We have been asked a lot of questions about the changes to the “IR35” rules which came into effect earlier this year. As the dust settles on the new rules, this article looks again at these changes and their impact for organisations engaging with individuals who work through a limited company. Although the changes currently only apply in the public sector, in our view it is likely that the new rules will be extended to cover the private sector in due course – so private sector organisations entering into this type of engagement should also take note.
The taxation of intermediaries rules (better known as "IR35" after the Inland Revenue Budget Notice 35 in which they were announced) were introduced in 2000 with the aim of requiring individuals who work through a limited company (and are supplied by that company in an employee capacity) to pay the same amount of tax and NICs as employees.
The rules enacted essentially require the engaged company to pay 95% of the value of its invoices to the employee concerned under PAYE when that employee works for the engaging business in an employee capacity, leaving the remaining 5% to cover the general administration costs of the company.
The new rules
These rules have been changed with effect from April 2017 where the engaging organisation is part of the public sector.
The key changes are that where an individual is supplied via a limited company to a public sector body, and is working in an employee capacity for that body, then the public sector body will need to operate PAYE on 100% of the value of the invoice and so pay it under deduction of tax and NICs. Likewise if the public sector body engages the company via an agency or other third party, then that agency or third party will have to operate the PAYE instead. This results in the additional cost of Employers NICs for the engaging organisation, as well as the worker effectively probably paying more in payroll taxes.
These changes have been implemented because HMRC believe there are many small companies supplying owner directors in an employee capacity who still reward them through dividends rather than through a salary paid under PAYE. They believe the public sector needs to lead the way in managing this properly.
HMRC Employment Status Indicator
In order to help the public sector decide when a contractor is an employee for tax purposes HMRC have made some adjustments to their online Employment Status Indicator tool to cover the new “IR35” rules. This can be accessed here.
This tool is not without its problems and many believe that it is biased towards suggesting people are employees rather than self-employed. However, it can nonetheless provide a helpful (albeit certainly not definitive) indicator as to which side of the line an individual is likely to fall.
Key factors in determining employment status
For a more definitive answer, you need to go back to the legal tests for self employment established in case law, the usual starting point being the case of Ready Mixed Concrete (South East) Ltd v The Ministry of Work and Pensions. This case determined the three key tests as being:
- Is there a master/servant relationship between the engaging organisation and the worker? Broadly speaking can the worker be told what to do and where and how to do it? I.e. “control”.
- Is there a right of substitution that could reasonably take place? I.e. can the worker reasonably send someone else to do the work for them?
- Are the other provisions of the contract consistent with a contract of service?
HMRC’s preferred approach can be one where other factors - such as who supplies equipment and level of integration into an organisation – have equal weight to the tests of control and substitution, but this is not the correct approach. We would recommend a right of substitution as the easiest test to include in a contract – but of course that needs to be a right that could reasonably take place. HMRC have been known to suggest that the right must actually take place which is again not strictly correct.
In one sense, nothing need change for the informed public sector body engager of personal service companies. They should ensure (so far as possible) that their contracts with their service companies enable the engagement to meet the “Ready Mixed Concrete” test and that therefore the workers supplied through those companies are supplied on a self employed basis. In which case the new Intermediaries tax rules will not apply and the engaged companies can be paid gross as before.
However, there has undoubtedly been a mood change and a move away from the “self employed” model in recent times (consider, for example, the various recent high profile cases in relation to the “gig economy”). More organisations are considering bringing consultants onto payroll who previously they might not have considered to fall within the “IR35” rules. While this removes the risk of falling foul of “IR35”, employers should be aware of the additional cost of employer NICs it will mean. It is also important to be aware that the fee paid to any consultants being brought onto payroll will also count towards the Apprenticeship Levy.
Where organisations wish to continue contracting with companies on a self-employed basis the ideal model is to have in place a “statement of work” setting a fixed price for the delivery of a specified project, not an agreement where the fee is based on hours or days spent (or materials used).
In case HMRC should disagree with an organisation’s analysis that self-employment genuinely applies, we would always recommend that the contract with the company includes a well-drafted indemnity clause so that tax can be re-charged to the company if necessary. Bear in mind, however, that employer NICs can never be passed on from the employer.
Posted on 09/06/2017 in Legal UpdatesBack to Knowledge