From 6 April 2020, new IR35 rules come into force which mean that medium and large private sector companies in the IT and Tech sector generally will now have to assess whether a person supplied to it by an agency is a disguised employee or a true consultant and notify agencies and the worker. Getting this assessment wrong (whether by the end client or an intervening agency) will mean that that party becomes liable to HMRC for any shortfall in tax that is not received, such as income tax and national insurance. The blog article examines:
- the impact of the new IR35 rules; and
- how to minimise this impact by having suitable contracts in place.
The much heralded IR 35 reforms to the private sector will soon be in place from April 2020. It is one of the biggest changes in contracting procedures to affect UK businesses for many years where contractors are providing services to an end client through an intermediary (i.e.a personal services company (PSC) or agency). In order to minimise the risk of “deemed employment” being held to exist with the requirement to deduct national insurance and income tax, it is vital that contracts between end client and agency and agency and contractor are drafted carefully and consistently and that the actual working practice reflects the written contracts. Getting it wrong could be costly as you may be paying someone else’s tax bill.
The main changes being introduced by the new IR 35 regime are as follows:
- they will affect medium and large enterprises in the private sector, that is any business satisfying two of the following three conditions:
– a turnover in excess of £10.2m;
– a balance sheet of more than £5.1m;
– more than 50 employees.
- the responsibility for assessing whether a contractor is an “employee” will fall to the end client (under the existing law, it is the responsibility of the contractor). The end client will be responsible for providing workers and agencies with a Status Determination Statement (SDS) giving reasons for its decision and ensuring there is an appeals process for agencies and workers to dispute a finding by the end client;
- where the end client decides that there is an employment situation between itself and the contractor, the end client will initially be responsible for deducting income tax, National Insurance and any apprenticeship levy (as well as paying employer’s National Insurance) when it pays the PSC, although this liability will pass down the labour supply chain as each party fulfils its obligations, so that it will be the agency paying the PSC (the “fee payer”) that will have to carry out PAYE procedures);
- there are transfer of liability provisions in place which allow HMRC to seek payment of the relevant PAYE taxes from the end client where the HMRC conclude that there is “no realistic prospect” of recovering these taxes from the agency that should have paid them in the supply chain.
What is the test for employment?
It should be emphasised that IR 35 is a set of anti-tax avoidance rules and regulations and is not meant to affect questions of employment law – accordingly, the existing test as to whether a worker is an employee or independent contractor stays the same. Under the existing law, this is an umbrella test which considers all the surrounding circumstances, the most important of which are:
- Control – the greater the extent to which the end client can direct the worker to do certain tasks, at certain times and in a certain manner, the higher the chance that there will be an employment situation in place;
- Substitution – the inability of a worker to provide a substitute or a substitution clause which is unlikely to be workable in practice result in a greater chance that the relationship will be seen as one of employment and vice versa;
- Mutuality of obligations – is there an ongoing obligation on the end client to provide work to the worker – if so, the greater the likelihood of employment being held to arise;
- Risk and reward accepted by the contractor – the more that the contractor/worker can show that he/she is accepting a certain amount of commercial risk in the relevant assignment, the greater the chance of avoiding the finding of an employment situation;
- Integration of the contractor into the end client’s business – again, the greater that a contractor/worker is regarded as being part of the end client’s personnel, the more likely it is that he/she will be seen to be an employee rather than an independent contractor.
In addition to the above factors, the courts have always made it clear that the actual working practices on the ground will also be highly relevant to deciding whether there is a contractor or employee relationship in place.
Getting contracts right for IR 35
Normally, there are going to be two main contracts which will have a significant bearing as to whether or not an employment relationship is held to arise: the first is the contract between the end client and the agency/intermediary that provides workers and, secondly, it will be the contract between the agency and the worker’s PSC.
End Client-Agency agreement
Following on from the legal test governing employment, it will normally be in both the interests of the end client and the agency to agree upon written terms which avoid excessive control being exercised by the client over the contractor and which allow a reasonable degree of flexibility in relation to questions such as substitution and the way in which services are provided, giving as much power as possible to the agency/worker rather than the end client.
The end client should, as a consequence of the new law, be seeking contractual provisions that:
- oblige the agency to co-operate and provide the end client with reasonable information to allow the assessment and issuing of an SDS;
- allow it the right to decide after an assignment has started that there is an employment relationship in place and to require the agency to enforce PAYE rules;
- allow it to monitor the activity of the agency to ensure that PAYE is actually being deducted from any fees paid to the PSC – otherwise, there is a danger that the agency defaults and, if HMRC cannot recover any unpaid taxes from the agency, it may exercise its transfer of liability powers and seek reimbursement from the end client;
- give it the right to terminate the agreement with the agency on short notice in the event that it later decides that the contractor is actually an employee;
- allow it to take on the contractor directly as an employee and to minimise or avoid altogether any termination fee/compensatory payment payable to the agency in such a situation.
The agency should look for protection such as:
- the right to end the appointment on short notice where the end client decides that a contractor is an employee;
- an obligation on the end client to carry out any PAYE obligations that arise or a clear indemnity to compensate the agency for the cost of doing so if it carries out the PAYE obligations;
- where the bargaining position allows, a requirement that the end client take on the contractor as an employee and requiring a termination payment on the basis that the agency has lost one of its workers.
Agency – PSC/Contractor contracts
In relation to any Agency-PSC/contractor agreements, both parties will have a common interest in having express terms which:
- minimise the risk of an employment situation being held to arise by only allowing minimal control over the PSC/contractor by the agency and allowing substitution reasonably easily;
- also allow the parties to terminate the engagement at short notice if an employment situation is felt to exist (the agency should ensure that this is consistent with its own termination rights against the end client);
- allow the agency to deduct PAYE taxes from the PSC if requested to do so by the end client;
- require the PSC/contractor to provide NI, tax code and related financial data to allow any PAYE deductions to be made;
- in all contracts, the agency should be seeking some form of indemnity whereby, in the event that the agency is required to make PAYE deductions by the end client, any such additional and unexpected costs are indemnified by the contractor (where not covered in the agency – end client contract).
Checklist of key issues
- Are you a medium or large enterprise under the new rules?
- Where is your organisation in the supply chain – to which party is the worker actually providing services?
- Reduce the risk of a deemed employment situation arising by reviewing/amending contract wording and checking that working practices are consistent with the contract.
- Reduce the direct control over the contractor/worker and be as flexible as possible in relation to substitution.
- Make the engagement as much “project-based” as possible rather than time-based – can payment be tied more to deliverables/milestones rather than a traditional time basis?
- Increased monitoring and compliance checks – agencies and workers need to be ready for additional requests for assistance and information from end clients and agencies respectively – do the contracts allow this?
- Increased threat to agencies that contractors/workers will leave and be engaged directly by end clients – minimise the commercial risk by inserting a liquidated damages or compensation clause to minimise loss of revenue.
- Nothing changes for genuine contractors – as they are not employees, they are not governed by the new IR35 rules!
Partner, Moore Blatch
Tel: 020 8332 8631