We have outlined the steps that your company needs to undertake now to ensure that you are prepared for the reforms when they come in.
The legislation governing the reformed rules, which will apply to the public sector and medium and large non-public sector organisations, has now been incorporated into law and will take effect from 6 April 2021.
Based on our experience, it can take several months to prepare for these changes, so it is important for organisations to start preparing now. There are practical steps that you can take in advance, to avoid the risks which can result from a more rushed the process at the last minute. This guide walks through some of the important steps to take over the next few months.
Right now, clients and other parties affected by the new rules should:
The reforms to the off-payroll working rules are coming into effect from 6 April 2021. The first thing for organisations engaging off-payroll workers to do is to consider whether they might fall within the new rules.
The reforms will only apply to clients who are:
For public sector bodies, generally, the organisation will be subject to the rules if they are a public authority as defined by the Freedom of Information Act 2000.
For non-public sector organisations – this includes voluntary sector organisations, such as charities – the rules will only apply to those who are medium or large.
Most organisations (corporate entities), such as companies, limited liability partnerships and unregistered companies, will need to consider the three-pronged test. Entities will be medium or large if, for two consecutive financial years, they meet at least two of the following criteria:
Non-corporate entities, including partnerships or sole traders, will need to simply consider the ‘turnover test’ (whether the £10.2 million limit is exceeded) in the previous year to determine whether the rules apply.
It is important to note that the exemption for small organisations applies only for small clients. If the client is medium or large, the size of any agencies or other parties in the labour supply chain is irrelevant.
If a client is ‘wholly overseas’, the reformed off-payroll working rules will not apply. ‘Wholly overseas’ means that the client is not UK resident and does not have a permanent establishment in the UK.
If the client is medium or large (or a public sector body), and is not wholly overseas, then it will need to consider the following steps to determine what obligations it may have.
Having determined whether the off-payroll working rules could apply, the next step is to determine whether any of the arrangements with workers could be subject to the rules.
In an ideal world, clients will have now identified many of the workers providing services while being paid gross amounts, i.e. off-payroll. Although of course those with a more fluid workforce may not have even engaged with off-payroll workers who may provide services in the coming tax year. As soon as is practically possible, the client should consider whether the worker is working through an ‘intermediary’. This term is defined by the legislation and can be any of the following:
The legislation is to be amended prior to 6 April 2021 to clarify the definition of an intermediary. We understand that it will reflect the following.
Not all of the organisations referred to above will automatically be classed as an ‘intermediary’. If the circumstances do not fall within one of A to C below, the IR35 rules will not apply.
A. An company will be an ‘intermediary’ if:
B. A partnership will be an ‘intermediary’ if:
C. An individual will be an ‘intermediary’ if:
If the off-payroll working rules could apply, clients will need to consider their risk appetite and organisational need to retain the workers who could be in scope of the rules. This process is likely to involve all functions and departments to make decisions on how to react to the changes in the rules.
Organisations who are risk averse are more likely to accept that the rules apply to the arrangements with workers or could change the way workers are engaged to remove the obligations and risks that the IR35 rules carry – this could include:
Each of these alternatives will have pros and cons, and should be carefully considered before being chosen as an alternative to engaging workers through a personal services intermediary.
When making these decisions, organisations will need to consider their commercial requirement to continue engaging with these workers beyond 5 April 2021. In addition, the value of contracts and costs may change if the rules do apply.
Budgets set for departments will need to be carefully thought through before deciding on future engagement methods for flexible workers, given both higher costs in terms of new employers National
Insurance Contributions and the impact on apprenticeship levy liabilities but also in terms of increased administration requirements. This is particularly the case where off-payroll workers are more common in specific departments.
It is unlikely that one function within an organisation can make these decisions on their own. It is extremely important that all relevant business functions are involved in the decision-making process.
In our experience, organisations who were most successful in preparing for the changes planned for April 2020 were those who:
To prepare effectively for the reforms, organisations should take a holistic approach to identifying off-payroll workers and whether the rules apply to each of them.
Once engagers have identified the workers who are providing their services through a relevant intermediary, the employment status of these workers must be determined; this should done on a case-by-case basis in order to meet the requirement in the legislation for the engager to use ‘reasonable care’ when undertaking this exercise.
To determine whether the IR35 rules apply, the client must look at the relationship between themselves and the worker. If the worker would be an employee of the client if they were contracted directly, the IR35 rules apply. If not, the engagement is considered to be “outside IR35” but certain steps must still be undertaken.
When doing this, normal employment status principles are used. However, this isn’t as straightforward as it sounds. The employment status principles are based on case law that have developed over a number of years. Ultimately, clients will need to consider a number of factors and ‘paint a picture’ as to whether the worker would be an employee if contracted directly. This can be extremely difficult and is a subject that experts are continuously debating with HMRC.
The most commonly used and most talked about source of help is HMRC’s Check Employment Status for Tax tool (also known as CEST). This is an online questionnaire that, when completed, provides
HMRC’s view on the employment status associated with the engagement. This service is free and HMRC will stand by the results of the tool if the information entered into it is accurate and complete.
