IR35 - Review and Update
In recent weeks more than one client has approached me asking whether it is possible to contract domestic staff using a personal services company (PSC) which has been set up by the individual undertaking the work. In addition, my brother in law has approached me and asked whether a potential ‘employer’ should be asking him to set up a company through which he would work for them.
These are two very different ends of the same spectrum but both queries point to the same issue – IR35 (or more accurately the ‘intermediaries legislation’).
What is IR35?
IR35 refers to a Revenue Budget Press Release dated 9 March 1999. This Press Release became known simply as IR35 and it first published the rules which aimed to counter the avoidance of class 1 National Insurance Contributions (NICs) by the use of intermediaries (such as PSCs) where, if it wasn’t for the existence of PSC, the individual worker would be classed as an employee. Where the IR35 rules apply, the individual is treated as if he were an employee (i.e. the PSC is disregarded and an employment relationship is imputed) and his ‘earnings’ are subject to income tax and NICs. These rules were then codified in law in the Social Security Contributions (Intermediaries) Regulations 2000 and Chapter 8 of Part 2 ITEPA 2003 and are more accurately known as the ‘intermediaries legislation’ but colloquially known as IR35.
The point of these rules is to ensure that an individual who contracts through a PSC pays broadly the same amount of tax as an individual who is employed directly and who does exactly the same job as the individual contracting through the PSC.
Under the IR35 rules it is for the individual who contracts through his own PSC to determine whether the rules apply. HMRC has estimated that around a third of people working through their own companies should fall within the IR35 rules. However, only 10% of this group actually determine that they should be taxed in this way. Given the potential tax and NIC savings, there is incentive for both the individual who owns the PSC and the contracting company to determine that the relationship is not an employment relationship.
In the past year or so the government has sought to tackle this issue. There have been some changes to how the IR35 rules are implemented with respect to the public sector and it is worth now considering where the law currently stands.
Public sector workers
Perhaps ironically, PSCs were frequently used by individuals ‘contracting’ with various branches of the government/civil service/public sector to provide their expertise. Often these relationships were encouraged by the public body in question and may even have been a pre-requisite for the individual to be able to undertake the specific role. Despite public bodies seemingly encouraging these types of relationship, the Treasury and HMRC were increasingly concerned by individuals, who would in most circumstances be considered employees, setting up companies to avoid tax (and more specifically NICs). HMRC referred to this issue as ‘off-payroll working in the public sector’. Contracting with workers in this way was not only attractive from a tax/NIC perspective but also enabled the public body to shrink and swell numbers according to need and without having to go through expensive redundancy processes.
As a result of Finance Act 2017 (‘FA 2017’), such arrangements were removed from what is considered IR35 and a new set of rules were implemented to target the public sector.
Section 6 and Schedule 1 FA 2017 inserted Chapter 10, sections 61K-61X, to Part 2 of ITEPA 2003 to deal specifically with the perceived tax avoidance resulting from the provision of services to the public sector through intermediaries by individual workers. In short, the introduction of Chapter 10 shifted the burden of establishing whether an employment relationship exists solely to the public sector body. The obligation to assess and pay income tax therefore ceases to be with the PSC. The same applies to NICs as a consequence of the introduction of the Social Security (Miscellaneous Amendments No.2) Regulations 2017 (SI2017/313). If the public body determines that an employment relationship exists, despite the use of a PSC, it will be the public body’s obligation to deduct income tax, employee’s NIC and pay employer’s NIC to HMRC.
It is still too early to tell what impact this has had on tax/NICs raised, but HMRC have said that ‘evidence suggests that the reform is increasing compliance’ and estimates that it has raised ‘an additional £410million of income tax and NICs’. This remains to be seen.
What about the private sector?
Perhaps directors of companies in the private sector who contract with individual workers in this way breathed a sigh of relief in 2017 when the government introduced the new rules applicable only to public sector workers. If they did, they were naïve.
In the Autumn Budget 2017 the government announced it would seek to tackle non-compliance with off-payroll working rules in the private sector too. On 18 May 2018 HMRC published a consultation document entitled ‘Off-payroll working in the private sector’ which seeks comments on ‘the best way’ to tackle non-compliance in this area. The consultation remains open until 10 August 2018. HMRC estimates the cost of non-compliance with the IR35 rules in the private sector to be £700million in 2017/18 growing to £1.2billion in 2022/23.
HMRC ostensibly remains open to suggestions as to how this issue should be tackled in the private sector but is specifically seeking views on taking a similar approach to the one adopted for the public sector. It remains to be seen what route HMRC take but don’t be surprised if it is the same as the one taken for public sector workers.
When is a worker in effect an employee?
