In addition to bracing for a possible Brexit, another challenge facing medium and large-size UK companies is an upcoming April 2020 mandate to begin assessing whether their contractors should be treated as employees for tax purposes.
With a general election calendared for 12 December, it is unclear whether the anticipated roll-out of the new off-payroll working rules will occur on schedule. Her Majesty’s Revenue and Customs (HMRC) has been urging businesses for months to prepare to meet their new obligations and has said that it remains committed to a spring 2020 roll-out. Under the long-planned rules, organisations must determine whether each contractor is genuinely self-employed and, if it determines instead that the person is employed, ensure that HMRC receives proper payment of taxes and National Insurance contributions (NICs).
A stricter approach
The new rules, frequently referred to as IR35, are designed to ensure that contractors who are working like employees, but through their own limited company, pay roughly the same NICs and tax as individuals who are on an organisation’s direct payroll.
In a nutshell, IR35 will shift responsibility for determining employment status from the worker to the engaging organisation in order to better assure that someone claiming to be self-employed genuinely is.
HMRC says the reforms are needed because, outside the public sector, “only one in 10 people who should be paying tax under the current off-payroll working rules are doing so correctly”. At present, a person earning £50,000 who works through his or her own limited company, but does not follow the rules, pays around £6,000 less (in tax, National Insurance, and employer’s NICs) than somebody performing a similar job as an employee. This includes employer NICs of around £5,000. The difference reflects the fact that NICs are lower for self-employed people than for others.
Smaller employers do not need to worry about IR35, which applies to businesses that meet two or more of the following conditions: (1) more than 50 employees, (2) annual turnover of more than £10.2 million, and (3) balance sheet total of more than £5.1 million. Generally, subsidiaries will be covered if their parent company is.
Perhaps the easiest way to understand the IR35 rules is to ask how they would impact a typical contractor. Imagine that Ted has his own personal service company (PSC) that contracts his services as an IT specialist to a large pharmaceutical company. Under the IR35 rules, the pharmaceutical company will become responsible for making an “employment status determination” of whether Ted is indeed self-employed for tax purposes. If it determines instead that he is employed, the pharmaceutical company will be responsible for deducting and paying his associated taxes and NICs to HMRC.
The rules are slightly more complex if additional intermediaries are involved. Let’s say that Ted’s PSC contracts with an employment agency that, in turn, has a contract with a pharmaceutical company. In this scenario, the pharmaceutical company is still responsible for making an employment status determination. If it finds, however, that Ted is employed rather than self-employed, the employment agency will be the one obliged to deduct and pay Ted’s taxes and NICs to HMRC.
Potential liabilities exist for the pharmaceutical company and the employment agency under the new rules. For instance, if the pharmaceutical company fails to take reasonable care in determining that Ted is genuinely self-employed, it will be responsible for his taxes and NICs. To help companies avoid mistakes in making employment status assessments, the government has created an online check employment status for tax (CEST) tool.
Because disputes may arise, the pharmaceutical company is required to provide an opportunity to Ted and the employment agency to challenge its employment status determination so long as they provide written reasons.
The key point is that Ted will no longer be the one deciding whether he is self-employed for tax purposes. Instead, his employment status will be determined by the client firm (here, the pharmaceutical company). Ted’s taxes and NICs usually will be deducted and paid to HMRC by the entity in the contracting chain nearest his PSC (here, the employment agency).
The IR35 rules are expected to significantly boost the government’s coffers, raising £3 billion for essential public services, including the NHS, over the next four years, HMRC estimates.
Some companies may become reluctant to hire contractors because of the complexity of administering the IR35 rules and potential liabilities. A further concern for companies is whether classifying someone as employed for tax purposes will make the person an employee for all purposes.
Whether the IR35 rules will go into effect on schedule remains to be seen. Last year, at Budget 2018, the government announced that it would expand the off-payroll working rules — which since 2017 have applied to the public sector — to all other sectors beginning 6 April 2020. With a general election now approaching, Chancellor of the Exchequer Sajid Javid declared last month that he will indefinitely postpone bringing forward the 2019 budget.
For now, a challenge for many UK businesses may be planning for the expected IR35 reforms amidst so much other change.
For more information about IR35, visit gov.uk.
— Dave Strausfeld (David.Strausfeld@aicpa-cima.com) is an FM magazine senior editor.