As announced in the 2018 Budget, the public sector off-payroll working rules will be extended to the private sector from 6 April 2020, after a public consultation due to take place this year. The rules will only apply to large and medium-sized businesses, with only the existing IR35 rules continuing to be relevant in relation to small businesses.
In relation to what a large and medium size business is – it appears that the Government will say it is any business which is not a small business – with a small business being as defined in the Companies Act 2006 (i.e one that satisfies at least two of the following requirements: turnover of not more than £10.2 million; balance sheet of not more than £5.1 million; and no more than 50 employees). Note that this is yet to be confirmed.
The draft legislation is expected in summer this year so we don't yet have the precise details on what the new rules will look like. However, many businesses are already thinking about the consequences of the proposed changes. For that reason, it's worth taking a closer look at how the public sector rules work currently. The key issues which private sector businesses will want to think about are –
- Their new obligations to determine employment status of their contract/agency staff
- When the liability to deduct PAYE and NICs arises in respect of those staff.
A short introduction to IR35
Many self-employed contractors use personal service companies (PSCs) to supply their services to their clients. This is a way of saving tax and NICs which is why HMRC introduced IR35 as a way of combatting the risk that PSCs and other intermediaries posed to the tax base. In essence this asks whether, but for the interposing PSC, the individual would have been regarded as an employee of the client organisation engaging them. This involves considering the nature of the work performed under the contract and the terms under which it is performed and is known as "deemed employment". If the answer to this is yes, then the PSC has to account to HMRC for income tax and NICs on the payments received from the client.
How the off-payroll rules work in the public sector
As IR35 has not been as successful as it ought to have been, from 6 April 2017 the government introduced new rules in the public sector, which effectively shifted the responsibility for accounting for income tax and NICs from the intermediary PSC to the person directly paying the PSC (known as "the Fee Payer"). The Fee Payer will therefore be either the public sector employer engaging the services ("the Employer"), or the recruiting agency/other specialist service provider ("the Agency") if one is engaged.
Where these new "off-payroll working rules" apply, payments received by a PSC, directly or indirectly from a contract with an Employer, will fall outside the IR35 rules. In addition, the responsibility for determining deemed employment also shifts from the intermediary PSC to the Employer engaging the contractor. If a contractor is considered to be in deemed employment, the Employer, or Agency (depending on who directly pays the PSC) must make payroll deductions for tax and NICs (through PAYE).
Four key questions the Employer must ask itself in respect of each contractor:
- Will the off-pay roll rules apply at all? The rules do not affect contractors supplied by an employment agency or umbrella company, where they directly employ them and operate tax and NICs on earnings they pay them, or staff supplied though a managed service company that operates PAYE on the payments.
- Where the rules do apply in principle, is the contractor using an intermediary which meets the relevant conditions for the new rules to apply? An "intermediary" would be a company (ie commonly known as a Personal Service Company – PSC) in which the contractor has a material interest (ie holds more than 5% of shares), but could include certain partnerships which the contractor is a member or even an individual.
- If the contractor is using a relevant intermediary (eg a PSC), is there a "deemed employment"? This will be for the Employer to determine and to inform the relevant parties as mentioned above.
- Where there is a deemed employment, who pays the PSC? In a chain of intermediaries between the Employer and the contractor's intermediary (or PSC), it is the lowest UK based intermediary in the chain (that is, the one that pays the PSC) that must operate PAYE.
Practical implications of the off-payroll working rules
- Determining deemed employment is not always clear cut and it is often necessary to seek legal advice. Although there is no obligation to use the government's new online tool (the CEST) for this purpose, the advantage of doing so is that HMRC will be bound by the output of the service, unless it has been obtained fraudulently.
- Informing the Agency/PSC about the determination of deemed employment. Having determined employment status, the Employer must inform both the PSC/contractor and, if applicable, the Agency which pays the PSC, of the outcome of the review and, if requested, provide a written response as to how the conclusion on employment status was reached. The Employer must have a clear process in place to comply with this information requirement.
- Extra costs. A key consequence of the new rules is that Fee Payer is responsible for an additional cost of 13.8% employer NICs and, if applicable, 0.5% apprenticeship levy on top of the payment. Broadly, the levy is 0.5% of pay bills over £3 million in the relevant tax year. The Fee Payer is not entitled to deduct these costs from the fee payable to the PSC. The contractor, on the other hand, is likely to be in a better position (although this depends on the circumstances) as the PSC no longer has to account for PAYE and NICs on the fee received from the Agency. For a contractor who formerly considered themselves to be self-employed and that IR35 did not apply, deduction of payroll taxes will result in a significant reduction in profit for the PSC that would otherwise have been available to draw as dividends.
- Pressure to re-negotiate contracts between the Employer, the Fee Payer and the PSC – due to these extra costs, it is likely that the Fee Payer will wish to re-consider the contractual terms -
- Where possible the Fee Payer may wish to re-negotiate its fee with the PSC/contractor to take account of the transfer of NIC liability to the Fee Payer.
- The Fee Payer may try to recover the extra cost of the apprenticeship levy (if applicable). The levy is payable by companies liable for employer's NICs and is calculated on the size of the pay bill. It's possible that the levy may be a new cost for very large agencies who become Fee Payers under the new rules.
- The Fee Payer may consider getting the contractor to abandon their PSC and supply their services instead through an umbrella company or on a fixed term employment contract.
- The PSC/intermediary will remain the employer for the purpose of paying benefits such as statutory sick pay and statutory maternity, paternity or shared parental pay.
What are the consequences for the Employer for not getting it right?
Even where the Employer is not the Fee Payer (and therefore not normally liable to account for PAYE and NICs of the relevant contractor) liability could fall to the Employer in certain circumstances, including if it -
- fails to notify its decision about deemed employment to the contractor/PSC or Agency with whom it has a contract to provide the services, within the timescale;
- fails to reply to the written request from the contractor/PSC or Agency for the reasons for the decision within 31 days of receiving it; or
- fails to exercise reasonable care in providing its view as regards employment status.
In the context of the private sector, the government has said it will explore options for the consequences of businesses failing to use reasonable care in making their decisions.
Private sector companies should familiarise themselves with the public sector rules and start thinking about how the rules will apply to them. In particular, companies should:
- conduct an audit of contractors used in their organisation;
- liaise with agencies and specialist service providers to determine which contractors may potentially be caught by the new rules; and
- estimate any likely cost increases due to employer NICs and Apprenticeship Levy charges and any potential changes in contractor charges.
Finally, look out for the government's public consultation on the new private sector rules, expected by summer 2019. Also look out for improvements to HMRC's online tool, CEST, which are expected to be in place before April 2020, along with updated HMRC guidance to the private sector.