Many financial services companies and consultancies operating in the sector rely heavily on IT contractors and project managers and others who operate via personal service company (PSC) arrangements.
PSC arrangements are generally tax efficient, not least in terms of avoiding the need to pay employer's national insurance contributions (NICs). In some cases there can be a 50% reduction in the headline rate of income tax and NICs payable. Many in the supply chain (including end-users such as financial services and companies) directly or indirectly benefit from this in terms of lower operating costs/higher profits.
Until now, there has been very little practical risk for UK end-users whose contractors use these arrangements. That is about to change. The UK government is consulting on plans to revise the so-called IR35 rules and make intermediaries and in some cases end-users liable from April 2020 for any failure to pay the correct levels of PAYE and NICs.
Who will be liable if the IR35 tax and NICs are not paid?
The basic position will be that the entity towards the bottom of the contract chain which pays the PSC (the so-called "fee payer") will be liable in most situations, and responsible for deducting PAYE and NICs when a contractor is "inside IR35", based on a "self-employment" test (usually known as the IR35 test).
However, the regime will impose a range of duties on end-users, including assessing whether each contractor would pass or fail. If an end-user fails to do this, or makes an incorrect call of "outside IR35" (i.e. an incorrect call that the contractor is self-employed), the end-user is likely to be liable. To help end-users, HMRC have developed an online employment status checking tool called "CEST", but that is regarded as a fairly unreliable and blunt tool, and in any event it has no statutory effect. In practice, HMRC may not be bound by results obtained from use of CEST, and heavy users of PSC contractors will need to be a little more sophisticated in their assessment of whether IR35 applies if they are to avoid liability.
Osborne Clarke comment: end users will now have much more of a vested interest in supply chain compliance. If they are sensible, they will cease to appoint suppliers based just on cost (many cost savings historically having been driven by non-compliance which the end user could afford to ignore). This means that end-users (and intermediaries) will have to carry out spot check audits of their supply chain and we may see substantial consolidation of supply chains.
Exemption for statement of work and "contracted out" services?
The consultation explains that where an end-user receives "contracted out" services (and not labour supply), that service will not be subject to the regime. Effectively, this means that the regime will only supply to entities in a supply chain involving labour supply.
Osborne Clarke comment: this confirmation is good news for suppliers and users of "genuine" statement of work-style services (in which consultant deliver a pre-scoped piece of work for a fixed price). But they will need to be "genuine" – merely labelling something as statement of work will not work, and the likelihood is that many time-charged based consultancy arrangements will be caught.
Small company exemption
It is still proposed that there will be an exemption for supplies into small companies. Broadly speaking, the Companies Act definition of small companies will be used, meaning that an end-user will be "small" if, at the start of the relevant accounting period: turnover is not more than £10.2m, balance sheet is not more than £5.1m and it has not more than 50 employees. There will be special rules for working out whether non-corporate entities are "small". Anti-avoidance measures will be in place to prevent end-users routing PSC supplies via small associated companies.
Osborne Clarke comment: small consultancies using a statement of work model may be able to on-supply PSCs without the new regime applying (and instead PSC contractors will have to self-determine).
Information to workers about determinations
There will be some form of obligation on intermediaries to cascade down the contract chain any decisions and reasons relating to IR35 determinations made by the end-user, and the worker may be entitled to ask the end-user direct for the assessment and reasons.
Worker right to challenge the determination?
There are no firm proposals about this – the current consultation suggests that the worker will have a right to have his/her evidence "considered" by the end-user. There is, however, no hint of what the worker's remedy is if the determination is still wrong.
Osborne Clarke comment: will some end-users therefore be able to blanket assess inside? If end users face increased risk of tax debt transfer liability, it's likely that they will be more inclined to issue "inside" assessments so it will be important to see how any workers' right to challenge determinations will actually work. End-users need to start preparing to justify their assessments.
Time for comment?
The consultation closes on 28 May 2019, following which draft legislation will be published in the summer (probably July) for further consultation later in the year. Following that, it is likely that the legislation will not come into force in April 2020 – there is little political opposition to it and the 2017 public sector IR35 regime on which these proposals are modelled is (rightly or wrongly) seen by HMRC as a great success.
Likely contractor responses?
Judging by what happened in the public sector in 2017, and on the basis of anecdotal evidence in the private sector already:
- many contractors will be seduced into alternative aggressive tax avoidance schemes carrying significant risk for end-users;
- some contractors will threaten to leave unless their pay rates are grossed up, and some will find alternative end-users prepared to assess them (and pay them) outside IR35; and
- many will just move to some sort of PAYE arrangement, perhaps (in the case of PSCs engaged via staffing companies) via a so-called umbrella company.
What should you do now?
- Make sure your suppliers are on top of all this – ask what their plans are.
- Liaise with suppliers to work out how many PSCs they use, including directly engaged PSCs, PSC supplied via staffing companies, and PSCs working via consultancies.
- Consider which PSCs may and may not be inside IR35. Consider finding an adviser who can support you with this exercise.
- Consider whether genuine statement of works arrangements may take some contractors outside IR35.
- For those inside, consider whether they have transferable skills and are business critical and if so consider budgeting so that you can gross up pay rates.
- For others, manage expectations to minimise grievances and the risk of claims.
- Work with suppliers to put in place procedures to ensure PSCs do not move into aggressive tax avoidance schemes.
- Do not create assignments now which will expire after 6 April 2020 – any assignment which straddles that date may, unless pay rates are grossed up, lead to claims because, amongst other things, employers NICs will suddenly have to be deducted leading to a material reduction in gross as well as net pay rates.
We have been involved in advising on IR35 since the late 1990's and in the last couple of years have run over 100 fixed-price workshops for clients affected by the proposed IR35 legislation. Our workshops help clients assess the impact of the proposals on them and build solutions. If you are interested in receiving one of those please contact one of the experts listed below, or your usual Osborne Clarke contact.