IR35 reforms in the Private Sector
Background to the reforms
The IR35 legislation (“IR35”) was introduced in 2000 with the principal aim of removing the tax advantages for individuals providing their services via intermediaries (such as their own personal service companies) who are not genuinely self-employed. These so-called ‘disguised employees’ work in the same way as employees but pay less tax.
Despite various amendments to IR35 over the years, successive Governments have claimed that numerous contractors in the U.K. who are engaged via intermediaries in this way are still illegitimately working outside the IR35 rules.
The Government hopes that the introduction of the new ‘off payroll’ rules for contractors working in the public sector in 2017, and the extension of these rules into the private sector from April 2020, will address this issue.
What are the private sector reforms and why are they controversial?
From April 2020, medium and large private sector businesses will be responsible for determining the IR35 status of their contracted workers, rather than contractors being responsible for determining this themselves. Where a contractor is deemed by the business to fall ‘inside’ IR35, the business (or the agency or third party paying the contractor) is required to deduct employees’ NICs and income tax from the contractor’s pay, and to pay employers’ NICs.
This move is an extension of the same reforms which were introduced into the public sector in April 2017. The public sector reforms have been heavily criticised by numerous industry bodies in light of the widespread issues that have been associated with their rollout. Many of the reported issues have related to the accuracy of the online ‘CEST’ (Check Employment Status for Tax) tool launched by HMRC - essentially, a series of questions which, when completed, gives a determination as to whether an engagement is considered to be ‘inside’ or ‘outside’ IR35. CEST has been widely criticised as not properly taking into account the specific issues that arise from this form of work and for being biased towards a finding that IR35 does apply (or, in many cases, failing to produce any answer at all, meaning that businesses have still had to determine the contractor’s IR35 status using normal employment status tests). Another criticism of the public sector changes is the speed at which they were introduced. As organisations had little time to prepare, it is understood that many panicked and applied a “blanket” approach of assessing all contractors as falling inside IR35 irrespective of their true employment status.
Introducing the same rules into the private sector could result in similar issues and will undoubtedly result in significant administrative burden and additional costs for medium and large private sector businesses with a contracted workforce. We understand that whilst CEST will be available for private sector businesses to use, HMRC will be carrying out a review of the tool to improve its operation and effectiveness in advance of April 2020.
How are the new rules likely to apply in practice?
In March 2019, HMRC launched a further consultation to provide guidance on how the reforms will be rolled out to the private sector. This is due to close for comment on 28 May 2019, following which a summary of responses will be issued.
We will keep you updated on the finer detail of the changes once further guidance is published.
What can businesses do to prepare?
Key considerations for businesses preparing for the implementation of the new rules are likely to include the following:
(i) Existing contracts with intermediaries (including personal service companies and umbrella companies) that are likely to still be in place by April 2020 should be identified and reviewed. Where IR35 is likely to apply, consideration should be given as to who should bear the additional associated costs. This may, for example, depend on the importance of the individual contractor to the business and the changes required to relevant contracts.
(ii) Robust procedures will need to be in place and relevant staff trained on the rules in readiness for April 2020 to assist in assessing each contractor’s true IR35 status.
(iii) Internal systems will need to be reviewed to ensure they can cope with the changes. Payroll and accounts payable systems will need to be assessed to ensure they are able to communicate with each other, and HR and on-boarding policies may need to be updated.
(iv) The cost of contingent labour is likely to increase, as it has in the public sector (it is estimated that the annual hire cost of a contractor in the private sector will increase by approximately 12%). This is because contractors are likely to request increases in daily or hourly rates to compensate them for the impact of tax and NIC contributions being deducted at source. As a result, some businesses may wish to reconsider (and potentially reduce) their reliance on contractors engaged via intermediaries generally, and instead look to engage them directly and be subject to PAYE.
One thing for certain is that if the upheaval caused in the public sector by these reforms is anything to go by, the private sector is in for a challenging readjustment to the new rules.