IR35 and Personal Services Companies
One of the few positives from the Covid-19 pandemic is the focus that it has compelled businesses to take, with regards to establishing new ways of working. The overnight shift for many businesses to a remote working model, together with the necessity of managing the employee cost base as effectively as possible, has resulted in many businesses shifting to the use of temporary workers or consultants. The attractiveness of consultants has perhaps been boosted by the number of experienced professionals looking to work in this way. From a commercial perspective, the business case for using consultants has never been more compelling.
However, every silver lining has a cloud, and this particular cloud takes the form of the off-payroll working rules, which have applied to public sector bodies since April 2017 and after a short Covid related reprieve, will apply to medium sized and large businesses with effect from 6 April 2021.
Use of consultants
There are a number of benefits to using consultants, some of which have been brought to the fore as a result of upheavals over the last 12-18 months. We’ve set out below just a few of the key benefits:
- the use of consultants means you get the right person for the job without having to train up an existing employee;
- consultants can bring fresh ideas to the business, based on experience in other organisations;
- consultants are typically flexible and can fit into the way your organisation works;
- they do not typically expect benefit packages;
- they are not subject to employment law rules, so can be let go in a cost effective way if the needs of the business change or the cultural fit is not right; and
- self-employed workers are not subject to payroll taxes, so there is lower administration as well as direct cost savings through not attracting employer NIC.
It is the last of these benefits that has meant that consultants have long been in the sights of HMRC. There is case law dating back to the 1960s considering the issue of when a worker should be treated as an employee for tax purposes and when they are truly self-employed. There has followed a raft of legislation under the general umbrella of “IR35” where the worker is engaged through an intermediary. Initially, the intermediary targeted was a personal service company (usually wholly owned by the employee or jointly with a spouse) although this has expanded to managed service companies and workers employed through agencies.
The key issue underpinning the operation of these rules remains the employed/self-employed distinction. There is no statutory test for this. There are a number of factors which operate to determine this relating to the contractual relationship between engager and worker and how the engagement operates in practice. Factors to consider include, control, bearing of financial risks, mutuality of obligations between engager and worker and the availability to use a substitute. It is necessary to consider these factors on a case by case basis and to keep them under review. A change in the way of operating could result in a change in the tax status of the arrangement.
Off-payroll working: April 2021
Initially, the IR35 rules operated to place the onus of any reporting on the intermediary. However, the off payroll working rules will, with effect from 6 April 2021, apply to medium sized and large businesses so that the responsibility for PAYE/NIC withholding (if any) will shift to them. For small businesses, the existing IR35 rules will continue to apply.
Whether a business is small is determined by reference to employee population, turnover and balance sheet. There are transitional rules for businesses ceasing to be or becoming small, which can delay the requirement to operate in accordance with the off payroll reporting rules. Careful attention should be paid to these to ensure that the reporting takes place at the right time.
How to navigate
Clearly the shift in the compliance burden to the end user means that there are increased risks of getting the analysis wrong. It is therefore important to make sure that not only are you comfortable that the contractual arrangements put your workers on the right side of the employed/self-employed line, but also the way in which the engagement is carried out.
It is equally important to check that this remains the case as the engagement progresses. Educating line managers as to what can and cannot be asked of workers is important to reduce these risks.
We recommend that businesses put in place a process to identify where contractors are being used, gathering information on how they are operating, analysing the nature of the engagement and documenting it, dealing with the contractor in relation to the determination (including if the contractor disagrees) and ongoing monitoring. HMRC has confirmed in its February 2021 compliance guidance that it will support businesses in becoming compliant and not seek to levy penalties in the first 12 months of the new regime, save in the case of deliberate non-compliance.
HMRC has put together an online tool called Check Employment Status for Tax (“CEST”) which asks a number of questions about the arrangement and gives a view on the status of the relationship for tax purposes. HMRC has confirmed that it will stand by a CEST determination as self-employed if the questions have been answered accurately and continue to subsist. However, there is a concern that the tool reflects HMRC’s interpretation and may be more employment biased than case law (albeit that the vast majority of cases have, when put through CEST, generated the same result).
It may be tempting to decide that the use of contractors now sits in the “too difficult” box and so any new engagements take the form of employment contracts. There are certainly a number of organisations that are taking that view, but before doing so, we recommend analysing whether there are any ways the existing or future contractor arrangements can be modified to fall on the right side of the line, once the new regime comes into force. There are material benefits on offer and giving some thought to addressing the risks could allow these benefits to be accessed at relatively little cost.
Other tax issues for PSCs
Workers operating through PSCs should not assume that IR35 is the start and end of their considerations relating to tax. Although these rules will be front and centre of concerns, there are other pitfalls which can befall PSCs, such as potential application of the settlement provisions or disguised remuneration rules. Particular care is needed where ownership of the PSC is shared with a spouse or other family members.
For the right circumstances, there remain a lot of benefits to operating with consultants, including significant potential costs savings. It would be a shame if, at a time when these benefits are needed more than ever, over prudence meant that some or all of these potential savings were left on the table.
If you would like to discuss any of the issues raised in the above article, please contact James Paull.