As announced in the 2018 Autumn Budget, the government will be extending the off-payroll working rules (IR35) to the private sector from April 2020.
With little time before the legislation takes effect, employers must ensure they understand the extent of their liability when it comes to engaging contractors and ensure all working relationships with contractors are compliant by defining the status of the contractor against HMRC’s criteria for tax purposes.
Yet, according to a new poll by recruitment firm Hays, one in three affected businesses which regularly engage contractors are simply unaware of the impending changes to IR35 – or rather, how to prepare. Already, we have seen key players in the banking world such as Barclays and HSBC take precautions for the rule-change by informing contractors that they will only continue to work with them on a PAYE basis. Meanwhile, Lloyds Bank opted for the risk-free approach, firing all current contractors ahead of next April and closing the door to contractors in the future.
It begs the question as to whether such measures are necessary; how organisations should prepare for the coming change and how these rules will affect their working relationships.
Small business exemption
Firstly, it’s worth noting that not all businesses will be affected in the private sector. When IR35 takes effect in the private sector in April 2020, the rules will only apply to medium and large businesses. Organisations that fall into the existing definition of a small company as specified in Companies Act 2006 need not change their processes. To be clear, a business must meet at least two of the following requirements in order to be exempt from IR35:
- An annual turnover that does not exceed £10.2m
- A balance sheet that does not exceed £5.1m
- An employee count that does not exceed 50
From 6th April 2020, if the end-client meets two or more of these criteria, the IR35 status of a contract remains with the Personal Services Company (i.e. the contractor) and the changes will not apply. Included in the IR35 rules are clauses to ensure medium-large companies who do fall under the criteria do not set up subsidiaries as a means to procure services from PSCs.
The legislation will apply to the parent company and liability will be calculated based on the aggregate amount of turnover and the aggregate amount of the balance sheet total of the connected entities. Simply put, if the parent company does not count as a ‘small company’ under this test, none of its subsidiaries can qualify as small.
Who is liable for the compliance of the contract under IR35?
Under IR35, the end user is responsible for determining whether the worker would be regarded as an employee if they were engaged directly. Under the legislation, the end user is the organisation who receives the work from the contractor/PSC.
If the end user finds that the IR35 rules do apply, the organisation paying the contractor is treated as the employer and will be liable for deducting income tax and NICs from the payments made to the PSC.
If the contractor has been engaged via an agency, the liability would be transferred to that agency or whichever organisation is paying the PSC for their services, and they would be responsible for determining the worker’s status and deducting relevant tax and national insurance contributions.
Preparing for IR35: ensuring compliance ahead of April 2020
Intended as a means of clamping down on contractors working under ‘disguised employment’ for the tax benefit, the roll-out of IR35 to the private sector has been dubbed the biggest revenue raiser on the Autumn budget, with figures from the Government’s own research predicting it will generate an estimated £1.3bn a year by the 2023-24 financial year.
The new rules will have a significant impact on how private sector firms engage with workers off-payroll, but it is worth noting that IR35 is still in draft-phase and may be subject to change – particularly amidst the current political uncertainty.
However, where the client is an end user in the private sector and does not qualify as a small company, urgency must be placed on the need to review the use of PSCs and, where necessary, review current arrangements and redraft contracts to meet the needs of the organisation in the event that IR35 should apply to a worker.
CEST: How to determine the status of a contractor
End users can determine whether or not IR35 rules apply to a contractor by using HMRC’s dedicated employment status tool Check My Employment Status for Tax (CEST). Through this checklist, you can establish whether a worker is more of an employee, using measures such as whether the person can do the job, how much control you as the employer have over the methods they use to produce their work and whether you have an obligation through your agreement to offer the contractor work.
However, it’s important to note that this tool does not currently consider all of the factors relevant to a worker’s status and so it should not be solely relied upon to reach a conclusion. While an improved version of the CEST tool is to be rolled out prior to the rule change in April 2020, we recommend speaking to a specialist employment lawyer who is qualified to advise on tax liability, risk and compliance.