Extension of off-payroll IR35 rules to the private sector in 2020, and other current tax and legal developments: how can staffing companies prepare?
Published on 12th Nov 2018
The long expected extension of the off-payroll IR35 rules was announced in the recent Budget. Following consultation, the government seems to have heeded concerns raised by industry about time needed for businesses to implement wide-ranging reform and has delayed implementation until April 2020. It has also limited the new rules to medium and large sized end user businesses. Small end user businesses (which may, if existing statutory definitions are adopted, be defined as those with annual turnover of less than £6.5 million, a balance sheet total of less than £3.26 million and 50 or fewer employees) will not be required to apply the new rules.
End users, staffing companies, payment intermediaries and contractors will now have more time than once seemed likely to consider how best to prepare for these changes….but in practice there is not that much time given that many users and suppliers will have to make substantial changes to how they use personal service company contractors if they are to avoid substantial increased costs or very unhappy contractors. This will involve major business process changes for many users and suppliers.
How will the reforms work?
As expected, the government favours following the public sector model in making the end user responsible for carrying out IR35 status assessments on a case by case basis. Whoever pays the PSC (the "fee payer") will be liable for paying employer's NICs and deducting PAYE and employees' NICs on an employed tax basis if the PSC contractor is assessed by the end user as being 'inside IR35'.
A further consultation on the detailed operation of the reform will be published in the coming months. This consultation will inform the draft Finance Bill legislation, which is expected to be published in Summer 2019 (for implementation in April 2020) and it is possible that the rules may be slightly refined to address the needs of the diverse private sector market.
One significant change, hinted at in the Summary of Responses, is that end user businesses will be encouraged to make correct IR35 determinations and not incentivised to make "safe" assessments of "inside IR35". In other words end users may in some way be prevented from making safety first blanket "inside IR35" assessments. It's also possible that a right of appeal for contractors (enabling them to appeal an "inside IR35" assessment) will be in the new legislation. We have been considering how the legislation could be amended along those lines and do not believe it will be straightforward to introduce these sorts of provisions into the legislation. As a result, legislation may end up being very complicated and hard to implement. But let's see.
If these changes happen for the private sector it's highly likely that they will also be carried across to the existing public sector rules to avoid differences between the two regimes.
We expect the new IR35 legislation to, broadly speaking, work like this:
- the end user will be 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, financial risk, personal service etc.);
- if the contractor is “inside IR35”, the party who pays the PSC (the “fee payer”) will 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);
- if the fee 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 assessed by the end user as being inside IR35, then it faces an uphill struggle unless it has very strong evidence supporting its stance, fighting any claim by HMRC;
- the end user has to exercise reasonable care when assessing a contractor as outside IR35 and carry out its assessments on a case by case basis. The end user will be liable if they assess an assignment as being outside IR35 and they have not taken reasonable care in reaching that conclusion. Under the current public sector rules there is no statutory liability for an end user who issues an assessment of "inside" IR35, even if they failed to take reasonable care in coming to its conclusion – this may be changed in the private sector rules.
What will this mean for end users and staffing companies?
Based on what the UK market saw following the public sector IR35 changes, private sector businesses would be wise to prepare for the following:
- 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 end users agree to increase the rate);
- confusion amongst the contractors about how the rules will work and what it means for them. Contractor blogs suggest that PSC contractors are concerned about the changes and are already starting to consider their options;
- a move to towards engaging higher skilled resource on a statement of work basis with defined deliverables and 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 of continuing to pay PSCs gross (with little or no assessment) due to the need to attract and maintain certain skills;
- 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 and possibly criminal penalties);
- some contractors seeking rate rises to compensate for loss of income due to increased deemed employment costs;
- some contractors threatening or bringing retrospective worker status claims and unlawful deduction from wages actions where they have been told they can no longer contract via their PSC;
- 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 end users issuing blanket "inside" assessments, in some cases, resulting in contractors moving to end users who are prepared to assess assignments on a case by case and "outside" IR35 basis;
- some staffing companies moving towards more of a consultancy or outsourcing model and employing the workers, which may in many ways help preserve/increase profits; and
- more sophisticated umbrella companies moving more towards a payroll outsourcing/software licensing model.
Clear communication with end users and contractors will be key between now and April 2020 to ensure that they are aware of how the changes will work and how existing arrangements will be affected. It will take time to carry out impact assessments and develop a range of workable responses and, possibly, new business models.
End users, staffing companies and contractors should continue to be on their guard against relying on payment solutions which appear to allow PSC contractors to maintain current pay rates. HMRC has signalled that it will clamp down on certain aggressive umbrella models that have proliferated since the public sector IR35 changes came into effect. Loan schemes, in particular, have been specifically spotlighted as being arrangements HMRC regard as being unlawful tax avoidance, and they may even, in some cases, expose all in the supply chain to criminal penalties under the Criminal Finance Act 2017 (CFA).
Staffing companies looking to exit in the next 18 months to 2 years will need to plan for how they will deal with PSC supplies post-April 2020. Failure to do so could affect company valuation, particularly for those staffing companies which are heavily reliant on PSC supplies. We know from recent sales we have acted on that private equity investors and other investors and purchasers are increasingly looking for details of IR35 planning and evidence that the changes will not adversely impact profits.
How can we help you prepare for the new regime?
