Upcoming rule changes and what organisations should know.
On 6 April 2021, changes are being made to the off-payroll working tax rules (often referred to as "IR35"). These changes will impact on medium and large-sized organisations in the private and third sectors if they engage an individual through an "intermediary". We give a brief summary of the changes below. We recommend that organisations which may be caught by these rules take prompt legal, accountancy and/or tax advice to ensure they are ready to comply. HMRC guidance on the new rules is available at https://www.gov.uk/hmrc-internal-manuals/employment-status-manual/esm10000.
A key point to highlight is that the new rules will not be relevant for organisations contracting directly with self-employed individuals rather than through intermediaries. However, there are other important tax and employment law risks to be aware of if this is the case. These are explored further below.
The off-payroll working rules
These rules are designed to ensure that income tax and National Insurance contributions (NICs) are deducted at source from payments where an individual would be the employee of the end user organisation if their services were not provided to the organisation through a contract with a company or other legal entity (an "intermediary"). This is called being in "deemed employment".
An intermediary is, very broadly speaking, a company or partnership in which the individual has an interest (for example more than 5% of the ordinary share capital). It can also be another individual, such as a gangmaster. An agency in which the individual has no interest will not be an intermediary under the off-payroll working rules, although other employment tax rules apply in that case. Commonly, the intermediary will be the individual's own personal services company.
The rules look through the contractual arrangements and apply broadly equivalent deductions to those made for direct employees of the end user. If the individual is assessed to be in deemed employment, income tax and NICs must be deducted at source and the employers' NICs must be paid. The question is, who must carry out this assessment or "status determination" and make the deductions?
Public sector organisations which use the services of individuals provided by intermediaries are already responsible for this employment status assessment and for making deductions at source. These organisations will, however, be subject to some additional obligations from 6 April onwards, including a requirement to issue a Status Determination Statement (SDS).
Up until 6 April 2021, where an intermediary contracts with an end user in the private and third sector, it is always the intermediary which is responsible for determining the employment status of the individual for tax purposes and making any necessary deductions. From 6 April onwards, this responsibility will pass to the end user unless it is classified as "small".
Which organisations will be caught by the new off-payroll working rules?
From 6 April 2021, medium and large-sized organisations in the private and third sectors with a UK connection will have to determine employment status, issue a SDS and deduct PAYE and NICs at source before making payments to the intermediary.
An organisation will be caught by these new rules if it is medium or large-sized. Details of what this means for different legal entities can be found at https://www.gov.uk/hmrc-internal-manuals/employment-status-manual/esm10006.
A company will be medium or large-sized if it meets at least two of the following criteria for two consecutive financial years:
- turnover of more than £10.2 million;
- a balance sheet of more than £5.1 million;
- an average of more than 50 employees.
If the parent of a group is medium or large-sized, their subsidiaries will also have to apply the off-payroll working rules, no matter the size of the subsidiary.
Some entities are assessed on turnover alone, such as unincorporated entities and general partnerships. Charities do not need to include donations in the calculation of turnover.
Small entities will not have to issue a SDS, but they will have to confirm their size when asked by the contractor or individual.
Checking employment status for tax
HMRC has a useful employment status checking tool (CEST) which is available at https://www.gov.uk/guidance/check-employment-status-for-tax. The output from CEST can be used to form the SDS, although other formats can also be used.
Organisations must take reasonable care when determining the employment status of a worker. Failure to do so will result in the organisation taking on responsibility for paying the individual's income tax and NICs.
Contracting with a "self-employed" individual: are they really an employee or worker?
Employment status for tax purposes
If an individual is determined to be in "deemed employment" by the end user organisation, this does not mean that they are employed by that organisation and the end user will not become liable for employees' or workers' rights for the individual.
However, IR35 and the off-payroll working rules are by no means the whole story. The upcoming changes are part of an on-going drive by HMRC to ensure that employment taxes are collected where there is an employment relationship between the parties. HMRC is also keen to ensure that deductions are properly applied where directly engaged individuals are labelled as self-employed but in reality they are in employment for tax purposes.
Separate to the IR35 issue, there is a risk that "self-employed" individuals engaged directly under a contract for services could be found to be employed for tax purposes. This could give rise to HMRC demands for tax / NICs arrears, interest and penalties. Because of this, even though the off-payroll working rules do not apply, organisations should consider whether their self-employed consultants or similar may be employees for tax purposes.
There is also a risk that an employment tribunal could find that an individual supplied by an intermediary is the worker or employee of the end user organisation for employment law purposes, no matter whether the off-payroll working rules apply for tax purposes. We reported on such a case in a previous article: Can someone who is paid through their own limited company be a worker or employee?
Employment status under employment law
If the reality of the working arrangement suggests an employment or worker relationship (no matter what the contract says), there is a risk that an individual could be found to be an employee or a worker for employment law purposes.
Workers are entitled under employment law to such rights as the National Minimum Wage, pension auto-enrolment, sick pay and statutory paid holiday.
Employees have additional rights, including the right not to be unfairly dismissed, to statutory minimum notice and redundancy pay.
Employment status is not a straight-forward area of the law and different cases turn on their particular facts. There has however been a recent line of cases in which individuals were initially happy to be treated as self-employed but subsequently have been found to be workers or employees. This usually happens after the relationship sours, when the individual becomes ill and/or their contract is terminated. The Supreme Court's recent decision that Uber drivers are workers confirms the recent trend (for further details see our case report: Supreme Court confirms that Uber drivers are workers after denying appeal).
Employment tribunals, HMRC and the tax tribunal take a similar approach to this question. HMRC makes no distinction however between workers and employees – both categories are in employment for tax purposes. It is also important to note that a decision by HMRC or the tax tribunal will not automatically lead to the same decision in the employment tribunal, and vice versa.
We set out below the key factors which tribunals will consider when deciding on employment status.
When will someone be genuinely self-employed?
- The individual can and does in reality arrange for and pay a substitute to carry out the work when they are unwilling or unable to carry it out;
- There is equal bargaining power between the parties – for example because of the individual's specialist skills;
- The individual is clearly in business on their own account – for example, they might be engaged by many others and market their services broadly;
- The individual takes a financial risk in the arrangement – for example payment only on satisfactory completion of the project;
- The individual decides how and when the work is done – there is little day to day control or line management by the end user;
- There are no or few restrictionson the business of the individual outside the arrangement, such as restrictive covenants applying after the contract ends;
- The individual is not integrated into the client organisation – for example, they do not represent the business or have to comply with company procedures.
When will someone be a worker?
- The individual must do the work themselves – providing personal service rather than sending a substitute to carry it out;
- The individual is controlled and managed by the end user in terms of how and when the work is done;
- The individual is part of the organisation and has to comply with rules, policies etc;
- They are not in business on their own account;
- The individual is subordinate to the end user organisation.
When will someone be an employee?
- The factors above applying to a worker are in place to a high degree;
- The end user is obliged to provide the individual with regular work and they must accept that work when it is offered (known as "mutuality of obligation").
What should organisations do now?
Many organisations have planned for the change to the off-payroll working rules for some time, as they were originally due to come in last year and postponed because of the Covid pandemic.
Those organisations which have not considered this issue should begin by reviewing their arrangements with consultants and other individuals who are not on the payroll as a matter of urgency. The CEST tool is a good place to start to assess whether this is an issue for the organisation.
We recommend that organisations take professional advice on the impact of the new tax rules where individuals are provided through an intermediary. However, it is also important to consider and take advice on the broader risk of contractual arrangements with individuals which may in reality be employment relationships.
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.