HMRC have published draft legislation about the IR35 reforms to come into force on 6 April 2020. These reforms will affect users and suppliers of personal service company contractors (PSCs) in private and public sector situations.
As with the public sector IR35 regime that came into force in 2017, the main IR35 tax liability will lie with the person who pays the PSC contractor, with the end user being obliged to assess whether the PSC is inside or outside IR35 and pass that assessment on to its supplier.
The main new proposals are that:
- End users will have much more risk where the relevant tax and NICs are not paid to HMRC – as a result they are likely to take much more interest in the future in the compliance of their supply chain.
- End users must pass their assessment to the PSC "worker". Workers and the entities their PSC companies work though will have the right to challenge (and require an explanation/new determination) relating to assessments they do not agree with, though there is no obvious right of recourse if the appeal procedure does not give them the answer they want.
The initial headline points are as follows:
The government is still intending that the new legislation takes effect from 6 April 2020. Payments made after that date will be subject to the new regime.
The existing IR35 regime is the template, but with some important changes
The proposed regime is largely modelled on the public sector IR35 regime but there will be some important differences as outlined in this briefing.
Who is liable if the IR35 tax and NICs are not paid?
The basic position will still 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. However, as suggested in the March consultation paper and our briefing, the draft legislation makes very significant changes.
- Broadly, the first key development is that whoever did not do what they should have - whether that is to make an IR35 status determination statement (known as an "SDS" in the legislation), to pass on that SDS down the supply chain, or to make the tax payment - will be liable.
- The second key development is that even if the end user does everything right, but its supply chain then fails to pay the IR35 tax and NICs, liability may transfer up to the chain to whoever HMRC think should have paid. It seems that it is intended that HMRC will, in certain situations such as where an intermediary has been involved in deliberate tax avoidance and becomes insolvent, have the right to transfer tax debt up the supply chain until they find someone who can pay. HMRC drily made the point in the consultation that end users should in future manage risk by choosing “to only work with reputable and compliant firms”. It seems there may be further regulations and guidance on this point.
Osborne Clarke comment: this will be good news for compliant suppliers. End users will now have skin in the game and it will be unwise just to appoint suppliers based 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 Managed Service Providers) will take a lot more interest in the compliance of their supply chain and we may see substantial consolidation of supply chains and/or a growth in market share of suppliers who can demonstrate compliance.
Will end users be able to blanket-assess inside?
Will some end users 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. The explanatory notes and other comments from HMRC suggest that HMRC consider that end users will have an obligation to take reasonable care when making assessments, including "inside" assessments. But the draft legislation on this point is not straightforward. It appears to suggest that if an end user fails to take reasonable case when assessing inside (for example by blanket assessing inside) and the supply chain then fails to pay the relevant tax and NICs to HMRC the end user may potentially be liable. This means that it might be unwise for end users to blanket assess inside where it has suppliers who may ignore that assessment and pay outside IR35. Nevertheless, there does not yet appear to be a clear and absolute rule against blanket assessments.
Of course, end users who blanket assess inside face the commercial risk of key contractors with transferable skills threatening to leave unless their pay rates are grossed up so that their net pay remains the same. They also face the prospect of a deluge of challenges under the new measures described below.
Osborne Clarke comment: This is an area to be looked at more closely in coming weeks and months.
Information to be given to workers about IR35 status determinations
Clients will be obliged to provide the SDS relating to a contractor not just to the supplier they have a contract with but also to the "worker" (which is not the case currently with the public sector regime).
Intermediaries such as Managed Service Providers appear to be obliged to pass the SDS to their subcontractors (i.e. second tier suppliers) and those suppliers are obliged to pass the information down to any suppliers they engage (until the information reaches the Fee Payer). If an entity fails to pass on the information, that entity will be deemed to be the Fee Payer for the purposes of the legislation (therefore making that entity liable for compliance/lack thereof with the legislation).
This addresses an information gap which some have considered unfair in the current public sector regime (under which reasons given to a Managed Service Provider do not currently have to be passed down).
Worker right to challenge the determination?
The worker (and entity that pays the PSC, i.e. the so-called "Fee Payer") will have a right to challenge a determination (and require an explanation/new determination from the end user). This is not the case currently with the public sector regime. However, there is no independent appeals process or obvious right of recourse if the appeal procedure does not give them the answer they want.
Osborne Clarke comment: End users (and certainly line managers at end users) should in our view generally avoid arguing the toss directly with contractors in relation to these challenges – even if they have the appetite for doing this, any more detailed discussion about the basis of the engagement and inevitably about the possibility of changing the terms of the assignment to squeeze it outside IR35 will increase risk (as well as administrative burden) for end users including under principles set out in cases like the Autoclenz Supreme Court decision. End users should be very careful about the processes they establish to deal with challenges.
How will end users reach a determination? Is the CEST tool reliable enough?
HMRC will be upgrading its own online status-testing 'CEST' tool. Whatever improvements are made, we and others have always felt that whilst a one-size-fits-all online tool may be helpful in some more obvious cases including in the large job families which characterise the public sector, for many more niche technical/professional roles in the private sector it will not give a reliable or definitive answer. That is partly because the CEST tool has no statutory effect – HMRC will still have the right to bring a claim where the CEST tool has generated an "outside" determination and will very likely do so where it seems to them that the (often subjective) questions have been answered incorrectly or (as will often happen for professional/technical roles) the CEST tool generates a "don't know " answer.