However, the tool is quite basic and reflects HMRC’s own view of the arrangement: recent tribunal judgements illustrate that HMRC’s view isn’t always correct, particularly on key parts of the evolving case law. The other major downside is that for many borderline cases, the online tool will produce an ‘unable to determine’ result, leaving clients to make the ultimate determination which may mean they need to obtain professional assistance.
HMRC also has a wealth of material included in their Employment Status Manual, which, although helpful in understanding how employment status is determined, is not too useful in ‘painting the picture’ case law requires to arrive at a determination.
Some tax advisors and other websites have produced their own tools to produce an employment status determination. Of course, these tools do come at a cost, and it isn’t clear how much they actually differ in practice from HMRC’s free tool. And if they do differ, HMRC is not bound agree with the determinations.
Rather than relying on an automated tool, which is unlikely to pick up the nuances of each worker’s particular circumstances, many will find that a professional view of the employment status is extremely useful, particularly in borderline cases. This will allow the client to rely on an expert view and will also go a long way to show that the client has taken reasonable care when considering IR35 – this is important to minimise any potential liability and something we will come to in a later step.
With IR35 specialists in our Employment Tax team at Crowe, we are able to assist in making determinations on behalf of clients.
The full range of responsibilities for clients will depend on two things:
However, in this step, we will cover the responsibilities that all clients have, regardless of the above scenarios.
As we have explained earlier, it is the client’s responsibility to determine whether the IR35 rules apply, based on whether they would be an employee if engaged directly. However, this determination should not be taken lightly. Clients are required to take reasonable care when making this determination. This could include using HMRC’s CEST tool in line with their guidance or seeking a professional view on the determination. If HMRC deem that reasonable care has not been taken, the client could be liable for any income tax and NICs due.
Regardless of whether a worker is subject to the IR35 rules or not, the client must provide the worker with a Status Determination Statement (SDS). This is a written statement that confirms that the IR35 rules have been considered and states whether in the client’s opinion the rules do or do not apply, along with the reasons for that determination.
The SDS should be passed to the worker and, if applicable, the agency that the client contracts with for the worker’s services. We also advise that it is sent to any other parties in the labour supply chain, for completeness.
Once the SDS is passed to the worker and other parties, they are entitled to disagree with the conclusion that has been reached. They must do this is writing (or via email).
If a client receives a representation from a worker, or other party in the labour supply chain, they are required to respond within 45 days of receiving it. If the client does not respond in 45 days, they will be liable for any tax and NICs liabilities until they do respond.
The response must state whether the original decision still stands or whether it has changed, along with the reasons for this decision and whether it has changed, the fee payer (if different to the client should also be informed).
Clients should ensure that an efficient process is in place to receive and deal with disagreements from workers. This can include a dedicated email address for disagreements and a clear end-to-end process for considering and responding to disagreements.
Similar to the disagreement process, workers or other parties are entitled to ask a client whether they fall into the small or medium/large category for IR35 purposes. If they do, the client will have 45 days to respond to this request.
Similar to the disagreement process, a process should be put in place to respond to such requests. If the request is not responded to within the time limit, there are no tax consequences. However, the requestor can take out an injunction to require the client to provide this information, which is clearly something that all clients would prefer not to happen.
The responsibilities covered in step 5 are fixed, regardless of whether the off-payroll working rules actually apply. If the off-payroll working rules do apply, another set of responsibilities then come into play, which will differ depending on the make up of the labour supply chain.
Generally, the fee-payer is the person who pays the worker’s intermediary. The fee-payer is the entity responsible for deducting and paying the appropriate income tax and NICs to HMRC.
In a simple labour supply chain – where the client contracts with and pays the worker’s intermediary directly – the client will also be the fee-payer. In this scenario, the client will provide the worker with the Status Determination Statement (see step 5) and will also deduct and pay the appropriate taxes before paying the worker’s intermediary, i.e. they are the deemed employer.
Where other parties (e.g. agencies) sit between the client and the worker’s intermediary, the deemed employer will usually be the party who pays the worker’s intermediary. The main exceptions are if:
In these scenarios, the deemed employer is the lowest entity in the labour supply chain that doesn’t come within any of these exceptions. Therefore, if the client doesn’t issue a SDS, they will always be the deemed employer, regardless of what the labour supply chain looks like.
On the other hand, if a fee payer is expecting to receive a SDS but do not, then they can pass on any outstanding payments to the next party in the labour supply chain without deducting tax or NICs. However, it is recommended that they enquire with the party above them in the labour supply chain as to why they have not provided a SDS.
The deemed employer is responsible for deducting and paying the appropriate income tax and NICs to HMRC; the income tax and NICs due is calculated in a similar way to that when the worker is an employee, but there are some more complex steps to take, including how to deal with VAT and expenses paid by the intermediary. Similarly, the deemed employer may also be responsible for paying the apprenticeship levy on the payments too.
If the deemed employer is responsible for employment taxes, are they also responsible for the employment rights of the worker? The short answer is no.
