There has been a fair amount of press coverage in recent months of HMRC challenging the working arrangements of TV actors and presenters, under anti-avoidance tax legislation more commonly known as “IR35”. Whilst these cases provide some interesting reading and hint at the difficulties in applying this complex area of law to practice, there is more pressing news on the topic of IR35. Nearly 20 years from inception, IR35 is going to be substantially reformed for the private sector from April 2020 (the public sector having been reformed in April 2017). This will impact all but the smallest of businesses who engage contractors through “personal service companies” or other similar types of intermediary, and those more generally involved in the private sector labour supply chain.
Whilst the Government is still consulting on some of the finer details, with less than 12 months to go until the private sector reforms come into effect (and further changes are made to the public sector), businesses should start planning and preparing for the changes now.
Recap of IR35
IR35 was conceived to tackle the abusive use of “personal service” companies (PSC) by contractors across the public and private sector. By interposing a PSC into the arrangement, fees are earned by the company (the profits being subject to corporation tax), and the individual contractor (as shareholder/director) receiving dividends, generally subject to tax at a lower rate than the equivalent amount of employment income. The broad objective of IR35 is that if an individual works like an employee, they are taxed akin to an employee, even when the engagement is through a PSC. IR35 requires the PSC to consider whether, ignoring the PSC, there would be a contract of employment between the end client and the individual contractor (under principles established by case law). If such a hypothetical employment contract exists, IR35 determines the amount of income tax and national insurance for which the PSC must also account to HMRC.
Interposing a PSC in the arrangement also has practical benefits to the end client – it can pay the PSC “gross” leaving such employment tax technicalities to the PSC to navigate. PSCs are widely used across industry. The genesis of these recent changes is compliance; HMRC doesn’t think that private sector PSCs are generally applying the rules as they should (read: income tax and national insurance receipts are below HMRC expectations), but believes that, as for the public sector, by shifting responsibility to the end client/fee payer, compliance (and therefore tax receipts) will improve.
Looking ahead to 2020
From April 2020, all businesses (with the exception of “small” businesses, due to be defined in line with the Companies Act 2006) engaging PSCs will be required to consider whether a hypothetical employment relationship exists between them and the individual contractor, ignoring the PSC. If so, income tax and national insurance must be deducted from fees paid to the PSC by the fee payer. In many cases the fee payer will also be the end client, but the rules are designed to deal with situations where there are multiple intermediaries in the labour chain. There will also be associated rules around status determination and information flows between actors in the labour supply chain. The “old” IR35 rules will continue to apply to PSC arrangements with small businesses.
What to do?
Given the appetite for HMRC to litigate in this area, doing nothing isn’t a realistically reasonable option.
The first step for businesses to take is to instigate a review of their existing labour supply arrangements to determine whether and to what extent PSCs and other intermediaries are involved. Once intermediary arrangements have been identified, businesses will need to consider whether their relationship with the individual contractor could be deemed to be employment for tax purposes under existing principles. This is likely to require consideration of both contractual documentation and also “reality” of the arrangement in practice. HMRC’s CEST online tool is due to be upgraded to assist with this. As a general rule, businesses (or other fee payers, if different) will be required to deduct income tax and national insurance from payments made to the PSC from April 2020 (and also account for employer NICs), so some thought as to the practicalities of compliance will also be needed.
Consideration should also be given to a contractor communication strategy in connection with transitioning to the new system and mitigating the risk of business disruption. Effective business operations generally require a motivated and productive workforce; clearly deduction of amounts at source (and costs of employer NICs) will result in a shift in the financial equation of the arrangement for both parties. Contractors may have their own views on whether IR35 applies to, and whether they may ultimately want to restructure, their existing arrangements, so early constructive engagement with those effected is likely to be important. Businesses should be prepared to openly share the reasons for a status determination and demonstrate that they have taken reasonable care in reaching that conclusion.
Finally, businesses should turn their mind to future arrangements. This may include considering whether the continued engagement of contractors through PSCs is desirable and introducing processes to deal with future engagements.
Stevens & Bolton will be hosting a seminar on 10 October to discuss preparing for the changes to IR35. Further details will be published in due course. If you are interested, please email firstname.lastname@example.org for further information.