In February 2020, we published an entry titled “E is for Employment Status” (here), which included a brief summary of the IR35 tax regime in the UK. At the time of writing, substantial reform to the regime was planned for April 2020, after which the onus to determine self-employed tax status in the private sector would shift from the contractor to the end client (as has already happened in the public sector).
This expansion will affect all medium and large businesses in the life sciences sector that engage contractors or freelancers through personal services companies (PSCs). Due to COVID-19, the reform has been delayed until April 2021, giving businesses additional time to prepare for its implementation.
What is IR35 and when do the rules apply?
The IR35 rules, also referred to as the “off-payroll working rules” or “intermediaries legislation”, are anti-avoidance measures designed to tackle abusive use of PSCs by contractors.
IR35 applies to individual contractors who work like employees but provide their services through intermediary entities (often PSCs) where, if that individual contractor had provided their services directly to the end customer, they would be regarded as an employee for tax purposes. The legislation looks beyond the contracts in place and instead considers the practical implications of an arrangement (i.e. the hypothetical contract shown by the red arrow in the diagram below).
In the public sector, the obligation to determine the worker’s employment status (and whether the IR35 rules apply) already rests with the end user of the relevant services. As above, this obligation will expand to medium and large businesses in the private sector in April 2021.
Where IR35 applies, payments made to the intermediary must be subject to deductions of tax and employee national insurance contributions, plus the paying entity must account for employer’s national insurance contributions (and, if relevant, the apprenticeship levy). It is important to note that businesses must also continue to pay VAT on the gross fees invoiced by the PSC, which may require new procedures to be followed in finance departments in order to reconcile the VAT position and the IR35 consequences.
What are the terms of the hypothetical contract?
The key criteria which are applied to determine whether the arrangement is a form of “disguised employment” or true self-employment are:
- Mutuality of obligation on both the individual and end user
- Right of substitution for the individual contractor
- Degree of control held by the end user over the worker
There are numerous additional factors to consider in each case, such as financial risk, length of the engagement, and equipment provision. Overall, the end user must take a holistic, and not a tick-box, approach when assessing the nature of its engagement with the worker.
Impact of the April 2021 IR35 reforms on life sciences businesses
Engaging contractors or freelance workers through PSCs is common practice in the life sciences industry. From April 2021, medium and large private businesses in the sector who do so will need to:
- Identify the workers impacted by this change
- Assess the underlying hypothetical contract between each worker and the end user
- Decide the workers’ employment status, keeping records of the reasoning behind each determination, and communicate this to the worker in writing before he/she is paid – keep in mind that workers have the right to appeal the determination
The new rules will also apply to complex labour supply chains (e.g. those involving multiple agencies) and to public sector bodies already within the regime, which will see some changes to the existing rules. Small private businesses (broadly those meeting at least two of the following tests: annual turnover of not more than £10.2m, balance sheet total of not more than £5.1m, and not more than 50 employees) will stay within the current regime, although the new rules will apply if they expand to become medium or large entities.
How can life sciences companies prepare for the reforms?
To prepare for the expansion of the IR35 rules, medium and large private companies in the life sciences sector may wish to:
- Audit their labour supply chain
- Consider who will have responsibility for implementing the new rules within the business
- Analyse the cost implications of status determinations
- Adjust existing contracts and/or working practices to clarify in advance which workers are self-employed and which should be engaged formally as employees
- Provide training within the business on any new processes, contract templates and controls to be followed
- Communicate with affected workers about contract amendments, status determinations and any dispute resolution procedures
Businesses concerned about the implications of the IR35 reforms or how best to prepare should contact their legal and tax advisors in the first instance. Lawyers in our multi-disciplinary life sciences team regularly advise on employment status issues, IR35, and other business tax regimes.
For more information, please see our article here.