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.
Whilst April 2020 may seem like some time away, we know that many staffing companies and umbrella companies have been anticipating and preparing for these changes for some time. Some end users and suppliers have already changed their business models to ensure that they can continue to use and offer relevant and useful services in relation to contingent and flexible workforce requirements.
We know that some staffing companies have already started to move towards statement of work (SOW), outsourced services and consultancy services. Obviously changes to tax treatment of contractors may partly be 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 and contractors 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. Some staffing companies and end users may also be sceptical as to whether these new models really can, in some situations, take the supply out of the new tax regimes for contractors.
Over the last five years we have worked with staffing and intermediary companies to explore how they can 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 "safe" 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.
What next, and what else is in the pipeline?
Alongside the IR35 consultation the government has been conducting a wider review of modern working practices following on from its response to the Taylor Report. It is possible that the outcome of this consultation will look closely at the interaction between the employment status tests for employment rights and tax. Increased focus on employment status and rights at the same time that some PSC contractors are "forced" to join PAYE payrolls may give rise to more contractors asserting their worker and employment rights. Earlier this year Susan Winchester, a contractor who supplied her services via her PSC to HMRC, successfully claimed £4,200 in holiday pay after being assessed (via CEST) as falling inside IR35 and being forced, without right to appeal, to be engaged as a PAYE agency worker. Although this case was settled it was clearly prompted by an enforced status change and is something that staffing companies and end users need to be on their guard against in light of the forthcoming changes to IR35.
CFA and POTAS
The “Promoters of tax avoidance schemes” rules last year (also known as the "enabling" legislation) seek to deter the development and use of avoidance schemes. Broadly speaking anyone who "enables" use of a scheme may be liable for the savings they have made as a result of the scheme. This has already started to make staffing companies and their investors think twice before entering into referral arrangements with intermediaries who operate tax avoidance schemes. This followed the introduction last September of the new corporate offence of failure to prevent tax evasion (under the CFA) which has given many staffing companies reason to re-assess their relationships with intermediaries whose models pose a risk under this legislation. Reports suggest that HMRC is stepping up its enforcement in this area. Please see our recent update on this.
MSC decision – are HMRC likely to step up their enforcement of the MSC rules?
The 2007 MSC legislation is potentially the biggest weapon in HMRC's armoury because it can allow HMRC to transfer debt liability to staffing companies and their directors if the staffing companies (i) have encouraged use of relevant PSC arrangements or (ii) fall within the definition of "MSC Provider".
For MSC to apply, HMRC have to prove that: (i) there is an MSC Provider (being an entity in the business of providing PSC support services etc., and which could include any volume provider of accounting or payroll services for PSC contractors) which (ii) is "involved" in the relevant PSC. HMRC has not found it straightforward to prove both (i) and (ii) in the past but a recent development has now given HMRC the opportunity to apply the MSC legislation to a far wider range of situations than was previously thought possible.
This is as a result of a decision this year by the Upper Tax Tribunal which found in favour of HMRC in Christianuyi Limited & Others v HMRC  UKUT10 ("Christianuyi"). This case is listed for appeal, but as it stands the decision makes it easier for HMRC to find situations where a MSC Provider is "involved". In particular the case focussed on situations where "involvement" will be deemed to exist on the basis that an MSC Provider charges 'on an ongoing basis' for its services (charging 'on an ongoing basis' being one of the statutory factors which will lead to a decision that the MSC Provider is "involved"). The Tribunal ruled that 'benefit on an ongoing basis' would include a situation where a MSC Provider has received fees whenever the PSC is providing services, for example on a monthly fixed fee or % of revenue basis (rather than, for example, just as a one off fixed fee up front). That sort of "ongoing" fee is common in the world of PSC contracting so there could be a serious problem here. Any staffing company that has referred or continues to refer a PSC contractor to such a MSC Provider could be liable, with its directors, as an "encourager".
Even more worryingly the decision could potentially also extend the MSC rules to any staffing company which from time to time operates on a so-called "payroll only" basis (relating to PSC contractors who are referred to the staffing company and whom it has not actually sourced and placed). We believe this aspect of the judgment to be not what Parliament intended when the MSC legislation was drafted but, as things stand, there is a potentially large problem for staffing companies which have payroll-only arrangements.
HMRC may be holding fire until the appeal has been decided, but if the taxpayer loses its appeal HMRC may take action with potential personal liability for many in the supply chain. We would encourage staffing companies to watch this space carefully and in the meantime to take advice about all referral arrangements relating to accountancy etc services for PSCs and about payroll-only staffing arrangements they are involved in.
Last week saw reports in the press that the government may be about to announce various measures relating to temp and gig workers including abolition of the so-called Swedish Derogation (which currently can be used to disapply equal pay rights under the Agency Workers Regulations), the right to a perm contract after 12 months of temping, clarification of who is and is not entitled to worker and employment rights, and how holiday and/or sick pay is enforced. We believe there may be disagreements within the government about exactly what should be done, and we believe that in some of the areas (such as employment status) it will take quite a long time to develop workable legislation. That legislation may therefore not be imminent in most of the areas covered by the Taylor Report (other than the Swedish Derogation which seems almost certainly to be abolished). However, change is coming at some stage in most of the areas covered by the Taylor Report and staffing companies and others should watch this space carefully.