From April 2020, the rules around who has responsibility for determining the tax status of consultants providing their services via an intermediary is changing for private sector organisations. Now is the time to start preparing for this change.
IR35 or the off-payroll working rules apply to situations where a consultant seeks to provide their services via an intermediary, usually a personal service company (PSC) - the consultant will generally be the sole director and shareholder of such company. The government is concerned that such arrangements result in disguised employees - that is individuals who act like employees but disguise themselves as companies by providing their services through the PSC.
For private sector organisations currently, it is the responsibility of the consultant to assess their own tax status and, where they are deemed to be an employee for tax purposes, the responsibility for deducting income tax and National Insurance Contributions falls on the PSC.
HMRC believes there is widespread non-compliance with the current rules and it is estimated that only 10% of PSCs that should apply IR35 do so. This results in significant loss of revenue for the government and it is difficult for HMRC to investigate, as separate enquiries are needed into each PSC and each individual assignment.
From 6 April 2020, this position will change for large and medium sized organisations in the private sector using PSCs for their services, to mirror what has been in place for the public sector since April 2017. A large/medium sized organisation is one which meets two or more of the following: over 50 employees, net turnover over £10.2m or a balance sheet over £5.1m.
What is changing?
The private sector organisation who is the engaging business will, from 6 April 2020, be required to determine the tax status of the consultant and, where they are deemed to be an employee for tax purposes - as distinct from for employment law purposes - the entity paying the PSC will need to make the appropriate deductions for income tax and National Insurance Contributions. This will often be the private sector organisation unless there is, for example, an intermediary sitting between that organisation and the PSC who will then be the paying entity.
IR35 will need to be considered on an engagement by engagement basis, looking at factors such as mutuality of obligation, supervision and control, the requirement for personal service and integration into the engaging business. Although HMRC has an online tool to assist with the determination process, this has been heavily criticised, not least because it often allegedly produces an unable to determine result!
The engaging organisation will need to exercise reasonable care in carrying out the tax status determination, which means that a blanket approach is unlikely to be appropriate. There are also complex rules around who the engaging organisation will need to inform about the tax status determination they have reached, depending on the particular arrangements in place. A failure to properly comply with these rules will mean the tax liability remains with the private sector organisation.
Significantly, where HMRC are unable to recover tax and NI from the paying entity in the first instance, liability can pass back up the chain to the private sector organisation. This is out of the ordinary and poses significant risk for all parties in the chain, in particular the private sector organisation at the top. For this reason, it will be important for engaging organisations to have appropriate indemnity protection in their contractual documents.
It is important to remember that the issue of status for tax purposes is separate from that for employment law purposes. However, inevitably any determination of employment status for tax purposes will lead to questions as to the individual’s employment status and any employment rights which might follow as a result. In addition, any contractors for whom organisations need to deduct tax and NI will increase the payroll bill for calculating the apprenticeship levy, so properly budgeting for the changes will be key.
How should organisations prepare for this change?
If your business uses consultants it is critical that you start to review these arrangements now to determine whether or not:
- contractual documentation needs to be updated;
- you need to be deducting tax at source;
- you need to re-consider the structure of your workforce.
You should also speak to those consultants who may be caught by IR35 to discuss your approach and consider what other communications or FAQs might be necessary in the run up to April 2020.
When similar rules were introduced in the public sector, many organisations were left with resourcing issues when consultants did not want to be treated as employees for tax purposes and then left that organisation. It is therefore important to consider this possibility and prepare accordingly.
It is also advisable to check whether your current systems will allow you to record and make the necessary deductions in respect of consultants who are deemed to be employees for tax purposes.