In April 2020, a new regime replacing IR35 will come into effect for medium and large private sector organisations.
The “Off-Payroll Working” (OPW) rules have applied in the public sector since April 2017 and will now apply to many private sector organisations as well. They are intended to address perceived non-compliance with IR35, which has resulted in a loss of revenue to the Treasury. In the run-up to the General Election, the Home Secretary made an announcement that the Government would look at the OPW rules to make sure that they were “right to take forward”. The review since announced by the Treasury makes clear that the new rules will still be introduced in April 2020 but consideration will be given to whether further steps need to be taken to ensure their “smooth and successful implementation”.
Here are the 5 big questions on the topic and our 5 recommended next steps.
What is the current regime?
In simple terms, IR35 applies to arrangements where an individual provides their services to an end-user client via an intermediary entity in which they have a material interest (often referred to as a personal service company or PSC) and where, if the intermediary was not present, the individual would be regarded as an employee of the client for income tax purposes or as an office-holder. The client pays the PSC a gross fee for the services provided by the individual. If the PSC then pays anything to the individual which is not employment income (commonly dividends), then that amount is supposed to be treated as employment income and income tax and employer and employee NICs liabilities should be paid on it accordingly. However many PSCs are deciding that there would not be an employment relationship and this has resulted in a significant loss of revenue to the Exchequer; some estimates put this at over £1 billion per year.
What will change with the new regime?
The end-user client will now have to assess whether the arrangement would be an employment relationship for tax purposes if they were engaging the individual directly. So responsibility for this decision is being shifted away from the PSC.
There is an online tool that can be used to determine status. It poses a series of questions about substitution, management responsibilities, working arrangements etc and if those questions are answered honestly then HMRC will accept the status determination that it generates. Whilst it is not mandatory to use this tool, we anticipate that most clients will use it, principally for ease and for the comfort it gives about the result.
Where the end-user client considers that there would be an employment relationship then it must notify the party that it is contracting with and the individual of that fact and the reasons for that determination. There is a form of appeal against the status determination which must be responded to within 45 days.
Assuming everyone has done what they are supposed to then the final party in the chain before the PSC is responsible for deducting income tax and employee NICs from, and paying employer NICs on, the contract fee (net of VAT). In many cases, this will be the end-user client itself.
It is important to note that we are talking about the existence of an employment relationship for tax purposes here. This is different to employment status for employment law purposes. Confusingly, an employment relationship for tax purposes would cover the employment law concepts of both employee and worker.
Who will this affect?
The new OPW rules will apply to medium and large organisations (both companies and non-corporates such as community benefit societies) who use individuals who provide their services via certain types of intermediaries. IR35 will no longer apply to these organisations.
The new OPW rules apply by exclusion i.e. if the end-user client is not “small” then the rules apply. The threshold for a small organisation is as follows:-
- A small company will need to satisfy at least two of:-
- Annual turnover does not exceed £10.2 million
- Balance sheet total does not exceed £5.1 million
- Number of employees does not exceed 50
- A small non-corporate will be one which has an annual turnover which does not exceed £10.2 million
Small organisations will be able to continue to operate IR35. Where there is a group structure, if the parent entity doesn’t meet the small criteria then it is irrelevant how small the subsidiary is as the OPW rules will still apply.
It will catch arrangements whereby an individual provides their services via:-
- A limited company in which they hold more than 5% of the shares and votes
- A partnership of which they are a member and entitled to at least 60% of the profits (either alone or with family)
- An individual
It may not always be obvious to the end-user client whether any of these arrangements will be in place because the end-user client may be contracting with an agency who in turn is contracting with a PSC. There is therefore a legal obligation on the individual to notify if they supply their services via such an arrangement.
What will this mean?
We commonly see arrangements whereby interims with PSCs fill existing posts within an organisational structure, for example Interim Director of XXX. In our view, these sort of arrangements are almost inevitably going to be caught by the OPW rules because the end-user client will not want a broad right of substitution to exist, will want to exercise a reasonable degree of control over when and where the individual works, and will be asking the individual to take on line management responsibilities for employees in that department. So if the PSC wasn’t in the picture then the individual would be an employee.
Unless fees can be negotiated down accordingly, arrangements of this nature will become more expensive for the end-user client because employer NICs and (where the fee-payer’s payroll bill is above £3million) the apprenticeship levy will need to be paid on the contract fee.
However it is important to recognise that application of the OPW rules does not make the individual an employee for employment law purposes, for example giving them the right to bring a claim for unfair dismissal. Employee status for tax law purposes and employment law purposes will remain subject to different tests.
There has also been a public statement by HMRC that the OPW rules are not retrospective and that decisions by end-user clients that individuals are covered by the OPW rules will not automatically trigger enquiries into earlier years.
What action should be taken now to prepare?
1. Check whether your organisation (and its parent if there is one) is a small organisation or not under the applicable thresholds.
- Assuming your organisation is covered by the new OPW rules:-
2. Understand your exposure
- Talk to the teams who have used/are using these sorts of arrangements to understand why they are doing so.
- Decide whether you are willing to continue to enter into these arrangements. HSBC’s response to the OPW rules was reportedly to cease engaging limited company contractors altogether. Whilst a blanket position may be inflexible, know what alternatives might be available, and even more appropriate, in certain cases
- Identify existing arrangements which will continue beyond 6 April 2020 and may be caught by the OPW rules
3. Review existing arrangements that will continue beyond 6 April 2020
- Ask individuals to confirm the nature of the entity via which services are provided
- Run the online CEST tool. When answering the questions, don’t rely solely on what the contract terms say – answer by reference to reality
- Notify of the result by way of a status determination statement. You need to do this before the first post-5 April 2020 payment is made under the contract
- Seek to renegotiate if you want to reduce the financial impact and consider termination if you can’t get a revised deal that you are happy with
4. Get your documents and processes ready
- Decide who is going to be responsible for determining status
- Introduce template forms to make it easier to gather the necessary information about the individual as a matter of routine
- Have a written process for the individual to challenge their status determination – reliance on your Grievance Procedure would not be appropriate
- Update your template consultancy agreement
- Prepare your Payroll team
5. Be at least a bit suspicious about solutions which purport to get around the OPW rules. We’re aware of:
- Attempts to rewrite consultancy agreements to disapply the OPW rules. Whilst we recommend that existing consultancy agreements should be reviewed, and may need some amendment, it will be what happens on the ground that ultimately determines whether the OPW rules have to be applied or not. The practical effect of how the arrangement may need to be structured to avoid the OPW rules might not be commercially acceptable to you
- The idea that consultants could be paid more in expenses to offset the loss in fees due to income tax and NIC deductions. Such a solution isn’t actually affecting whether the OPW rules apply, but it is an additional cost for you