Off Payroll Working and IR35 Changes
From 6 April 2021, there are two regimes that private sector “end users” need to consider where it contracts with or engages someone they consider to be an independent contractor or consultant through an intermediary vehicle (like a personal services company or “PSC”):
- The IR35 regime; and
- The off payroll regime.
The principal delineating factor between the two regimes is whether the private sector “end user” counts as a “large or medium sized entity”. Please note that if the end user is a public sector client contracting through an intermediary / PSC, the only regime that applies is the off-payroll regime (and this has been the case since April 2017).
It is also worth remembering that if you contract directly with an independent contractor or consultant in his / her personal capacity (in other words, not via an intermediary or PSC) then neither the IR35 nor the off payroll regime apply. That does not mean, however, end-users are free of the tax and employment law risks associated with incorrect status classification. Before entering into any type of contract with a contractor whom you consider to be self-employed, it is always worth reflecting on the status tests outlined below.
What is a large / medium sized entity?
Remember that what we are looking at here is the size of the private sector end-user, not the size of the intermediary / PSC.
This is defined in the reverse – an entity is medium or large if it is not small. The precise definition of what counts as “small” depends on the type of corporate entity in question (e.g. is it a company, a partnership, an LLP, a sole trader etc.).
Taking a limited company as an example, a company is small if it satisfies two or more of the following requirements:
- Its annual turnover is not more than £10.2 million.
- Its balance sheet total is not more than £5.1 million.
- It does not have more than 50 employees.
In addition, a company is always “small” for its first financial year.
I’m a “small corporate entity” client. What does IR35 mean for me?
In summary, the IR35 regime requires the intermediary (usually a personal service company (PSC)) to determine whether the contractor / consultant (termed a “worker” by IR35) would have been a deemed employee of the end-user client, but for the existence of the intermediary / PSC.
This exercise must be carried out on a contract by contract basis. If the worker would have been a deemed employee, the intermediary must: operate payroll; make deductions for income tax and employee's national insurance contributions; and pay employer's national insurance contributions on the fees received for the services. In other words, the intermediary / PSC (and not the end-user / client) takes the risk over the status or classification of the worker.
To give an example, the worker is Rachel Penny, and the end user is Carson McDowell LLP. Assume that Carson McDowell LLP meets the “small corporate entity” definition, so it is the IR35 regime that we are looking at, not the off-payroll regime. Rachel Penny has her own personal services company, Rachel Penny Limited, and she uses that to provide her services, so the contractual relationship is between Rachel Penny Limited and Carson McDowell LLP.
What IR35 does is require Rachel Penny Limited to assess whether the relationship between Rachel Penny (the worker, not the PSC) and Carson McDowell LLP (the end-user / client) is in reality one where, if Rachel Penny Limited (the PSC) was taken out of the equation, Rachel Penny is really (for tax purposes) an employee of Carson McDowell Limited. This is what “deemed employment” means.
If that is the case, then IR35 requires that Rachel Penny Limited pay the fees that it received from Carson McDowell LLP to Rachel Penny via payroll, making deductions for income tax, national insurance etc. as if the fee was salary.
To the extent that the earnings from the deemed employment are not paid to the worker in the form of salary during the accounting period of the PSC, the PSC must make an end-of-year return accounting for payroll taxes on the balance.
This requirement will continue to apply to PSCs that supply a worker's services to a small private sector client on or after 6 April 2021.
I’m a large corporate entity. What do the off-payroll rules mean for me?
In short, instead of the PSC being responsible for determining whether the contractor / consultant would have been deemed an employee of the end-user client, if you are a large corporate entity end-user, you must consider the consultant’s true status using the tools and methods set out below. You cannot leave this task to the PSC, and you cannot simply “bury one’s head”. You have to take pro-active steps to make this determination.
To take the same scenario as above, with Rachel Penny Limited and Carson McDowell LLP, only this time Carson McDowell is a large corporate entity. Under the off payroll rules now Carson McDowell LLP is required to assess whether the relationship between Rachel Penny (the worker, not the PSC) and Carson McDowell LLP (the end-user / client) is really one of employment (for tax purposes). So to compare and contrast, when Carson McDowell is a small entity (IR35 regime), Rachel Penny Limited takes the responsibility and tax risk, when Carson McDowell is a large entity (off payroll regime), Carson McDowell takes the responsibility and tax risk.
Having determined the contractor’s deemed employment status, you must then issue a status determination statement (known as “SDS”), which sets out not only your status determination in respect of the contractor, but also the reasons for reaching that determination. There is a “dispute resolution” mechanism that the worker / contractor can use if he / she disagrees with the SDS.
