The extension to the private sector of the public sector IR35 off-payroll working rules, postponed for a year because of the COVID-19 pandemic, will go ahead on 6 April 2021. The delay in implementation has given staffing companies more time to prepare for the new rules. It also gave the Government the opportunity to make some positive changes to the draft legislation, changes which are now in the final legislation. This article provides a brief outline of some of these changes and ideas on how to prepare for the new rules.
Background
On 6 April 2017, responsibility for assessing IR35 tax status transferred from personal service company (PSC) contractors (and other intermediaries such as partnerships and sole traders) to staffing companies that place PSC contractors on public sector assignments. An assignment is within IR35 if:
- the individual contractor who works on the assignment would be regarded as an employee of the public authority client for tax purposes if that client engaged the individual contractor directly; or
- through the assignment, the individual contractor is an office holder of the client or of an entity associated with it.
The staffing company is then responsible for deducting and paying deemed employment income tax and employee's National Insurance contributions (NICs) from the fees it pays for the PSC contractor's services and for paying employer's NICs.
Similar rules will be rolled out to the private sector on 6 April 2021 along with some changes which will apply to both the private and the public sector.
Positive changes
Positive changes and clarification introduced by the new legislation and explored in more detail below are:
- Greater scope to challenge employment status determinations
- Application of rules only to services provided on or after 6 April 2021
- End user clients to provide information on their size
- Rules will not apply if the end user client is a non-UK company
- Clarification on recovery of tax in the supply chain
Greater scope to challenge employment status determinations
The new IR35 off-payroll rules require the end user client to issue to the contractor and the staffing company a Status Determination Statement in which the end user client provides its assessment of whether or not it would regard the individual contractor as its employee if it engaged the individual contractor directly. The end user client must give its reasons for coming to its conclusion on employment status and take reasonable care when making its assessment. Failure to provide a Status Determination Statement means that any tax liability will rest with the end user client. This assists staffing companies greatly as it will ensure that end user clients provide them with their conclusions on employment status.
Under the new IR35 off-payroll working rules for both the private and public sectors, the contractor or the staffing company can challenge the end user client's determination on the contractor's employment status and make representations to the end user client that the status determination is incorrect at any time up until the final payment is made for the relevant assignment. If a status determination is challenged, the end user client must inform the contractor or the staffing company of the outcome of its consideration of their representations and either:
- if the client is of the view that its original conclusion was correct, give to the contractor or the staffing company who made the representations a statement that its Status Determination Statement is correct and give reasons; or
- if the client finds that its original conclusion was incorrect, provide a new Status Determination Statement stating the date from which the end user client considers that the new status determination became correct and that the previous Status Determination Statement is withdrawn.
If the end user client fails to respond to the representations within 45 days of receipt of the representations, the end user client bears any tax and NICs liability until it responds. This potential liability gives end user clients a strong incentive to comply; and the addition of a process under which an end user client's status determination can be challenged should result in end user clients ensuring that they take reasonable care in making their status determinations.
Application of rules only to services provided on or after 6 April 2021
Unlike the public sector rules, which applied to services provided under assignments which started before the implementation date of 6 April 2017 and continued beyond that date, the new private sector rules will apply only to services provided on or after the 6 April 2021 implementation date. This has an impact in the following respects.
A "just and reasonable apportionment" is to be made to payments for assignments for periods which bridge the 6 April 2021 implementation date. For any contractor who is deemed to be the employee of the end user client and who is providing services under an assignment with a start date earlier than 6 April 2021 which continues beyond that date, staffing companies must deduct tax only in relation to payments for services performed by that contractor on or after 6 April 2021.
End user clients can issue the Status Determination Statements required by the new rules before 6 April 2021. Representations that an employment status determination is incorrect can also be made before 6 April 2021, but the end user client will not be deemed to have received these representations until 6 April 2021.
End user clients to provide information on their size
There is an exemption from the new private sector rules if the end user client is a small company. A company qualifies as small if it satisfies two or more of the following requirements in its financial year:
- no more than £10.2 million turnover;
- balance sheet total of no more than £5.1 million; and
- an average number of no more than 50 employees.
Where this exemption applies, the old IR35 rules will continue to apply. This means that the PSC contractor will be responsible for considering IR35 status and for paying the deemed employment income tax and NICs if within IR35.
