IR35 update: end user liability where its supply chain fails to pay
Published on 28th Sep 2020
New HMRC guidance clarifies the supply chain compliance risks and obligations that end users need to take into account as they prepare for changes to the IR35 regime that come into force in April 2021.
HMRC has just issued guidance about when end users will be liable for unpaid IR35 tax where the intermediary which the end user was expecting to pay that tax (the "fee payer"), fails to pay and is actually or effectively insolvent when HMRC tries to recover the debt.
The guidance makes clear that ends users who use personal service company contractors (PSCs) will be expected to carry out checks on their supply chain if they are to avoid the risk of transferred tax debt liability. This briefing sets out what those checks should cover.
This guidance may mean that many end users will become concerned (to the extent they were not already) about the use of PSCs via staffing companies and consultancies. In October 2019 to March 2020 many banks and other large corporates issued cautious policy statements about no longer using PSCs, presumably driven by a wish to avoid getting embroiled in IR35 determinations and tax risk. However, experience in the public sector following the 2017 changes to IR35, suggested that this policy risked loss of key talent or increased project costs.
As a result many end users have begun to consider whether they can afford completely to ban PSCs and we are aware that many have started looking at usage of PSCs (and engagement of PSCs via consultancies) in at least some circumstances. As some PSC usage will survive, this guidance will be highly relevant to many end users, MSPs and staffing companies. The guidance will determine the compliance processes they need to put in place.
Will the IR35 changes ever actually happen?
You may be asking: do we really need to worry about this? Surely the new regime will be postponed again given the difficult economic and political position the UK is in.
The legal position is that the new IR35 regime is already law (albeit not yet in force) and does not need further debate or votes in parliament, and there would need to be further legislation to undo it. Even if the government wanted to introduce the further legislation, there would likely be procedural issues effectively preventing that. This means that the new IR35 regime will come into force on 6th April 2021, barring some very unusual political and legal developments.
When will end users be liable?
The legislation already provides that end users will be liable where they fail to issue a status determination statement (SDS) using reasonable care, or fail to deal with challenges (both of which are reasonably within the end user's control). The new guidance highlights an additional source of liability for end users, as well as for MSPs and similar intermediaries higher up the payment chain than the Fee Payer which pays the PSC. The liability arises when the Fee Payer has received a properly done SDS and simply does not pay the tax. This was known to be within the coming regime but we did not have details until now.
What will HMRC do when the Fee Payer is not able to pay?
Where HMRC cannot recover the IR35 debt from the Fee Payer (for example, because the Fee Payer company has dissolved) or has attempted to recover the debt and is satisfied that there is no realistic prospect of recovering the debt from the Fee Payer within a reasonable period of time, HMRC may decide to recover the debt from a "relevant person".
Relevant persons are:
- the first entity in the supply chain (the agency or consultancy the end user contracts with – referred to as ‘agency 1’ – which may in practice often be an MSP or master vendor), and
- the client (the highest person in the contractual chain).
HMRC would look to recover the liability from agency 1 or, if there is no realistic prospect of recovery from agency 1, the end user.
Crucially neither agency 1 not the end user can appeal the amounts listed in a recovery notice if it has already been decided by the Tax Tribunal that the debt is a relevant debt payable by the Fee Payer.
HMRC says it will exercise its judgment and discretion in determining whether it is appropriate to use these powers.
Is there any defence for the MSP or end user?
HMRC will not seek to recover from agency 1 or the end user where the failure to account for tax and NICs by Fee Payer who should initially have paid it is as a result of a genuine business failure on the part of the Fee Payer. That would seem to include where the Fee Payer becomes insolvent because, for example, its largest client fails to make a critical payment due to the Fee Payer for reasons unconnected to tax avoidance by the Fee Payer.
