Financial Directors, HR Managers and company secretaries will be well aware of the existing IR35 regulations, which have been around for almost 20 years, and the obligations that these historical rules have placed on contractors working within the private sector who have been employed via Personal Service Companies (PSCs). However, while the obligation to assess whether PAYE and National Insurance Contributions (NIC) applies for the work of these contractors has historically sat with the PSCs, from April 2021 the Government is updating the IR35 legislation.
The new regulations mean that private sector firms who enter into contracts or make payments to workers engaged through a PSC on or after 6 April 2021 will need to check the individual’s ‘deemed employment’ status. That is, would the individual be regarded as an employee of the company if it were not for the legal wrapper PSC between the contractor and the hiring company? This change in the private sector is designed, in many respects, to mirror the changes that were introduced from April 2017 in the public sector.
Under the proposed changes, the hiring company will need to assess whether the contractor’s role and duties are genuinely those of someone who is ‘self-employed’ or rather, more akin to those of an employee. If the contractor’s role and duties are those of an employer, from 6 April 2021, the hiring company will need to:
a) account for PAYE/NIC withholding on the invoices, and
b) account for Employer NICs
If the contractual arrangement involves third parties (e.g. an agency between the hiring company and the PSC), the withholding obligation sits with the agency. However, the hiring company still has the obligation to undertake the ‘role assessment’ – i.e. to assess whether the individual is deemed an employee as per the IR35 regulations and will need to notify the agency in these situations re the obligation to account for PAYE and NICs. In addition, the hiring company needs to ensure that the agency is operating the withholdings correctly, so that there is no risk of any PAYE failure being transferred to the hiring company.
The good news
Companies that qualify as ‘small’ businesses will not be required to apply the new rules. In such cases, the historical rules remain, and the PSCs will be responsible for assessing the IR35 position for each individual contract (and the PAYE/NIC obligation), as they are currently required to.
A company will be regarded as small for this purpose under either of the simplified tests– i.e. if the turnover of the company is under £10.2m (relevant for unincorporated businesses); or for incorporated businesses if it has at least two of the following:
- turnover – not exceeding £10.2m
- £5.1m or less on the balance sheet
- number of employees not exceeding 50
However, small companies that are part of a larger group will still be caught by the IR35 requirements, where the group as a whole meets the above conditions. Growing businesses that don’t meet the above definitions at present, but then meet the conditions for two consecutive years, would fall into the new IR35 regime from the start of the tax year following the end of the filing period for the second financial year in which the business met the conditions. So, for example, a private company that meets the tests for the two financial years ended 30 June 2023, would need to apply the new rules from April 2024.
The Government has also confirmed that the reform is not retrospective and that HM Revenue & Customs (HMRC) will not carry out targeted campaigns for earlier years where a PSC falls within the new IR35 rules from April 2021. As such, an organisation’s decisions about whether workers are within the rules should not create any enquiry into earlier years.
The payment process
Where a PSC-linked contractor works for a medium or large-sized business, and falls within these rules:
- the party paying the worker’s PSC (the fee-payer – e.g. the hiring company or an agency) will be the deemed employer for PAYE and NIC purposes
- the amount paid to the PSC for the contractor’s services is deemed employment income
- the party paying the PSC (the fee-payer) will be liable for secondary Class 1 NICs and must deduct tax and NICs from the payments they make to the PSC in respect of the services of the contractor
- the deemed employer for tax purposes must remit payments to HMRC and send them information about the payments using real time information (RTI).
Client-led disagreement process
One of the criticisms of the public sector rules from April 2017 was that there was no innate opportunity for contractors to challenge the ruling issued by the deemed employer. This resulted in many institutions taking a blanket approach and treating all contractors as deemed employees – regardless of the reality of individual arrangements.
Therefore, the private sector regulations will allow contractors (or agencies if applicable), to challenge the determination of the hiring company.
This process requires the end-client to review a decision and provide a reasoned response within 45-days. If this deadline is not met the end-client will assume the IR35 liability. Hiring companies will therefore need to develop a clear and robust process for handling such disputes and ensuring that the decisions are legitimately reviewed, and all deadlines are met.
The challenges for employers
While it is understandable that the Government wishes to introduce these new regulations, given the number of tax leaks they believe have occurred under the existing IR35 regime, the changes will bring a number of significant challenges for employers including:
- It may be difficult to assess whether someone is genuinely self-employed or a deemed employee. This challenge is compounded by weaknesses with HMRC’s Check Employment Status for Tax (CEST) tool – though the Revenue have promised to update this tool in the coming months – and the subjective manner in which some of the tests of employment/self-employment may be interpreted by different individuals.
- Do companies have a full understanding of who is presently employed via PSCs? Do they know whether such individuals will be employed after April 2021 or not? What communications should the company have with individuals who could be affected by these changes?
- How does the company capture any changes in the working pattern of contractors, so that any possible change to the deemed employment status is correctly assessed?
- The process of reviewing the working patterns for contractors and assessing their employment/self-employment status will be time-consuming and should not be undertaken on a blanket basis.
- Do companies need to review their contracts with agencies or PSCs? For example, to ensure that agencies providing PSC-linked contractors do correctly operate PAYE/NICs? Is it possible to put indemnities in place in this regard?
- Could this change increase cost pressures for businesses – e.g. because of employer NICs? Could contractors also look for higher pay rates because of the changes or look at receiving holiday pay?
The new IR35 rules represent a substantial change to the employee/employer business model in the UK. As such, impacted businesses will need to put in place a clear, robust process and ensure that sufficient resources are allocated to this issue. One lesson from the introduction of similar rules in the public sector in 2017 was that employers didn’t give sufficient time/resource for these reviews, which increased the problems that the public sector faced in retaining and motivating their contractors.
Companies also need to realise that this issue of employment versus self-employment can be highly complex and they may need to accept that it will be difficult to avoid all risks in this area, while ensuring that the staff involved in the decision are (a) appropriately trained on the issue of employment versus self-employment, and (b) genuinely understand what the real working arrangements for each individual freelance contractor are – not just the official position as laid out in the contract for services.
Though these changes create significant challenges for companies with a significant number of contractors, taking the time to get a clear, effective system in place and to ensure that discussions are undertaken with the affected individuals on a timely basis can provide companies with a real advantage compared to their competitors.