The existing public sector restrictions and rules on IR35 are being extended to medium and large private sector employers from 6 April 2020. Despite the current political uncertainty, the Finance Bill 2020 is still expected to be introduced into Parliament in November as usual. Additional guidance was published by HMRC on 22 August 2019 on the application of these changes.
The proposed changes, which essentially shift the burden for compliance with the IR35 regime onto the hirer/end user, is expected to bring £3.1 billion in additional revenue for the Exchequer between 2020 and 2024. HMRC has written to around 1,500 contractors working for GlaxoSmithKline (GSK) advising them to check whether they are compliant with the IR35 rules and has confirmed that it will be sending such letters to contractors in other sectors where there is the highest risk of non-compliance with the IR35 rules.
Employers who receive services from individual workers through an intermediary need to ensure that they are ready to implement the changes before 6 April 2020. Getting it wrong could result in liability for the unpaid tax!
We unpack the 'who, what and when' of the draft legislation and HMRC guidance and their potential impact on employers.
IR35 a quick recap
IR35 refers to the anti-avoidance tax legislation that applies when an individual worker provides services to an end client through an intermediary, such as a personal service company (PSC) or a partnership, in circumstances where the individual would otherwise:
- for income tax purposes, be regarded as an employee or an office-holder of the client, and
- for National Insurance contributions (NICs) purposes, be regarded as in employed earner's employment by the client.
In 2017, changes to the IR35 regime were introduced for public sector employers essentially shifting the burden for compliance onto the end-user/hirer. The final draft legislation (contained within the Finance Bill 2020) and HMRC Response to the Consultation for the implementation of the extension of these changes to medium and large private sector employers was published on 11 July 2019. Getting the call wrong on whether an individual falls within the ambit of the IR35 regime can have significant tax implications. Recently, three BBC presenters were held liable for £920,000 of unpaid tax having incorrectly claimed to fall outside the IR35 regime over a number of years. In addition, it is always worth remembering that while a similar approach is taken, there is no direct link between employment status for employment law rights and employment status for tax purposes.
Who will be caught by the changes?
The new rules apply to large and medium sized incorporated and unincorporated enterprises.
For incorporated enterprises, HMRC is using the definition of 'small company' in the Companies Act 2006 and this test will be applied to the tax year that falls after the company has filed their accounts showing that they were a small company. For example, if a private company has a calendar year end, the accounts will be due by September and if those show that the company is a small company, the new rules will not apply from 6 April the following year (and the current IR35 rules will apply).
In order to be a small company, the company must meet at least two of the following requirements:
- Annual turnover of not more than £10.2m
- Balance sheet total of not more than £5.1m
- Average number of employees must not be more than 50
For group companies, the small company test is applied to the parent undertaking, rather than to particular subsidiaries but if the parent undertaking is a medium or large company, its subsidiaries will also have to apply the new IR35 rules.
For unincorporated enterprises, the simplified test applies of those with turnover not exceeding £10.2 million. Companies, limited liability partnerships, unregistered companies and overseas companies are unable to use the simplified test.
If the conditions of either test are met on 6 April 2020, the new rules must be applied from this date.
Going forwards from 6 April 2020, if the simplified test is met and the new rules apply, they must be applied from the start of the tax year following the end of the calendar year when the conditions were met. If the simplified test is not used and the company meets the conditions for two consecutive years, the new rules must be applied from the start of the tax year following the end of the filing period for the second financial year when the conditions were met.
What is required for compliance?
Under these controversial changes, instead of the intermediary having the responsibility for determining their employment status for tax purposes, the end client will need to make the decision and document it with a status determination statement (SDS) setting out whether the client determines that IR35 applies and providing reasons. If the client gets the decision wrong, they could be liable to account for PAYE and NICs if they have not taken reasonable care in making the decision.
The draft legislation and guidance requires the client to provide the SDS to the party which the client contracts with and to the worker directly. If the client does not provide the SDS, they will be liable to account for PAYE and NICs.
There will also be a client-led status disagreement process aimed at resolving any disputes around the determination status and measures aimed at preventing clients from making blanket determinations.
The client will be required to implement the status determination disagreement process for both the worker and the fee payer to dispute the SDS. Once the worker or fee payer has made representations to the client, the client has 45 days to complete the disagreement process and inform the worker or fee payer of the outcome (revised or not) and, if the outcome remains the same, the reasons for its decision.
If the client fails to provide the outcome within 45 days, the client is deemed to be the fee payer for the purposes of the rules and becomes liable to operate PAYE and NICs.
HMRC has inserted a requirement for the client to take reasonable care in coming to the conclusion stated in the SDS which is aimed at preventing clients making blanket determinations to the detriment of PSCs legitimately operating outside IR35.
If a client has failed to take reasonable care in making status determination, the SDS is not valid, which means that the client is in default of its obligations and becomes responsible for PAYE and NICs. This is a significant risk for clients as it is not yet clear what constitutes 'reasonable care'. HMRC states it "will set out in guidance how a client can fulfil its obligation to take reasonable care and how it might implement the status disagreement process". We await further guidance from HMRC on this point.
However, if anyone in the contractual chain provides a fraudulent document (with the intention of changing the outcome of the SDS), this takes priority and whoever provided the fraudulent document is liable for PAYE and NICs.
There are no specific provisions if a fee payer follows the determination, made using reasonable care, provided to it by the client, which turns out to be incorrect. In those circumstances, the liability appears to fall on the fee payer even though it is only following the SDS that was provided to it.
The draft legislation also contains wide powers to allow HMRC to recover amounts where HMRC considers that another person should have operated PAYE and NICs. These rules will be set out in PAYE regulations that are yet to be published. HMRC's response to the consultation suggests that these "are not intended to transfer liabilities in cases of genuine business failure", but where someone in the contractual chain has not met their obligations. We await the PAYE regulations and further guidance from HMRC on this point.
When can the liability be transferred from the fee-payer?
The default position is that the party paying the worker will be liable to account for PAYE and NICs but the liability can be transferred in the following scenarios:
- To an agency which is not the fee-payer but has not passed on the client's SDS to the party which they contract with;
- To the first agency in the supply chain where the HMRC cannot collect the tax from the fee-payer;
- To the client if the client doesn't make the SDS;
- To the client if the client doesn't pass the SDS to the worker and the party that they are contracting with;
- To the client if the client doesn't take reasonable care in making the SDS;
- To the client if the worker challenges the status determination and the client doesn't respond within 45 days; and
- To the client if the size of the client changes from medium or large to small and the client doesn't notify the worker.
What should you be doing now?
Further guidance, in particular on how HMRC intends to apply to the power to recover unpaid tax from other entities in the supply chain, is awaited and the ICAEW have received confirmation from HMRC that their current guidance provided is likely to evolve. HMRC have also confirmed to the ICAEW that they will be contacting the largest organisations affected by the changes soon to arrange one to one engagement.
While we wait for further developments, employers can take steps to prepare for the changes by considering how easily they will be able to collect the information required for making the SDS; establish a process for making the SDS; and for implementing the status determination disagreement requirements with the aim of having these ready for operation from April 2020.