But many situations where the Fee Payer cannot pay HMRC will not be "genuine business failure" and will be deemed to relate compliance failings or other bad practice on the part of the Fee Payer. HMRC may then recover from the end user or MSP in circumstances including:
- where a promoter of tax avoidance or any other party has entered into the labour supply chain, or other similar contrived situations where the intention is to avoid the tax and NICs liabilities that would rest with the person who should have paid those liabilities;
- where an end user or agency 1 in the chain requires workers to provide their services by contracting through a particular party that is likely to have been chosen due to its non-compliance with the off-payroll working rules;
- where the deemed employer liquidates where the intention of liquidation was to avoid payment of the income tax and NICs liability due from application of the off-payroll working rules; or
- where an end user or agency 1 in the chain knew, should have known or had reasonable grounds to suspect that the labour being supplied to them was supplied through a party or parties in the labour supply chain that did not comply, or had no intention of complying with the rules.
What checks should end users and MSPs carry out on their supply chain?
HMRC's guidance says that end users and MSPs must carry out checks on their supply chain in order to prevent the IR35 liability passing up to the end users and MSPs. HMRC expects them to establish the credibility and legitimacy of their supply chain.
This could include checking:
- What is the agency/labour supplier’s history? (HMRC does not explain what this means but if there is evidence of historical problems with HMRC that may be relevant.)
- Is the agreed contract price for the supply of contractors lower than market value, without a clear explanation for why?
- Have normal commercial practices been adopted in negotiating prices? This might include unusual "referral fees" received by agency 1 or sharing of tax savings with end users.
- Is a newly established intermediary with minimal trading history offering to supply contractors cheaper than a long-established intermediary? Is this the same agency/labour supplier as previous, but operating under a different name? If so, why?
- Is a supplier insisting that they can further subcontract the labour supply? If so, why?
HMRC says that suitable checks to secure the supply chain will vary depending on the circumstances and length of supply chains. Each organisation should consider what checks are suitable in their individual circumstances.
The recent guidance also gives further information about how the new regime will apply where the end client is an overseas entity and how the exemption where the end user is a small company will apply.
How do these checks fit alongside other supply chain "checking" requirements?
The 2017 Criminal Finances Act (CFA) already effectively requires end users and staffing companies to check that contract workers paid via intermediaries like preferred umbrellas are paid into a UK bank account in the name of the worker after a credible tax amount has been deducted. Failure to do this is likely to be a criminal offence if the contract worker is instead paid via an unlawful offshore scheme.
In addition, the Modern Slavery Act, the National Minimum Wage legislation, the 2014 Intermediaries Legislation, immigration legislation and the 2017 "enabling" legislation directly or effectively require end users and/or MSPs to be sure that there is compliance in their labour supply chains.
What will be the impact of all this?
Many of the best contract worker talent will insist on continuing to operate on a PSC basis and, if not permitted to, will insist on grossing up of pay. Many may point to the fact that they are now remote working as further evidence that they are not "supervised" and therefore genuinely outside IR35.
End users who do wish to continue to use PSCs and avoid leakage or inflation in relation to key PSC contractors will need to carry out rigorous assessment processes for making sure they are indeed outside IR35 (which many specialists will be, especially where they operate on a project deliverable/output basis of supply rather than on a time and materials basis).
No doubt there will, for other types of contract worker, be a continuing trend amongst many end users (and MSPs?) prohibiting use of PSCs.
Ultimately it seems likely that end users will increasingly concentrate spending power relating to contract workers on the more sophisticated suppliers who can most easily evidence the checks that are carried out, on behalf of the end user, on the supply chain. Specialist recruiters may have to accept margin-only appointments. And where MSPs are required to operate on a vendor neutral basis with multiple second tier agencies, they may prefer to do so on a "managing agent" basis, with the end user retaining a direct contractual relationship with each agency.
And we expect increased use of specialist third party compliance checking services, though, given the huge liabilities that could arise, all involved in the supply chain will need to make sure that the service providers do in fact carry out the correct checks. It will be important to carry out careful due diligence on compliance checking services/software to ensure that it is based on a sound legal understanding of IR35 and other workplace task risks, and advice will be needed in relation to the effectiveness of any insurance-backed compliance checking services – insurance may not always work in these situations and in some cases may itself cause tax liabilities for the supply chain relying on it.
Workshops to help manage compliance risks
With six months to go until the new IR35 regime is in force, we are resuming our very popular fixed-price workshops for businesses who supply or use PSC contractors. We have done 200 of these workshops to help suppliers and end users work out which options and new contract models will help manage risk best and in some cases allow continuing use of PSC contractors. Let us know if you would like one of these workshops.