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Key points
- From April 2020, medium and large private sector firms will be responsible for determining the employment status of contractors.
- Is there any chance of a last-minute review of the implementation of the new rules?
- About 170,000 contractors are expected to be affected. yielding extra revenues of more than £1bn in 2020-21.
- The changes could lead to loss of contractors and increased business costs.
- Could the new rules also dampen entrepreneurial activity?
- Employers may take a broad brush approach rather than reviewing individual contracts.
Many business and contractors fear that the upcoming changes for off-payroll workers in the private sector will prove disruptive and costly. However, the government’s stance to date has been that these changes are necessary to increase compliance with the existing IR35 rules. Although hopes have recently been raised that the newly installed government might review the changes, businesses have no choice but to prepare for them as a matter of urgency, since their scheduled implementation is just weeks away.
The government policy paper setting out the changes explained the stated objective of the IR35 rule changes as follows:
‘To ensure fairness between individuals working in a similar way. To increase compliance with the existing off-payroll working rules in the private and third sectors, medium and large engagers will become responsible for assessing an individual’s employment status and deducting the right tax and National Insurance contributions.’
However, during the recent election campaign, the now ex-chancellor Sajid Javid pledged that the next Conservative government would review the IR35 rule changes. Speaking on BBC Radio 4, he said: ‘One thing in particular that I want to look at again are the proposed changes to IR35 … I want to make sure the proposed changes are right to take forward.’
Chris Bryce, CEO of the Association of Independent Professionals and the Self-Employed (IPSE), welcomed the prospect of such a review, saying: ‘We campaigned hard against the disastrous changes to IR35, and we will be holding chancellor Sajid Javid to his promise to review them. To truly support the self-employed, this government must also halt the changes, which are due in April, while a full review is carried out. Time is short: the new Conservative government must act now to protect this vital sector.’
The Conservative Party manifesto did not specifically mention the IR35 issue, although it did pledge a review as to how to better support the self-employed more generally. It remains to be seen whether Javid’s off-the-cuff remarks will translate into a meaningful review of the IR35 rule changes. However, as it stands, companies have no choice but to prepare for the impending changes.
Changing responsibilities
The IR35 rules were first introduced in 2000 to require individuals who were working like employees, but through an intermediary, such as a company, to pay similar tax and National Insurance as employees. However, it was for the contractors and intermediaries themselves to assess whether the IR35 rules applied to them. The result was that many determined that IR35 did not apply and HMRC simply lacked the resources to tackle non-compliance in this area effectively because this would have meant examining the nuanced detail of each contractual relationship.
The Finance Bill 2019-20, which incorporates the proposed changes in respect of IR35, is now making its way through a new parliament. The changes as currently set out mean that from 6 April 2020 the responsibility for assessing whether they ought to operate PAYE on contractors’ earnings in the private and voluntary sectors is set to shift to medium and large companies that employ contractors. This mirrors changes already made in respect of public sector contractors in 2017, which shifted responsibility for assessing the application of the tax rules from the contractor to the public sector body. The new measures are expected to affect some 170,000 contractors, and those who employ them.
HMRC has estimated that the introduction of the revised rules in respect of the public sector in 2017 netted an additional £550m in income tax and National Insurance contributions in the first year alone. The department estimates that the new measures will increase its revenue by £1.165bn in 2020-21, with increases in revenue continuing to accrue long into the future.
HMRC says the measures are necessary to tackle what it calls ‘disguised employment’, where people who, in effect, work as employees, operate instead through companies and wrongly assess themselves as being contractors outside the IR35 regime. HMRC estimates that as few as one in ten private sector contractors are compliant with IR35. The practice can suit both companies and contractors. Companies can avoid National Insurance contributions, holiday pay and all the other costs and obligations associated with having an employee. Contractors, meanwhile, achieve greater flexibility and a higher net income.
Be prepared
Many businesses are unprepared for the upcoming changes, and some have called on the government to delay the implementation of the new rules. Some are concerned that if they assess a contractor as being taxed as an employee, they will simply move to a competitor that takes a more favourable view as to their status. There is, after all, a fair amount of room for interpretation when it comes to assessing whether a worker is within the off-payroll working rules. Indeed, the complexity of the rules is such that an additional cost to businesses may well be the legal or other advice required to interpret them correctly, in respect of each particular contractual situation.
Another fear businesses have is of their cost base increasing as a result of the changes. Contractors are expected to seek higher rates if they are to be taxed as employees, arguing that wage increases are necessary to compensate for the reduced take-home pay that PAYE inevitably implies. Indeed, this fact is explicitly recognised in the government policy paper introducing the measures. It states:
‘This measure is expected to impact 170,000 individuals working through their own company, who would be employed if engaged directly. Those who are complying with the existing rules should feel little impact. The measure is targeted at individuals who are not compliant with the current rules. These individuals will be required to pay tax at the correct levels and will therefore face additional tax liabilities. For individuals who were previously non-compliant, adhering to the off-payroll working rules could have an impact on the disposable income available to them and their families.’
