Arguably the biggest announcement affecting UK employment practices from the 2018 Budget was confirmation that changes will be made to the 'off payroll working rules' (known as IR35) in the private sector. IR35 rules, introduced in 2000, require that individuals who work via a company, such as a personal service vehicle, should be subject to equivalent employment tax rules as directly engaged employees if the reality of how they carry out their work is akin to employment. In other words, if the individual would be an employee for tax purposes if there was no company sitting between the individual and the provider of work, then they should be treated as such when assessing the taxes due on their income.
How IR35 now operates in the public sector
Historically, in such arrangements, it has been the limited company entity that is responsible for assessing whether the arrangement falls within the scope of the IR35 rules and for paying any employment taxes that may be due. Effectively, for 'one man band' limited company contractors, this means it is the liability of the individual's company, not the engager. It was announced in the Autumn Statement in 2016 that for any limited company arrangement where services are being supplied to the public sector, this burden of assessing the application of IR35 and paying the relevant taxes would shift to the public sector engager. This change, which took effect from April 2017, caught numerous arrangements involving the NHS and local government as well as less obvious public sector employers like the BBC. There have since been a number of HMRC investigations and findings of unpaid employment taxes and National Insurance contributions (NICs) which can now be enforced against the large engagers of, often, numerous limited company contractors. This is a much more efficient way of collecting significant tax payments than pursuing individual limited company entities which invariably engage and pay only one or two individuals. HMRC estimates the reform has raised £550 million in income tax and NICs in its first year.
The Government has long had concerns over non-compliance with IR35 in the private sector as many personal service companies will claim that they do not fall within the provisions. Contractors who do not comply with the rules pay significantly less income tax and NICs than an equivalent employee. The cost of non-compliance is estimated by HMRC to reach £1.3 billion a year by 2023-2024.
April 2020: proposed changes for the private sector
Mirroring what is now the position in the public sector, the announced change in the 2018 Budget means that from April 2020, individuals working through their own limited companies will no longer be responsible for determining whether or not IR35 applies. Instead, it would be for the engaging company to decide whether the individual would be considered an employee for tax purposes. If so, the engager will need to deduct PAYE and employee NICs at source and pay employer NICs. It will be responsible for such liabilities, rather than this falling to the individual's limited company. This will potentially affect levels of income paid to individuals, bringing them into "employment" for tax purposes. It will fall to the negotiation of contracts and the commercial bargaining positon of the parties as to who will take the burden of increased tax liability, particularly the employer NICs charge.
Acknowledging perhaps that extricating individuals and businesses from their current tax and contractual arrangements might not be straightforward, the Chancellor indicated that these new rules would be delayed until April 2020 and would only then apply to large and medium sized businesses. It is not currently clear what the test will deem to be a large or medium sized business, but HM Treasury has stated that the 1.5 million smallest businesses will not be affected and the original rules will apply to them in terms of which party must assess the application of IR35 and pay the taxes as appropriate. However, there has been no guarantee that these rules will not be expanded to apply to all businesses at a point in the future following a successful period of it applying only to large and medium sized businesses.
As a result of these reforms limited company contracting arrangements are likely to become a lot less popular with larger businesses, particularly in industries where large numbers of limited company contractors are engaged. These include financial services, IT and business consultancy sectors. Although highly skilled and autonomous professionals may be likely to fall outside IR35 anyway, as they are truly self-employed, many large companies may not be willing to take the risk of an HMRC investigation and potential for a finding of unpaid employment taxes and NICs, penalties and interest. They are likely to move to employing their staff directly instead, making contracting roles with smaller firms where the parties are more likely to agree that IR35 will not apply, more attractive for skilled individuals. This would mirror the exodus of skilled contractors from public sector engagers to private sector businesses which is alleged to have taken place when the public sector changes came into force in 2017, at least in certain sectors such as healthcare and broadcasting.
What businesses need to do now
All companies which engage individuals via personal service company arrangements will need to assess whether they could fall within the definition of a large or medium sized business and start to carry out an audit to assess whether they are likely to fall foul of the IR35 rules. Consideration should be given to reviewing the arrangements, whether by considering terminating them in advance of the change, or renegotiating the arrangements, such as looking to engage the individuals as employees and reviewing payroll arrangements. HMRC's Check Employment Status for Tax ("CEST") tool can be a starting point to make an assessment in respect of specific arrangements. The results of the assessment can be used in support of an assertion that an arrangement should fall outside IR35, as long as there is no evidence that the answers provided have been deliberately misleading. However, the tool in its current form has received significant criticism and the government has confirmed that "enhancements" will be made to support the needs of the private sector and help them prepare to implement the changes.
Responding to the consultation on this issue, the government confirms that "the reform is not retrospective" and "HMRC will not carry out targeted campaigns into previous years when individuals start paying employment taxes under IR35 for the first time following the reform". It will also issue a further consultation on the detailed operation of the reform during the coming months.
