The government today announced in its Budget that it will consult in 2018 about the extension of recent IR35 tax legislation to cover all supplies of Personal Service Company (“PSC”) contractors to private sector organisations. Contrary to news reports last month, it appears that this extension, if it happens, will NOT take effect from next April. Before any implementation the government wishes to draw on the experience of the public sector reforms earlier this year, and external research already commissioned by the government and due to be published in early 2018.
HMRC seems to be confident that the public sector reforms have been largely successful and so we think the writing is on the wall such that the reforms will be extended in some way to the private sector, in 2019 or 2020.
If and when the changes are applied to supplies of PSC contractors in the private sector it is likely to have a massive impact on the cost of using personal service company contractors (PSCs), not least because it will involve the additional costs of employer’s NICs where PSCs are assessed as falling “inside” IR35.
The government also announced investment of a further £155 million in additional resources and new technology for HMRC to help step up its enforcement activity in relation to: tackling marketed tax avoidance schemes, holding intermediaries accountable for the services they provide using the Corporate Criminal Offence and to increase their ability to tackle non-compliance among mid-size businesses.
And, perhaps most importantly in the short term, a very important measure (known as “POTAS”) comes into force in April 2018. Under this measure any end user or staffing company involved in promoting (by active referral etc.) tax schemes (for example some types of more aggressive umbrella arrangement) will have tax liabilities if the tax scheme is subsequently found to not work.
How might any new IR35 rules work for suppliers and users of PSC contractors in the private sector?
It seems reasonable to assume that any new IR35 legislation will largely reflect the changes made in relation to supplies to the public sector earlier this year. Those measures apply where PSC contractors are used by a public sector end user and broadly speaking work like this:
- end user is obliged to assess (and inform whoever supplies the PSC contractor to it (the “supplier”)) whether the contractor is inside or outside IR35 (which broadly amounts to an assessment as to whether the contractor is genuinely self-employed or not based on the usual tests regarding control etc.);
- if the assessment is “inside”, the party who pays the PSC (the “payer”) is be liable for paying employer’s NICs, and deducting employees’ NICs and PAYE on all payments made to the PSC;
- where the supplier considers the assessment by the end user to be wrong it can challenge that assessment and ask for reasons;
- if the end user fails to make an assessment or (when challenged) give reasons, the end user is liable (as will also be the case where it directly engages the PSC); and
- if the payer (for example a staffing company) takes a risk and (based on its own assessment of the “outside IR35” status of the PSC contractor) decides not to deduct PAYE and NICs on any payment to a PSC who has been judged inside IR35 by an end user then it faces an uphill struggle, unless it has very good evidence supporting its stance, fighting any claim by HMRC.
How will the market respond? What new supply models will grow?
If the private sector changes are indeed similar to those introduced in the public sector then, based on what the UK market has seen following the public sector IR35 changes, this is likely to lead to:
- many relatively lower paid contractors moving away from PSC contracting to PAYE options or conventional low-risk umbrella arrangements;
- a significant reduction in the take home pay of contractors (unless hirers agree to increase the rate, which has happened in some public sector cases);
- some more highly skilled contractors (and their staffing companies) wishing relevant assignments to continue to have tax efficiency (by staying outside IR35) and therefore moving further towards “genuine” outside IR35 arrangements. This will involve a statement of work-type contract with defined deliverables with the supplier accepting a material element of responsibility for the outcome of a project;
- some end users and staffing companies deciding to take the risk (with little or no assessment) due to the need to attract and maintain certain skills; and
- many other contractors signing up to alternative payment “solutions” designed to minimise tax and NICs in some ways which HMRC would deem aggressive tax avoidance (exposing users to retrospective penalties). Some so-called umbrella companies have offered these schemes.
Other indirect consequences of all this may include:
- retrospective worker status claims and unlawful deduction from wages actions by those former PSC contractors shunted into PAYE arrangements but effectively doing the same job;
- many consultancies and labour intensive outsourcing companies having to review their usage of PSCs and costings of long term fixed price projects which currently involve use of PSCs outside IR35;
- some staffing companies moving towards more of a consultancy or outsourcing model, which may in many ways help preserve/increase profits; and
- more sophisticated umbrella companies moving more towards a payroll outsourcing/software licensing model.
What about recent aggressive umbrella schemes?
We believe that certain aggressive umbrella models that have proliferated in the last 6 months to engage former PSC public sector workers will be heavily attacked by HMRC in the future, not least as a result of the proposed POTAS legislation referred to below. Those models may not (even to the extent they are usable now) be available for long.
