In the final article in our “how to draft consultancy agreements” series, we take a look at some common problem areas which businesses need to be alert to.
Taxation and the consequences of IR35
In our first article of the series, we explained the importance of correctly identifying the status of the consultant from an employment perspective (that is, whether the individual should be properly classed as genuinely self-employed or whether they should more properly be described as an employee or a worker). Not only is this relevant when determining what employment rights an individual has; it is also important when considering the individual’s tax treatment.
If a consultant is found to be an employee by HMRC for tax purposes, any consultancy fees paid directly to that individual will be subject to income tax and National Insurance contributions. As a business engaging this person, you would be required to deduct tax and NICs under PAYE. If the individual is accepted by HMRC as being a consultant, then the consultant will be required to account for their own tax via self-assessment. So far, so good…
Matters become slightly more complicated when a consultant seeks to provide their services via a personal service company (the consultant will generally be the sole director and shareholder of such company). This is where IR35 or the “off-payroll working rules” come into play.
In short, IR35 seeks to crack down on personal service companies being used to reduce the tax and National Insurance liabilities for both parties in circumstance where the consultant is not genuinely self-employed. Whilst the rules aren’t new, an important change takes effect in April 2020 which medium and large private sector businesses need to be aware of. A business will be large/medium sized if it meets two or more of the following: over 50 employees; net turnover over £10.2 million or a balance sheet of over £5.1 million. The following example illustrates the change taking effect in April 2020:
Harry Smith works for Made Up Company Limited. He provides his services via his personal service company HS Services Limited.
Harry works at Made Up’s premises for 40 hours a week and does not provide services to any other business. He has a Made Up email address, he wears a Made Up-branded polo shirt and is subject to the management of a Made Up employee. Harry does the same role as five other individuals who are employed directly by Made Up.
In this scenario, it is likely that Harry wouldn’t be regarded as genuinely self-employed and that, had he been engaged directly by Made Up, he would have been classed as an employee for tax purposes (and therefore subject to PAYE).
Under the current regime, the responsibility to account for tax and National Insurance contributions lies with HS Services not Made Up. From April 2020, however, this is going to change so that this responsibility shifts to Made Up. Assuming that the arrangement falls foul of IR35, from April 2020, Made Up will need to make deductions for tax and National Insurance from the consultancy fees payable to HS Services.
Where businesses do engage consultants via personal service companies, we would recommend that you start to review these arrangements now to determine whether or not contractual documentation needs to be updated; whether or not you need to be deducting tax at source and, more generally, whether you need to re-consider the structure of your workforce.
Is there an exclusive relationship?
A question which we are commonly asked is, ‘can we stop the consultant from working elsewhere?’. Without wanting to labour the point about employment status for too much longer, a blanket ban on a consultant from working elsewhere is likely to be an indicator of an employment relationship rather than evidence of genuine self-employment (think of Harry and his 40 hours a week!). For that reason, an absolute exclusivity clause is generally not recommended.
That said, businesses should consider whether it would be appropriate to consider a middle ground which allows the consultant to provide their services to other businesses, provided that those other businesses aren’t competitors.
Another tricky area is post-termination restrictive covenants. Such clauses aim to restrict an individual’s ability to work after their consultancy has ended with a view to preventing damage to their former client’s business. A typical restrictive covenant may, for example, seek to prevent an individual from contacting former customers or clients for a number of months after their consultancy ended.
Businesses cannot, however, seek to restrict the activities of former consultants without careful consideration. In order to be enforceable, restrictive covenants need to protect a legitimate business interest and go no further than is reasonably necessary to protect that interest. If a consultant hasn’t had access to clients whilst working for you, a covenant restricting dealings with them is unlikely to get off the ground.
If, as a business, you are concerned about the risk which a consultant could pose post-termination, we recommend that you get in touch and seek specific advice on the drafting of the requisite restrictions. Unfortunately, you don’t get a second bite of the cherry so, if the restrictions aren’t right at the point at which they are entered into, you can’t simply redraft them.
Is the consultant a commercial agent?
Whilst it’s not a particularly common scenario, it is possible that a consultant will fall with the scope of the Commercial Agents Regulations 1993 and this is often something which gets overlooked. If an individual is deemed to be a commercial agent, then both parties will be subject to certain duties and obligations which can’t be contracted out of. For businesses, this can involve paying out considerable compensation on termination of the agreement.
If the consultant is going to be involved in the sale or purchase of goods on behalf of the business, we would recommend that specialist advice be sought to check whether or not the regulations are likely to apply and the implications of this..