25 Mar IR35 and the 6th April 2021: Is it the death of the Personal Service Company (PSC)?
Introduction
Businesses and freelancers have been bracing themselves for the imminent changes to the private sector associated with the delayed introduction of the IR35 off-payroll working tax rules. Although some were hoping for a further delay being announced in the Budget, it has been confirmed that the rules will come into effect from 6 April 2021.
IR35 was introduced to legislate against individuals using a Limited Company structure (PSC) or similar to avoid being paid via payroll and the taxation associated with that. Such Companies often pay their shareholders in dividends rather than via a payroll and this form of payment can effectively side-step PAYE and National Insurance deductions, ultimately reducing the individual’s deductions from income.
The Government’s reforms for private sector companies are intended to improve compliance with the existing rules by moving the responsibility for tax assessment and payment from the contractor to the end client. This revised approach follows similar measures introduced in the public sector in 2017.
The impact of the IR35 off-payroll working tax rules.
Post 6th April 2021, another IR35 rule called ‘off-payroll working tax rules’ will apply to large private organisations (subject to the exemption below). The aim is again to shift the burden of determining the employment status of contractors or workers from the contractor to the private organisation. This will radically change the current status quo and means that the employer will have to assess the employment status of the arrangements. Avoiding making a decision leads to liability and regardless of the outcome, HMRC is entitled to the PAYE and NICs if the arrangement is in fact one of employment. This means that an incorrect status decision will result in the hirer being liable for these taxes.
It is therefore only where a status decision of ‘no employment’ is correct will a hirer safely be able to pay the contractor gross on its invoice. As liability for taxes and NICs last for 6 years such a determination requires careful consideration. A hirer would therefore need to be extremely confident that the arrangements did not fall within the rules and that they would not be exposing themselves to a potential tax liability further down the line.
The exemption to the ‘new’ rules
The forthcoming change will only impact large and medium-size businesses, meaning that private sector employers which fall into the category of a ‘small business’ will not be affected by the new provisions. The Companies Act definition of a small company will be used for this purpose. Therefore where the private sector client does not have a turnover of more than £10.2m, balance sheet value of more than £5.1m and employees of more than 50 (remember any two of the three tests will suffice) then it does not have to assess the employment status of its workers.
So, for contractors who are concerned about the application of the new IR35 rules, it would be a prudent exercise to find out a bit more about the end client and whether they are in fact caught by the new rules. It is worthy of note that the Federation of Small Businesses has warned that both companies and contractors will feel the pinch.
What then are the choices for private sector businesses?
Private sector businesses, therefore, face a difficult choice. They can either:
- Continue to treat contractors as contractors and risk a substantial financial penalty if HMRC takes a different view.
- Treat them as employees with the additional costs and responsibilities this entails.
- Use an umbrella company, negotiating the rate and absorbing the cost.
- Hire the individual on a self-employed basis. Although direct-hire carries similar risks if the individual is subsequently deemed to be employed, namely: rights entitlement, tax implications for PAYE and NICs.
It is important to appreciate that using an agency does not alleviate risk or the application of the IR35 rules. Although the agency is normally responsible for making the payments to the individual, the hirer remains responsible for the status decision and can still be liable if the tax and NICs are not correctly accounted for further down the chain. There is also an obligation to pass on information, as well as review requirements, that increase the burden to the end-user.
Attitudes of contractors and employers
There is widespread concern that if private sector companies adopt a risk-averse approach then genuine contractors will be improperly classified as employees, and so will either take an unfair tax hit or lose their contracts altogether.
Some 45 per cent of contractors have stated their intention to continue contracting through a personal service company even after April 2021. Conversely, around 17 per cent stated that they are likely to become employees instead and 18 per cent state that they are closing down their companies. Of those who are predicting to stop contracting next year, an overwhelming 75 per cent have stated that this decision was directly influenced by the forthcoming IR35 reforms.
75 per cent of contractors also stated that they did not have faith in their client to determine IR35 correctly whilst only four per cent of contractors felt that their client would. 21 per cent stated they were unsure.
As set out above the new rules, create an increased administrative burden on private sector employers to not only carry out a “Status Determination Statement” (SDS) but to also provide their assessment to the worker or contractor; together with the reasons and rationale behind the assessment, in order to objectively justify the status determination.
A number of private-sector employers have concluded that a blanket approach to IR35 is the easiest way to ensure compliance post-April 2021 and have decided to engage all staff on a PAYE basis. This was certainly the approach adopted by a number of large UK financial institutions who informed their existing contractors who work as limited companies that they must either transfer to the PAYE system of paying income tax or operate via an umbrella company.
What does the future hold for contractors?
From a contractor’s perspective, some companies will be exempt from the new rules so there will remain the option for contractors to work with these companies and not with the big banks and PLCs. A second option would be simply to accept an employment contract with the end client. Alternatively, they could choose to work under an umbrella company that deduct the relevant taxes and pay them over to HMRC.
