and an Intermediary after the Rules are implemented as well as any existing contracts in force at the implementation date.
Assuming that an End User meets the size threshold, it will need to evaluate whether the individual that it hires through an Intermediary is deemed to be “employed” by the End User for tax purposes. HMRC have developed a specific “Check Employment Status for Tax” tool (the “Employment Status Tool”), which provides a questionnaire for End Users to complete in order to determine the employment status of its workers, and therefore the applicability of the Rules. You can access it here.
An evaluation must be done for each contract that the End User has in place with an agency or individual, and the End User must produce a Status Determination Statement (“SDS”) after each evaluation (the SDS can be generated automatically through the Employment Status Tool). The SDS must be issued to the worker and (if applicable) the agency, together with reasons for the determination. The End User must take “reasonable care” in preparing the SDS. In the event that the individual or the agency notifies the End User that it disputes the SDS, the End User must consider the reasons for the dispute and provide a response within 45 days of receiving notification of the disagreement. Failure to take reasonable care and/or to respond to a dispute within 45 days will result in the End User being automatically responsible for the individual’s tax and NICs.
The Employment Status Tool focuses on the nature of the relationship between the End User and the individual. In particular, the questionnaire asks for information about the level of control that the End User holds over the individual and the respective rights of each party (for example, whether the individual has a right to send a substitute, or whether the End User can control how/where the work is done). Generally speaking, the more control the End User has, the more this will point to the Rules applying (and on the other side of the coin, the more independent a worker is, the more likely it will be that Rules will not apply).
We have set out below some of the questions that arise as part of the Employment Status Tool, to give you an idea of the types of issues that organisations will need to consider:
1. Worker’s Role:
(a) move an individual from the work they have been hired to do (i.e,. to do other work);
(b) decide how and where the work is done; or
(c) decide the individual’s working hours?
4. Financial Risk:
(a) buy equipment or materials;
(b) fund any vehicle costs; or
(c) fund any other costs (e.g., specific business premises for the relevant work only), before being paid by the End User
5. Nature of the Contract:
As noted, the Rules will apply to both new and existing contracts. Given that many contracts with intermediaries will have been negotiated on the basis that the Intermediary will be responsible for deducting tax and NICs from the individual’s pay, the additional cost of the 13.8% employer’s NICs and (potentially) 0.5% Apprenticeship Levy will likely have a significant cost implication for End Users. Conversely, for an individual who previously considered that services s/he provided to an End User through an intermediary had the nature of self-employment, deduction of payroll taxes may result in a significant reduction in profits for the Intermediary.
The parties will need to consider how best to address these (potentially significant) cost implications, which will likely result in contracts being re-negotiated to effectively account for the transfer of NICs liability.
If the Rules are found to apply to an existing contract, this could also give rise to uncertainty about historical (pre-Rules) periods of payment. In these circumstances, renegotiation of the contract could help to draw a line between historical and future periods. It is worth noting that HMRC has confirmed that it will not actively look to investigate the historic application of the IR35 rules by Intermediaries retrospectively or carry out “targeted campaigns” into previous years.
Beyond the obvious financial implications, it is also possible that if the Rules are found to apply to an existing contract, this could result in the individual seeking to receive broader employment rights such as the right to paid holiday, Statutory Sick Pay and Statutory Maternity / Paternity / Adoption Pay, and (in some cases) unfair dismissal protection. Whilst each case would have to be considered on its individual facts and determination of “deemed employment” for tax purposes will not automatically confer employment rights on the individual - in some cases, the Intermediary will continue to be the individual’s employer for employment law purposes. In practice, though, there is often significant overlap between the determination of employment status for tax and employment law purposes. As such, deemed employment for tax purposes could result in individuals engaged through Intermediaries challenging their employment status with the End User. End Users should consider seeking indemnity protection in contracts with Intermediaries against such claims by the individual.
Many organisations might have already put steps in place to prepare for the introduction of the Rules in preparation for 6 April 2020. In any event, the announcement on Tuesday that implementation of the Rules will be deferred for at least one year will give medium and large organisations who engage individual services through the use of Intermediaries additional time to prepare for the upcoming changes. We have set out below some tips for organisations to consider in preparation for the Rules.
Organisations should take the time now to review existing contracts with Intermediaries in order to determine whether or not the Rules could apply to an existing contract. This will likely require input from HR and/or Procurement teams.
In the event that existing contracts have been identified as potentially being subject to the Rules, organisations should consider opening a dialogue with the individual where possible. This will prepare the individual for the fact that the Rules might apply from April 2021 and give the parties the opportunity to consider what changes might need to be made to the existing terms to address subsequent changes.
As noted, End Users must take “reasonable care” in preparing the SDS. Accordingly, organisations should ensure that they put in place a fair and transparent process for determining and communicating the SDS to individuals. It might be appropriate in some cases to apply the same determination to groups of individuals providing off-payroll services, although such “blanket” determinations must take account of the individual’s contract and actual working arrangements.
Similarly, organisations must be prepared to respond to any challenge to the SDS within 45 days. This will likely require the implementation of a clear policy for use by HR or Procurement teams as appropriate.
Organisations should engage with payroll providers to ensure that the payroll systems in place are in a position to process payments to those individuals caught by the Rules. Many providers will already have put processes in place in anticipation of the introduction of the Rules in April 2020, and so it will be important to ensure that these processes are up and running in time for the implementation of the Rules in April 2021.
We will continue to review developments regarding the proposed implementation of the Rules, and we would be delighted to assist clients with any specific questions or concerns regarding these changes.