IR35, and the changes brought about by the Off-Payroll Rules to be rolled out on 6th April 2020 (now delayed by Covid-19 until 6th April 2021) are complex and can make for some sleepless nights if you’re paying a contractor that could wrongly be considered an employee, or if you’re a private service company (PSC) and are perhaps avoiding the elephant in the room that you, or whoever provides the service who holds a material interest in your company, could be classed as a ‘deemed employee’.
This article intends to simplify a somewhat mystifying area of tax law, and provides guidance on how you may be able to revise your service contracts to ensure you’re staying on the right side of HMRC. Please note the terms ‘PSC’ and ‘Intermediary’ will be used interchangeably throughout, and that for Managed Service Companies and the Construction Industry Scheme, PAYE (pay as you earn) is operated automatically for both.
The original purpose of IR35 was to prevent tax avoidance, whereby companies, typically owned by one person, would supply their services, including office holding (executive positions, like a director) to somebody else, who wouldn’t have to operate PAYE or incur employers NIC (national insurance contributions) as they were paying a company, and not an individual employee. In turn, the worker supplying their services through their own PSC would benefit from all the tax advantages of being paid through a limited company, and then pay themselves in dividends, which would also not incur NIC. On a larger scale, IR35 catches any intermediary where the worker being provided owns more than 5% of the ordinary share capital or voting power in the company, or is entitled (including relatives or civil partners) to 60% of the profits in a partnership.
Also, IR35 was not to be circumvented by PSCs masquerading as satisfying the employer’s tax liability by paying a fraction of what they received as an employment payment, and then transferring the rest in dividends. Anti-avoidance measures even apply to equity transfers to spouses as well, unless of course it was an outright gift.
As IR35 currently stands, the responsibility for making an employment status determination falls on the intermediary supplying the worker, or any public authority, which includes universities, parish councils, and the NHS. Please note that IR35 does not apply to sole traders and umbrella companies, as the very status of each ensures the proper tax functions.
The biggest changes brought about by the Off-Payroll Rules is the introduction of placing the burden of the employment status determination on the private sector for any organisations that satisfy two of the following criteria:
· A turnover of £10.2 million or more, or;
· A Balance sheet of more than £5.1 million, or;
· More than 50 employees.
Of course for organisations of this size, complications can arise in terms of the length of the supply chain, with various agencies in the fray. Under the new rules, a party cannot be responsible for PAYE unless they’ve been given the status determination by someone immediately above them in the supply chain. If everyone along the supply chain complies with their obligations, it is the end client that should be responsible for operating PAYE. In fact, even if a party in the chain fails to pass on the determination, and also fails to operate PAYE, after the prospect of penalties for that party, HMRC then has the power to turn to the end client to operate PAYE on the deemed employment payments. Please note that HMRC is yet to publish guidance on when it would not use this power.
It is also worth noting that an intermediary/worker can challenge the results, which must be responded to within 45 days, either confirming or reversing, and stating the reasons for doing so. Failing to respond within that period will result in the end client being automatically obligated to operate PAYE and NIC.
The new rules also remove the 5% deduction for expenses on the amount on which PAYE is to apply. After a deduction for VAT and materials, at the discretion of the payer of the deemed employment payments (normally the end client) they can also deduct reasonable expenses that would normally be allowed for an employee. In addition, the employer’s NIC and apprenticeship levy (if applicable) must be borne by them, and not deducted from the payment to the intermediary. To avoid double taxation, the intermediaries’ payment to the worker will then be tax free.
In conclusion, the status determination should be carried out by the obligated party at the soonest possible opportunity, as the employment status will of course change the amount of remuneration for the services, among other features of the relationship, like employment rights. The simplest way to make a status determination is to use HMRC’s online CEST tool. Also, HMRC will then be bound by the results, unless they’re obtained fraudulently, of course.
For other ways to assess the application of IR35 to service contracts, and other employment related purposes, you need to consider the following:
· Is there a right of substitution that can actually be exercised by the worker, free of approval or veto by the client? This is perhaps the most important differentiation test.
· What degree of control is there? Set hours would indicate a small element, whilst the amount of control is less applicable to highly skilled work.
· Is there mutuality of obligation? Essentially, in a typical employment relationship the employer is obliged to provide work, whilst the employee is obliged to accept it.
· Is there a notice period on termination? This would normally imply an employment relationship, as service contracts are often terminated on completion of a project.
· Is payment structured on results rather than hours? The latter would suggest an employment relationship.
· What element of financial risk is the worker taking on? Imposing penalties for non-compliance of the anticipated outcomes from the relationship, such as rectification of unsatisfactory work in the worker’s own time, would indicate the worker is not an employee.
· Is there a requirement to maintain insurance? Again, this obligation would indicate the worker is not an employee.
· Are there any policies and benefits in place typical of an employment relationship, like paid leave, firm pension schemes, a car park space, or canteen facilities?
· Whose equipment is the worker using? Use of their own equipment would favour the worker being an independent contractor.
· Do the services offered constitute a ‘brand’? In Albatel Limited v HMRC [2019] Albatel was the PSC of well know television presenter Lorraine Kelly, who used the company to contract her services to a number of different TV shows. Although clearly no substitution could exist, the unique element of control that Ms Kelly had over her services overrode this. Instead of being part of a jigsaw as an employee usually is, “Ms Kelly was the Jigsaw”.
· Also, unless the above applies to the contrary, it’s always worth mentioning in the contract that the relationship is not to be one of employment.
Status determinations are not to be taken lightly. If you’re in any doubt, then please feel free to get in touch. Alternatively, you can submit your queries to us by commenting on our Topic of the Week post on LinkedIn.
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