Osborne Clarke comment: End users who deal with this uncertainty by blanket assessing inside may face challenges and/or loss of contractors to suppliers/end users who are prepared to carry out a more nuanced assessment. As a result, we are aware of a number of suppliers and end users who are looking at developing their own tailored assessments for more critical roles, and we are working with several in relation to these tailored status checking tools. We are also aware of some third parties offering to carry out these assessments on behalf of end users and, if structured correctly, believe this approach will prove safe, cost-effective and commercially attractive for all involved.
“Contracted out” services and SOW
Where an end user receives output-based services (and not labour supply or the supply of personal services) that service will not be subject to the regime.
Osborne Clarke comment: suppliers of “genuine” statement of work-style services will be outside the regime. But they will need to be “genuine” – merely labelling something as a statement of work will not work.
We are aware of a number of staffing and consultancy companies who have, for at least some of their supplies, moved to a genuine statement of work approach and we believe they will gain market share, especially for certain more specialist projects. Clearly some types of assignment and industries lend themselves more easily to others.
Retrospective claims risks?
Where assignments started now straddle 6 April 2020, there is a serious risk of claims by contractors where their gross pay rates have to be reduced to cover the employers NICs which will need to be deducted from any payment made after that date.
In addition, there is potential - where an assessment of "inside" is issued in relation to those ongoing assignments - for retrospective tax claims against the contractors.
Osborne Clarke comment: Suppliers and end users will need to put steps in place now to manage these risks. We have helped many companies do this already.
Risks with some "solutions" and some umbrella arrangements that are being marketed
The lesson of the public sector IR35 reforms is that many contractors did not just take the reforms on the chin – they moved to new schemes which, in many cases, were even more risky for end users and suppliers than the new IR35 regime. As we have explained in previous briefings, some of these arrangements could expose users and suppliers to tax and potentially criminal law risk under the Criminal Finances Act, enabling legislation, DOTAS and Intermediaries legislation. The types of arrangement that may present risks for end users and the supply chain include:
- Some (but not all) third party IR35 status checking arrangements. These may, if not properly structured, expose all the supply chain to MSC risk following the Christianuyi decisions in 2018 and 2019;
- 'Rangers'-style loan schemes (under which, for example, nurses and care workers were told by umbrella companies that they would be paid by way of tax free loan arrangements supposedly designed to circumvent the loan charge regime);
- Certain mini-umbrella company arrangements; and
- "Pretend" statement of work arrangements where the documents say one thing but the reality is that the contractor is integrated into the end user's workforce and charges on a time spent basis.
Many staffing companies have a limited audit methodology in place to check their umbrella suppliers etc. but these are not usually sufficient to deal with liabilities under therelevant legislation. Many involved in using/supplying contractors are substantially upgrading their checks and completely reforming their referral arrangements with accountants and umbrella companies.
Same regime for public and private sectors
When the legislation comes into force there will be the same regime for public and private sector supplies – some aspects of the new regime will effectively change the current public sector regime.
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” and connected companies will be taken into account when working out how big a company is for these purposes. Public sector entities will never be deemed small.
Exemption for supplies to individuals
Where an individual engages a PSC for reasons other than related to the individual's business, the new regime will not apply. This means that where homeowners engage care workers and builders etc. directly they will not need to worry about making assessments or tax debt transfer risk.
What should businesses be doing now to prepare?
Staffing companies, consultancies and end users should work out what contractors they have working for them directly or indirectly (for example via consultancies), identify which solutions (if any) suit the different categories of contractor and start planning for implementation. We are aware that many are already doing this and we have helped many suppliers and users analyse their options and plan solutions.
Many staffing companies, consultancies and end users who are currently heavily dependent on the use of PSC contract workers (especially in occupational sectors like IT, engineering and construction) will need to undertake significant planning to avoid:
- Possible loss of talent where the end users decide they cannot risk (from a brand or potential liability perspective) continuing to use self-employed models outside IR35;
- Unprovided-for increased costs in long term projects;
- Retrospective employment or tax claims, or attempted claims; and
- Unwittingly having unlawful new tax schemes in their supply chains leading to potential civil and criminal liability under various new legislation such as the Criminal Finances Act.
Specific actions will be needed to reduce the risk of retrospective claims and liability for aggressive replacement schemes.
For those companies who believe a lot of contractors will be caught, there will be a need to come up with PAYE solutions, in some cases possibly using umbrellas or other payroll intermediaries. Where umbrellas are used, supply arrangements with those umbrellas will need to be set up carefully to avoid tax and other liabilities.
There will be a consultation on the draft legislation, running until 5 September 2019.
For those planning to fill their weekends with a bit of light reading on this topic, be warned. The draft legislation is not an easy read, the explanatory notes are quite sketchy, and the papers issued today contain some comments about the intentions of the legislators which do not appear yet to be exactly reflected in the draft legislation.
We are running fixed-price strategy workshops with clients to help them develop strategies to deal with the IR35 changes. We have done over 120 now, and have developed a range of methodologies and solutions for aspects of the new regime for different types of staffing company, consultancy company and end user. Let us know if you would like to book one.