HMRC helpfully provide an online check that provides a view of whether the intermediaries legislation applies to a given scenario. If the individual answers a number of questions, then the system spits back an answer as to whether the legislation applies or not. The cynic in me assumes that more often than not the answer will be ‘congratulations, you are an employee!’, however HMRC insists that 60% of the time the answer is that the intermediaries legislation does not apply and consequently an employment relationship is not imputed.
It should of course be noted that this ‘employment check’ tool is guidance not law, and ultimately an individual should refer to the case law in this area (which is extensive) in order to determine whether IR35 applies.
The following is a (non-exhaustive) list of the kinds of things to be taken into account when determining whether an employment relationship should be imputed or not:
Can the worker provide a substitute to perform the duties under the contract?
Can the worker decide how the work is done?
Does the worker provide his own tools/equipment?
Can the end client move the worker to a different task (project or location)?
Can the end client decide working hours?
Can the worker choose where they work?
Is the worker taking on any financial risk? How is the worker paid?
Is the worker entitled to sick pay, holiday pay, maternity/paternity pay?
The more power the end client has over the worker (i.e. can insist the specified worker does the job, can tell him where to work, how to do the job and what his working hours are) and the more integrated the worker is with the company (i.e. is entitled to sick pay etc, is provided with the tools to undertake his job and is paid on a monthly basis regardless of whether he has completed his work or not) the more likely an employment relationship will be imputed and IR35 will be at point (or in the case of a public sector worker the Chapter 10, Part 2 ITEPA 2003).
As an aside, the test of whether an individual is an employee or not has far broader implications beyond IR35. If one considers the recent cases brought against Uber and Deliveroo then treating individuals as contract workers when they would meet the requirements for an employment relationship is currently a hot topic with both tax and employment rights implications (unfortunately beyond the scope of this article but nevertheless a point worth noting).
Employing domestic staff?
Returning to the original questions posited by my clients and my brother-in-law:
How does IR35 impact my clients who wish to ‘employ’ domestic staff?
As the law currently stands, because my clients are not public bodies, they are not obliged to establish whether an employment relationship exists, it is for the individual who is contracting through the PSC to do this.
From the contractor’s position, to the extent IR35 applies, a deemed employment income tax charge is charged on the PSC, calculated by reference to the payments made to the service company by the client.
While IR35 posits responsibility for making this distinction away from my clients to the PSC, it would be remiss of me not to point out the changes made to the position of public sector workers who contract through PSCs. This together with the Consultation Document released last month, points to the possible outcome that the burden of establishing of whether an employment relationship exists will in time shift to become the responsibility of the client together with the responsibility for withholding taxes and NICs.
What about my brother-in-law?
Looking at my brother-in-law’s position, he is being pressured into incorporating a PSC in order to take on a role. Although his enquiry was in passing, I intend to recommend to him that he avoids this arrangement, assuming IR35 is in point, he will be responsible for the tax on the deemed employment income received by his company. If he really is a de facto employee he should insist on an employment contract and all the benefits that come with employee status, including pension rights with tax and NICs being deducted from his wage at source under PAYE.
I would point him to the widely publicised case of the BBC presenter Lisa Ackroyd who, despite the BBC insisting that she be contracted through a PSC, nevertheless faced a tax liability of £420,000 after the tribunal found that IR35 applied to her facts.
Whilst HMRC seems happy not to investigate Uber for a potential £1bn in unpaid VAT liabilities, it is increasingly aggressively going after the individual taxpayer who is deemed to be low hanging fruit. Cynically I cannot help but consider this approach may be based on the respective legal resources and political clout of those taxpayers.
In the context of IR35, many individuals have structured their affairs on advice from their accountant with the assurance ‘everybody does this’ (I have heard these words uttered), or at the insistence of a potential ‘employer’ (I refer you back to the Ackroyd case where even after the judgment a BBC spokesman insisted “the use of personal service companies was entirely legitimate and common practice across the industry”).
I am not arguing that these individuals should not pay the tax that is rightly due under the law, but it leaves a bitter taste in one’s mouth when one witnesses the aggressive way in which these types of individuals are pursued by HMRC (who in a lot of cases had no nefarious desire to do anything wrong), when Uber are not even investigated for a potential £1bn unpaid VAT liability.
This is Great Britain. A brave new world.
Nevertheless, the IR35 legislation continues to evolve. We see in the context of the public sector that the burden of determining the kind of relationship that exists with a contractor now lies with the public body. I suspect that in the near future the same will apply to the private sector. It is important that advisers who have clients that use PSCs to contract for work (either as the client or contractor), keep a keen eye on the continuing metamorphosis of IR35.