If the worker is a deemed employee, then the end-user must operate, withhold, and account for the worker’s payroll taxes (income tax and employer’s and employee’s NICs).
How do I assess “deemed employment”? What are the tests for “employment” in this context?
Unfortunately there is no statutory test to determine employment status for tax purposes. We have to look to the tests which have been established by case law. It is worth noting that whilst these tests are similar to the tests applied for employment law purposes (for example, to determine if someone is an “employee” in order to bring an unfair dismissal claim), they are not identical. It is possible to be an “employee” for tax purposes but not employment law purposes, and vice versa.
Some of the key factors to take into account in assessing “deemed employment” include:
- Is there mutuality of obligation (i.e. an obligation to provide work and an obligation to accept work)? If yes, then that is a strong pointer to employment status.
- Is personal service required (or is substitution permitted)? If substitution is permitted, that is a pointer against employment status.
- What is the degree of control exercised by the end-user? The more control (the what / where / when / how) exercised by the end user, the greater the pointer to employment status.
- Other factors such as the degree of integration, the level of financial risk, the provision of equipment.
HMRC has a “Check for Employment Status Tool” (CEST) on its website which end-users, intermediaries and their workers may find helpful. Whilst HMRC say that they will “stand over” CEST results (assuming the inputting of information is carried out accurately, and provided the test is refreshed / updated if circumstances change), there have been some high profile instances where the tax tribunals and courts have disagreed with and disregarded CEST determinations.
The CEST tool indicates that the independent contractor is actually a “deemed employee”. I know I now need to account for PAYE. That means the PSC will be receiving the fee net of tax. The independent contractor (the owner of the PSC) is not happy and is saying that we should “gross up” the fee to account for what he is ultimately losing out on. Do I?
This will depend on what your existing contract with the PSC says about who is responsible for tax and national insurance – most of those contracts are drafted to make clear that the end user is not liable for tax and NICs.
The immediate consequence of the new off payroll rules are that the end user will see its costs increase by 13.8% (employer’s NICs) and the PSC will see its fee income decrease by the independent contractor’s rate of income tax and employee’s NICs.
These changes may make the existing fee structures uneconomic, and we are aware that many end users are terminating or amending their existing contracts with PSCs to re-calibrate / re-negotiate the fees payable, taking into account these additional costs. Some larger companies and sectors that historically engaged a large number of its workforce through PSCs (like the IT sector, for instance) are ceasing using this model completely.
If the CEST tool indicates that the independent contractor is an employee for tax purposes, does that mean that I have to employ them as an employee? Should I issue a contract of employment to them?
Classification of a contractor as a deemed employee for tax purposes will not of itself make the person your “employee” for employment law purposes. The new off-payroll rules do not confer any employee rights on the individual – the new rules are all about the allocation of tax / PAYE risk.
However, do bear in mind the tests of “employment” for tax versus employment law purposes are similar, and an SDS of deemed employment may indicate a strong possibility that the contractor is also an employee or a worker for the employment law purposes. This is relevant, for example, for holiday pay purposes where incorrect classification of status can lead to years’ worth of back pay liability (as was the case in King v Sash Window Workshop where Mr King had been wrongly classified as a self-employed / independent contractor for many years, when in fact he was a worker, entitled to 12 years’ worth of holiday pay).
However, employment status for employment law purposes is not at all straightforward to determine. Each case will turn on its own specific facts, so we encourage you to seek legal advice about your own cases and circumstances.
What should I do to prepare my business for these changes?
- Educate your HR, finance and procurement teams to understand the rules.
- Identify which regime if any (IR35 or off-payroll) applies to your business.
- Identify existing relationships / agreements with independent contractors and consultants and gather the information necessary to analyse those relationship.
- Conduct the employment status review using CEST or with appropriate legal and accounting advice.
- Notify the results (the SDS) to the intermediary and the “deemed employee”, together with an explanation of how the determination has been reached.
- If SDS indicates “deemed employment”, speak to your finance department, tax advisers and payroll providers as soon as possible – there are likely to be lots of administrative arrangements that you need to put in place prior to 6 April 2021, not least of which is the need to operate PAYE for them.
If you have any questions on how this might affect your business or if you want more information, please contact a member of the Employment team.
*Please note that this information is for guidance purposes only and does not constitute, nor should be regarded as, a substitute for taking legal advice that is tailored to your particular circumstances.
* Please note that these changes straddle both issues of employment law and taxation. If there are any specific tax issues / queries those should be addressed to accountants / tax advisers.