UPDATE - Sweeping changes are afoot this April regarding the payment of contractors in the private sector...
With effect from 6 April 2020, new rules will apply to individuals who provide their services through an intermediary, such as a personal services company (PSC).
The changes are quite dramatic, so we thought it worth providing a brief overview of the new regime and what it might mean for your business.
Background to the new rules
Back in April 2017, the government reformed the rules so that public sector organisations who engage contractors take responsibility for making sure they and their workers pay the right tax.
Largely a response to perceived non-compliance with IR35 rules, the aim was to ensure that individuals who work like employees, but through their own limited company, pay broadly the same income tax and NICs as other employees.
The change led to an estimated additional £550 million in income tax and NICs in the first year alone following its introduction.
With effect from 6 April 2020, these rules will be extended to the private sector and so will apply to contracts entered into with, or payments made to, a relevant intermediary, on or after that date.
Effectively, they shift responsibility onto the client to police the arrangement, to determine the issue of employment status, and to account for any statutory deductions for income tax and NICs.
So quite a sweeping change.
To which clients do the new rules apply?
They apply where an individual provides services to a ‘medium’ or ‘large’ client via a relevant PSC or other intermediary.
A client will be deemed ‘medium’ or ‘large’ in a tax year in which it satisfies two or more of the following:
an annual turnover of more than £10.2 million;
a balance sheet total of more than £5.1 million; and/or
more than 50 employees.
A small group company will be caught by the rules if the parent meets the above criteria, otherwise small companies won’t be affected.
To which intermediaries do the rules apply?
The rules must always be considered where the individual is contracting through an intermediary that meets any of the following conditions:
condition A:
a company in which the individual has a material interest (more than 5% of the shares and 5% of the votes);condition B:
a partnership of which the individual (or a family member) is a member and is entitled to at least 60% of the profits; and/orcondition C:
is an individual.
What do the rules require?
They are pretty pervasive.
They require a client to review all contracts made through a relevant intermediary for the supply of an individual's services and ascertain whether, if the contract were directly between the client and the individual, the relationship would be one of employment.
The client must then inform the individual of the outcome of that review and, if there is deemed employment, deduct, or instruct the ultimate fee-payer to deduct, tax and NICs from all payments made to the intermediary on or after 6 April 2020.
So the onus is shifted well and truly onto the client.
‘Deemed employment status’
If the rules apply to the contract, the client must consider the employment status of the individual and make a decision on it.
If the services that the individual provides personally, are similar to those of an employee, ‘deemed employment status’ will apply.
‘Deemed employment status’ only applies for tax purposes and does not confer employment rights generally on the individual.
The intermediary retains responsibility for statutory benefits, such as SSP, SMP and pensions auto-enrolment.
However, the burden of determining employment status will fall squarely on the client.
Determining employment status
Alas, there is no definitive single characteristic of an employment relationship, it requires a detailed consideration of the overall picture, considering all of the usual indicators, including:
personal service
substitution rights
level of control
mutuality of obligation
payment arrangements
degree of financial risk borne by the parties
activities conducted for other clients
level of integration into the business
nature and length of the engagement
provision of equipment
description of the arrangement to the outside world
provision of benefits and/or insurances
CEST tool
The question of employment status is a thorny one, but some help is at hand in the shape of HMRC’s CEST tool.
This is a useful online tool for determining employment status for these purposes. Known as CEST, it received mixed reviews initially, but recent improvements have helped a lot.
There is no obligation to use it, but HMRC has agreed to be bound by a decision reached by CEST, unless it has been obtained fraudulently.
At the risk of stating the obvious, the greater amount of genuine indicators of self-employment in the arrangements, the greater the chance of CEST reaching a result of self-employment.
As matter of good practice, where the rules apply, it is advisable to use it and record the result.
‘Status determination statement’
Having considered the issue of status, the client must provide a ‘status determination statement’ (SDS) confirming its decision (and reasons) to intermediary and the individual who performs the services.
If there is a chain of intermediaries, each is responsible for providing a copy of the SDS to the entity below it in the chain. Any party that fails to meet this obligation will be treated as the fee-payer under the legislation.
The individual or intermediary may appeal the outcome of the SDS. If a client receives an appeal it will need to review its decision and respond to the appeal within 45 days, either confirming its original ruling, stating its reasons for so doing, or reversing its original decision.
What if there is deemed employment?
The party that pays the intermediary must make payroll deductions and account for NICs – including employer’s NICs - on the ‘deemed earnings’ of the contractor.
‘Deemed earnings’ are likely to be the fee invoiced by the intermediary to the fee-payer, net of VAT, and net of the invoiced value of any materials supplied and recharged.
The cost of employer’s NICs
And herein lies the kicker…
The employer’s NICs and apprenticeship levy, if applicable, must not be deducted from the payment to the intermediary, but must be borne by the fee-payer.
This increases the potential cost to the fee-payer of the contractor by:
13.8% employer’s NICs; and
0.5% apprenticeship levy.
Impact on existing contracts
So the immediate effect is the additional cost of 13.8% employer’s NICs and 0.5% apprenticeship levy on top of the payment to the intermediary.
The individual will also suffer a net loss as they will in effect be paying more tax (in some cases considerably more).
The client would also need to place the individual on its payroll and so will need to bear the additional administrative burden of all that entails.
What practical steps can be taken?
Getting on top of the issue early is key.
A potential approach is to seek to terminate existing contracts and enter into new contracts that reflect the transfer of the employer’s NICs liability through a reduction in the level of fees charged by the PSC.
Naturally, that will require discussions with the contractor and the relative negotiating strength of the parties will be highly relevant in this regard.
Anecdotal feedback suggests it is the contractors who hold many of the cards, particularly in sectors such as IT and PR. However, do bear in mind, there is no longer any tax or cash flow advantage in providing services through a PSC if deemed employee status applies.
Consider other arrangements?
Many businesses will simply follow the new regime. Whilst a fairly alien concept at present, the practice of the client making payroll deductions, may well become the new norm.
However, businesses may also wish to consider alternative ways of engaging the services of the individual, such as:
contracting directly with the individual (rather than through an intermediary);
reviewing their contracts (and arrangements in practice) to ensure they contains as many indicators of self-employment as possible
engaging the individual as an employee (whilst this does not remove the employer's NICs, it may make it possible to negotiate a lower hourly rate); and/or
the use of an umbrella company.
Either way, the clock is now ticking and so any business which uses contractors and is likely to be caught by the rules, should start planning for them now.
NOTE
Further to the posting of the above article, Stephen Barclay, Chief Secretary to the Treasury has announced to Parliament that the new legislation will be delayed until 6 April 2021. He stressed this is a "deferral, not a cancellation", but the move provides some much needed breaching space to businesses already under considerable pressure dealing with the COVID-19 outbreak.
For more information, do contact: john.skelly@bakerskelly.com
The above is intended as general commentary only and is not intended as a substitute for specific legal advice.
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