A welcome addition to the rules is the requirement for a private sector end user client to state, if asked by the contractor or by the staffing company with which it has a contract, whether, in its opinion, it qualifies as a small company. Such a request can be made if the contractor personally performs, or is under an obligation personally to perform, services for the end user client. The end user client must respond by whichever is the later of:
- "the end of the period of 45 days beginning with the date the end user client receives the request, and
- the beginning of the period of 45 days ending with the start of the tax year specified in the request".
If the end user client fails to respond within the time limit, the contractor or the staffing company can apply to court for an injunction. Having the ability to ask end user clients about the size of their company is particularly helpful for staffing companies which have not received a Status Determination Statement from an end user client and are unsure whether the end user client has failed in its obligation to provide one or has not provided one because it considers that the small company exemption from the new rules applies.
Non-UK company end user clients
If the end user client is a non-UK company, the new private sector rules will not apply. The rules will only apply if the end user client is UK resident or has a UK permanent establishment immediately before the relevant tax year. However, the law on UK residency and permanent establishment is complex and a recent update to the section on the new rules in HMRC's Employment Status Manual confirms HMRC's view that the new rules will apply where a non-UK end user client has a UK connection through a UK permanent establishment. International issues and some example international scenarios that staffing companies which place contractors overseas may find useful are covered in sections ESM10025 and ESM10026 of HMRC's Employment Status Manual.
Clarification on recovery of tax in the supply chain
The new legislation has clarified when an unpaid tax debt payable by the "fee payer" can be recovered from other entities in the contractual chain. If an HMRC officer considers that there is no realistic prospect of recovering from the "fee payer" (the entity which contracts with and pays the PSC) within a reasonable period, HMRC can recover the tax debt first from the second highest entity in the chain, if there is one (this might be, for example, a first tier supplier where there is more than one tier of suppliers). If there is no such entity or there is no realistic prospect of recovery from such an entity, HMRC can recover the tax debt from the highest entity in the chain, namely the end user client. Examples recently added to the section on the new rules in HMRC's Employment Status Manual show what HMRC considers to be cases of genuine business failure. HMRC would not seek to recover the unpaid tax from other persons in the chain in such a case. No staffing company wants its business to fail. However, this does mean that staffing companies can provide reassurance to end user clients and entities like first tier suppliers that liability for payment of a tax debt will not pass to them in these circumstances.
Anti-avoidance measure
In an important, if less welcome, development, the final legislation broadens the scope of the IR35 off-payroll working rules so that they cover not only company intermediaries in which the contractor holds more than 5% of the company's share capital, but also company intermediaries from which the contractor has received, or has the right to receive, a payment which can reasonably be taken to be a reward for the contractor's services to the end user client. This expansion of the definition of a company intermediary will stop schemes designed to avoid IR35 by making sure that contractors don't band together to provide services through a company in which they hold no more than 5% of its share capital. Unfortunately, however, this change will increase the administrative burden of those who have to assess the IR35 status of assignments.
Steps to prepare for the new rules
Staffing companies should, if they haven’t already, devise a strategy for dealing with the new rules and consider including the following key components:
- Assign a team to educate themselves and the business on the new rules and take responsibility for planning for the implementation of the new rules.
- Make a full assessment of the status of their contractor base and consider how to engage contractors going forward.
- Review private sector clients by size to work out which are small companies and will be exempt from the new rules.
- Work with all end user clients to reassure them and educate them on the new rules before they come into force, making sure that large and medium-sized businesses in the private sector are aware of their obligations and ensuring in particular that they understand that the legislation will not permit them to take a blanket approach to assessing status and simply decide, as some did when the public sector rules were introduced, to treat all contractors as being within IR35.
- Find out from large and medium-sized private sector end user clients which contractors are business-critical and explore options.
- Communicate with, educate and reassure contractors.
- Train recruitment consultants to understand the new rules, be able to deal with straightforward queries from clients and contractors and know when and where to refer more complex queries internally.
- Review existing client and contractor contracts and vary them where necessary or enter into new ones. Remember that contracts must reflect the reality on the ground and the correct status. Look out for "own goals" because of inaccuracies such as employment indicators in contracts.
- Anticipate the introduction of the new rules when tendering for new client contracts and factor this in when negotiating and entering into new contracts.
- Change or set up systems for on-boarding, invoicing, payment and payroll processes to take account of and apply the new rules.
- Forward plan to monitor the size of private sector end user clients and employment status of contractors during assignments.