For many contractors though, the new rules may sadly spell the end of their limited company. They will need to take specialist tax advice to make the most tax-efficient decision when deciding which solution best suits their situation.
IR35 and the “New normal”
The new normal has created a demand for more flexible working. As companies exit lockdown and seek to navigate the challenges and opportunities of the post COVID landscape they will desperately need the skills, flexibility and savings offered by contractors. In that regard, IR35 reform may appear slightly anachronistic and short-sighted having regard to the impact of the pandemic on the economy.
So while the blanket approach adopted by a number of companies may seem like an easy solution in the short term, it removes access to a skilled contractor workforce that wishes to remain flexible. This may damage businesses ability to scale resource up and down at short notice.
Businesses that are forward-thinking, and proactive enough, to take the necessary steps to continue working with contractors who do not want to work within IR35, may find they can scoop up some of the best talents and gain a competitive advantage by accessing this pool of expertise. In light of this, a number of commentators have suggested that fears that the forthcoming changes to IR35 will spell the death of freelancing are exaggerated. It is of course important to bear in mind that the general legal principles that govern employee status will continue to apply. Therefore, by taking appropriate steps, both contractors and businesses can seek to ensure that they do not fall foul of IR35.
It is also important to remember that IR35 applies to a role rather than an individual. Therefore, each assignment will have to be assessed on a case by case basis. What that means is that because you were outside IR35 on your last assignment, it doesn’t automatically mean that you won’t be inside its application on your next one. For every assignment, a contractor needs to be able to objectively demonstrate that they are ‘in business on their own account’ and not an employee.
How then do contractors take advantage of the “new normal”
If you are a contractor operating through a limited company (either your own or an umbrella company), HMRC may ask for evidence that you are a genuine freelancer, rather than just an employee of your client.
There are a number of ways that you can seek to demonstrate that you are not an ‘employee’ these include:
- Emphasise how your work situation differs from ‘genuine’ employees. Genuine employees have certain set working conditions, such as minimum hours, pension arrangements and other benefits, An employer also has a duty to provide work for them, which the employee has an obligation to (Mutuality of obligation) test. An employer can also stipulate where and how the work is to be carried out.
- Retain any correspondence (including texts and e-mails) that state you are not under the control of a manager at the business, but are simply contracted to provide a service.
- Include a right of substitution in any service contract. This will help demonstrate that your company is distinct from you, and that you could delegate the work to another person if necessary.
- Create your own marketing materials to indicate that you are in business on your own account.
- Maintain your own office and place of work. Also invest in software licences, trade literature and professional memberships that are in your own name.
- Maintain business insurance. Having professional indemnity insurance is a good way to demonstrate that you assume “risk” personally and are therefore not just an employee
- Invest in your professional development. Some professions require you to take continued professional development (CPD) to remain qualified. Paying for this yourself supports your contractor status.
- Try to have multiple clients so you are not working ‘exclusively’ for one client or at one place of work.
IR35 tips for businesses hiring contractors
If your business hires contractors, either from time to time or on an ongoing basis, then you should review your relationships with them to ensure they don’t fall inside IR35. As in the case of a contractor, each assignment will have to be assessed on a case by case basis
You will have to issue a Status Determination Statement to your contractors, which makes their IR35 status clear (inside or outside the rules) and explains why. As long as you support your decision with sufficient evidence and file the appropriate tax documents, you should avoid any penalties.
In summary, businesses should:
- Review all their relationships with contractors and/or consultants
- Make sure the terms of their engagement are clear and accurate
- Provide contractors with their Status Determination Statement and make sure each determination is evidenced-based.
- Consider changing some contractors into employees if they fall within the scope of IR35 this is a practical solution for both parties.
Conclusions
The implementation of the new IR35 rules is going to bring an increased number of challenges, and burdens, to both private sector employers and contractors. Private-sector employers may find themselves needing to upscale their HR and legal resources to deal with the increased administrative demands associated with status determinations and managing PAYE employees. It will almost certainly mean that a number of people who have been using a PSC to disguise their true employment status will suffer a financial detriment.
However, the “new normal” and the demands for quick upscaling of talent may mean that the death knell of the PSC is premature. Private-sector employers and contractors may still be able to take advantage of the demand for flexible talent and the opportunities by taking a proactive and more forensic approach when defining their business relationships to ensure that each engagement does not fall within IR35…………….. It may just take a little bit more time and effort than before.
One thing that is clear though. Although the road ahead will definitely be more complex it certainly won’t be boring.
How Aquitas can help you
Aquitas Law’s specialist Employment Law and HR teams can assist in you to review your existing work policies and implement HR solutions that protect your business.
Call us on 0207 099 4444 or email us @ enquiries@aquitaslaw.com for a free consultation.