While the worker is essentially treated as an employee for tax purposes, if they continue to work through their own intermediary (such as their personal service company) they are not an employee of the client for employment rights purposes.
This means that the worker is not entitled to any traditional employment rights. In addition, the deemed employer is not responsible for deducting any student loan repayments or paying statutory payments, and the worker should not be included on any pension schemes arranged via auto-enrolment. The worker should ensure that any such applicable payments are made via their own intermediary.
Picture a scenario where a client meets all of their responsibilities: they identify a worker, determine that the off-payroll working rules apply and provide a SDS to the worker and to the agency they contract with for the worker’s services. You might think that because the client has done all they should that they won’t end up being liable for the tax and NICs liabilities, right? Wrong.
A particular point of note is the rule on ‘recovery from other persons’. This is a power that allows HMRC to collect the tax and NICs liability from other parties higher up in the contractual chain if “there is no real prospect of recovery within a reasonable period” from the deemed employer.
The power allows HMRC to instead collect the liabilities from:
The legislation that contains this power is very broad and could be used in a wide range of circumstances. However, HMRC’s guidance on this subject does provide more detail on when HMRC intend to use the power.
The guidance states that HMRC will not seek to recover from agency 1 or the client where the failure to account for tax and NICs by the person who should initially have paid it (the deemed employer) is as a result of a genuine business failure on the part of that person. The guidance provides some examples of what is and isn’t genuine business failure.
This means that HMRC will instead be looking to use this power when the failure to pay by the deemed employer is as a result of tax avoidance or deliberate non-compliance, even in the event that the client or agency may not have had knowledge of this.
This power may be seen as unfair, however it is unlikely to change, so it is essential that clients and agencies are aware of who they are contracting with and can assure themselves that agencies in the labour supply chain are acting faithfully and are compliant.
The additional cost of undertaking this due diligence is likely to be outweighed by any unexpected income tax and NICs liabilities that a client could face if HMRC decide to apply this power.
As we have covered, the changes to the off-payroll working rules come into effect from 6 April 2021. Therefore, it might seem strange to be asking the question as to when the rules really kick in.
However, what if a worker completes their work before 6 April 2021, but the client pays for the work after 6 April? Or if a worker is contracted prior to 6 April 2021, but continues their work after 6 April? It is important that clients and employers are aware of when the rules actually take effect in practice.
Starting with the most obvious scenario, where a worker contracts with a client to provide services on or after 6 April 2021 onwards, and they are paid for those services on or after 6 April 2021, the reformed off-payroll working rules will apply.
Next, we consider the scenario where a worker provides their services to a client wholly before 6 April 2021, but the payment for the services is made on or after 6 April 2021.
In this scenario, as the services were completed before the commencement date, the reformed rules do not apply to the payment, even though it was made after 6 April 2021. The only exception to this is if the client is in the public sector.
If a worker contracts for a client for services that are performed both before and after 6 April 2021, and is paid for those services after 6 April 2021, then the part of the payment that relates to the service provided on or after 6 April 2021 will be subject to the reformed rules.
The payment should be apportioned on a just and reasonable basis. For instance, if a worker agrees a contract with a client for £2,000 and as part of that, works 5 days before and 15 days after 6 April 2021, then the reformed rules will apply to £1,500 of the payment.
The legislation states that the rules only apply to payments made on or after 6 April 2021 for services performed on or after 6 April 2021. Therefore, in theory, payments made in advance of 6 April 2021 for services due to be provided on or after 6 April 2021 will not fall within the rules.
Rules governing the way in which off-payroll workers are taxed were introduced in 2000 and were set out in an HMRC document known as ‘IR35’ which has given them their name. IR35 comprises a set of tax rules that are designed to address the lower amounts of tax and National Insurance Contributions (NICs) being paid by certain workers, and the firms hiring them. The rules apply when a worker supplies their services to a client via an intermediary, such as a limited company, in circumstances such that they would be an employee if they contracted directly with the client.
Currently, it is the responsibility of the intermediary to determine whether the IR35 rules apply and pay the appropriate amount of tax to HMRC.
HMRC believe the existing IR35 legislation is not working effectively, and “non-compliance is widespread". They estimate that only 10% of intermediaries that should apply the legislation actually do so. As a result, the government reformed the off-payroll working rules (IR35) in the public sector from April 2017, and have now legislated for similar changes to working arrangements in the private sector. These reforms were intended to take effect from 6 April 2020, but the government deferred their introduction due to the COVID-19 disruption until 6 April 2021. It is very unlikely that there will be any further deferral.
Under the new rules, the responsibility for operating the off-payroll working rules will move from the worker’s intermediary to the ‘client’ (the organisation engaging the worker).
Broadly speaking, the reforms will require medium and large private (and other) sector organisations to identify and review the employment status of all workers engaged through intermediaries, including those workers provided via an agency or third party. If the client determines that the rules apply, the worker will be treated as a deemed employee for tax and NICs purposes from 6 April 2021.
We can assist helping organisations review their engagements with off-payroll workers, by producing detailed employment status reports which help minimise risk where the position is not clear. For further advice contact Caroline Harwood or your usual contact partner.