We are now less than two months away from the new IR35 regime: important changes to the way companies engage contractors via third party companies are coming into force on April 6. Following up on our recent webinar, below we recap new rules and set out the steps companies should be taking to prepare.
What is IR35? IR35 is a UK tax rule, which provides that payments made to contractors are taxed as employee income where the individual is working through an intermediary (normally a personal services company or umbrella company) but is effectively working as an "employee" of the end user (or "Client"). This is effectively an anti-avoidance rule. According to HMRC (the UK Tax Authority), there is widespread non-compliance, with individual personal services companies being used to shelter contractors from tax liabilities. HMRC is now looking to recover more of this tax.
What is changing on April 6? Currently, the intermediary is responsible for assessing whether IR35 applies and accounting the correct tax/social security, and the intermediary will pick up any liability for the underpayment. The changes mean that ultimate responsibility will shift so that:
- The Client will now be responsible for assessing whether a contractor should be classified as an employee for tax purposes i.e. whether IR35 applies (and responding to any challenges from the individual within 45 days); and
- If IR35 applies, the "Fee Payer", being the party which ultimately pays the contractor, will be responsible for deducting the tax/social security through the PAYE scheme and for any liability that arises for underpayment.
In a direct engagement the Client will also be the Fee Payer, but where there is a third party agency, the agency will be the Fee Payer.
When will the Client be liable? If the UK tax authority determines that IR35 applies, the Client will pick up the tax/social security liability in three scenarios: if it either (i) failed to make the original assessment (ii) did not apply "reasonable care" in making the assessment, or (iii) where the Fee Payer itself failed to make the correct deductions under PAYE and there is no realistic prospect of recovering the deductions from them. This means that the Client is responsible not only for its own actions, but also if an intermediary agency does not properly apply IR35, or is unable or unwilling to pay.
We only have a small UK operation. Do these rules only apply to larger businesses? "Small companies" are excluded, meaning they meet two or more of the following requirements:
- Annual Turnover not more than £10.2 million
- Balance sheet total not more than £5.1 million
- Number of employees not more than 50
However, importantly, overseas group companies are included in these figures. So a small UK subsidiary of a larger US or global group is likely to be caught.
What approach should we take? Some well-known companies have announced they will no longer contract individuals via personal services companies. Alternative approaches include:
- Apply IR35 blanket assessment to all. However, this may push up costs if the agency or contractor pass the increased PAYE deductions back to the Client. It will also mean the Client has failed to apply "reasonable care" to the assessment, with the result that the Client would still be on the hook if any of the contracting companies in the chain have failed to operate the relevant withholdings. In addition, if the Client applies IR35, this potentially increases the risk that contractors can claim worker or employment rights from the Client.
- A case by case assessment is likely the only way to ensure that reasonable care has been applied, but it is time consuming and needs to be repeated at least annually or when working arrangements change.
- Other options include amending terms and working arrangements (i.e. to ensure contractors are genuinely working independently, and outside of IR35), bringing contractors on board as employees, or fully outsourcing functions.
What should we be doing now? The most important step is to audit your arrangements and identify any risks. For example:
Is there a status risk?
Review contracts and working arrangements against status indicators (e.g. level of control, requirement for personal service). Use the government online tool (known as "Check Employment Status for Tax" or "CEST"), but given the limitations of this, also ensure HR/Legal analysis.
Do you know the contractual
arrangements in place?
Is there a flow of information from all parties in the chain—to be able to make the assessment and address any challenges by contractors (within the 45 day deadline)?
Will any intermediary take the
Are there indemnities and can you rely on them? Are all intermediaries in the chain financially sound? If not, the Client picks up the liability.
The final legislation will not be confirmed until March 11, but no substantive changes are expected. Therefore companies need to ensure now that they will be ready to implement the changes by April 6.
Seyfarth's International Employment Law team are helping various clients in reviewing their arrangements and assessing their contracting model.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.