The broad brush approach
The new rules carry risks for employers. Those that fail to make a determination, or make a determination with which HMRC later disagrees, risk having to pay the arrears and penalties. As a result, many big businesses are reacting to the proposed rule changes by taking a broad-brush approach. Major banks including Lloyds, Barclays and HSBC are reported to have already told many of their contractors that they will have to go on payroll to secure compliance with the new regime.
This year, the pharmaceutical giant GlaxoSmithKline (GSK) found that some 1,500 of its contractors had been contacted by HMRC regarding possible non-compliance with the IR35 rules. Its response to the proposed rule changes has been to require all contractors to re-engage with the company as employees. An email recently sent to contractors is reported to have given them a stark choice, saying bluntly that ‘GSK will not extend the contracts of any workers who operate through their own personal services company in the agency worker category beyond March 2020.’ The email went on to say: ‘This change means that those of you who work through a personal services company will have a choice to make over the coming weeks – to move to a PAYE contract and remain working with GSK, or to complete or terminate your existing contract.’
Changing status for workers
Clearly, HMRC would be happy to hear of the approach taken by major companies. Rather than reviewing the details of each contractual relationship, they are requiring swathes of contractors to become employees. Needless to say, this will have an affect beyond the area of taxation. Contractors who work through intermediaries and who are within the off-payroll working rules will pay much the same tax as employees, but they will not automatically become employees or gain employment rights.
Employees have significant legal rights which self-employed or intermediary contractors do not have, including protection from unfair dismissal and rights to redundancy pay and consultation. Some contractors may enjoy lesser rights as ‘workers’, such as holiday pay, sick pay and paid parental leave. Changes to tax status under the off-payroll working rules need not mean that consultants become employees, but the tax benefits of working through an intermediary company will have been lost and few employers would require intermediary companies just to avoid employment rights. Some workers prefer to take their own chances with their own businesses, but many would welcome the security of employee status.
Implications for employers
Having employees instead of contractors makes it more difficult for businesses to reduce headcount during a downturn, but that reflects the long-established policy of protecting staff who are made redundant and providing some security. Moving to employment status will carry costs and risks for businesses in terms of their flexibility and ability to weather change. Further, if large numbers of contractors with their own companies are suddenly made into employees, this could be detrimental to the UK’s culture of entrepreneurship. If someone with their own company is required to become an employee of their main client, it may make sense for them to wind up their company and to cease pursuing new clients and new business ideas.
Inevitably, there are grey areas where contractors with their own small businesses begin to work regularly for certain clients. Requiring ever more people in this category to become employees could disincentivise people from expanding their small businesses. And companies may be deterred from using small business suppliers of services for fear of finding that the relationship drifts into disguised employment and lands the employer with a tax bill.
The complexity of the IR35 rules is demonstrated by a recent case involving BBC presenters Joanna Gosling, David Eades and Tim Wilcox (Paya Ltd, Tim Willcox Ltd, Allday Media Ltd (TC7377)). Their dispute with HMRC ran for eight years, before the High Court eventually, in September 2019, ordered that they must pay HMRC £920,000 after their contracts were found to have fallen foul of IR35 rules. The case follows another recent high profile case involving ITV presenter Lorraine Kelly, who won her case (Albatel Ltd (TC7045)). If highly paid TV presenters and their expert advisers cannot get IR35 right, what chance does an ordinary IT contractor have?
Scope and perceptions of the new rules
Small companies are in the fortunate position of being exempt from the proposed changes – for now, at least. The criteria are that a small business does not have two or more of:
- a turnover above £10.2m;
- a balance sheet of more than £5.1m;
- more than 50 employees.
A survey by Hays UK and Ireland during the summer of 2019 revealed the extent of the confusion, lack of awareness and negative perceptions of the off-payroll working rule changes among the business community. The survey garnered 31,598 responses. 11,047 of the respondents were deemed to be ‘employers’ and 20,551 were deemed to be ‘employees’. It found that more than a third of private sector organisations using contractors were unaware of the proposed changes.
Only 43% of medium and large private sector organisations had begun preparing for the changes by last summer. 56% of respondents were concerned about a resulting loss of key talent, while 68% thought the greatest risk posed by the rule changes was cost increases.
HMRC support
HMRC says that it is providing support and workshops to help businesses deal with the new changes. It is also providing new online guidance, including its updated but much-criticised check employment status for tax (CEST) tool (tinyurl.com/zg4ufoc).
CEST has been shown to produce results inconsistent with legal decisions on off-payroll working and still does not give weight to mutuality of obligation, which the cases show is important. HMRC’s interpretation of the relevant rules can also be at variance with that of many legal and tax advisers, potentially leading to more expensive disputes, or employers erring on the side of caution and abandoning beneficial economic arrangements due to the risk of challenge.
Conclusion
It is entirely legitimate for HMRC and the government to take steps if they believe there is tax avoidance and evasion, resulting in substantial losses to the exchequer. The reason for the controversy is the uncertainty over who should be treated and taxed as an employee.
Ideally we would have a simple and clear definition of an employee. That challenge has eluded successive governments over decades. HMRC is unlikely to want rigid rules that could be avoided. But if the changes are to go ahead, as seems likely, clear and effective guidance for companies and contractors is vital to make any new rule changes less disruptive and costly to business at a time of economic fragility and political uncertainty.