In addition the government today announced new measures to stop some employers abusing the Employment Allowance to avoid paying the correct amount of NICs (by use of offshore arrangements) and to tackle disguised remuneration avoidance schemes used by close companies (companies with five or fewer participators).
HMRC will also have greater powers from 1 October 2019 to pursue an entire supply chain where there has been a failure to pay the correct amount of VAT at the bottom of the chain (for example in relation to misuse of flat rate VAT).
What next, and what else is in the pipeline?
Extension of IR35 to the private sector would, perhaps, be no surprise to suppliers and users of the services of PSC contractors. But announcements in the Budget report confirm that the government is also keen to tackle what it regards as false self-employment from an employment law rights point of view. The government will publish a discussion paper as part of the response to Matthew Taylor’s review of employment practices in the modern economy, exploring the case and options for longer-term reform to make the employment status tests for both employment rights and tax clearer.
Earlier this week the Work and Pensions and Business, Energy and Industrial Strategy (BEIS) Committee issued their joint report, “A Framework from Modern Employment” together with a draft Bill which aims to “close the loopholes that allow companies to use bogus “self-employment” status as a route to cheap labour and tax avoidance”. The report seeks to build on Matthew Taylor’s Good Work Review, calling for the “best of the Taylor Report recommendations” through the introduction of new laws as well as “much tougher enforcement to weed out those businesses seeking to exploit labour laws and workers, for their competitive advantage.”
The Independent Workers Union of Great Britain also filed a landmark test case against the University of London on behalf of a group of 75 outsourced workers who are seeking more rights at work. Co-employment is not currently recognised under English employment law but, if successful, this case could affect rights for outsourced workers with their de-facto employer as well as their direct (contractual) employer.
Looking ahead to next year, the “Promoters of tax avoidance schemes” (POTAS) rules will seek to deter the development and use of avoidance schemes by influencing the behaviour of promoters, their intermediaries and clients. This will, almost certainly, make staffing companies think twice before entering into referral arrangements with intermediaries who operate tax avoidance schemes. This follows the introduction this September of the new corporate offence of failure to prevent tax evasion which has already given many staffing companies reason to re-assess their relationships with intermediaries whose models pose a risk under this legislation.
In short, the general direction of travel seems to be, as long predicted by us (please see briefings by us on this topic in 2011 and onwards) to push as many contract workers into full PAYE and employment/worker status as possible.
How can we help you?
Given the growing tax and employment law risks involved in using contract workers it seems likely that UK businesses will increasingly expect their staffing suppliers to find new ways to provide their services.
We know that many staffing companies and umbrella companies have been anticipating and preparing for these changes for some time. Some have already changed their business models to ensure that they can continue to offer relevant and useful services in relation to contingent and flexible workforce requirements.
In particular a lot of staffing companies have started to move towards statement of work (SOW), outsourced services and consultancy services. Obviously changes to tax treatment of contractors are partly driving this: genuine SOW arrangements are outside IR35 and genuine outsourced service or consultancy arrangements should move any future IR35 risk down the supply chain away from the ultimate beneficiary of the service. But for most there are other drivers including taking market share from consultancies, better margins, easier international expansion and better multiples on exit.
Staffing companies have often held back from genuine SOW, not least because it involves adopting a completely new business model, clearly identifying and framing output (involving a move away from time and materials), cash flow difficulties and “selling” the new way of doing things to their clients. Staffing companies and end users alike are also, understandably, sceptical as to whether these new models really do take the supply out of the new tax regimes for contractors.
Over the last 4 years we have worked with staffing and intermediary companies to explore how they could adopt new supply models in light of growing pressures and risks in the market.
This involves an assessment of current business models and opportunities, client appetite for change and testing new supply arrangements. We have developed a fixed price methodology to helping companies who want to look at “genuine” SOW or who want to check that what they are already doing does in fact work (in terms of avoiding IR35/intermediaries tax and regulatory problems in the UK and abroad and appearing kosher to an investor).
Linked to this we also offer reviews and updates of Intermediaries due diligence checks and IR35 assessment arrangements to ensure that they cover all relevant risks. We know from M&A deals we have done in the sector that tax risk around the use of payment intermediaries has been a big focus for investors. Our reviews and advice is carried out with this in mind.
For more information please contact your usual Osborne Clarke contact.