After the government’s postponement of the IR35 changes, the off-payroll legislation in the private sector reforms are now imminent. The focus of decision-making and tax liability moves almost universally away from the contractor to end clients and recruitment agencies.
Thankfully, with just over four months until the ’go live‘ date, there is still time for end clients and fee payers to prepare and potentially avoid some of the potential downsides to the changes.
This article considers the reactions and trends as well as what end clients and agencies can do to make the best of the off-payroll legislation.
HMRC’s objectives and their potential effect on the labour supply market
To create a level playing field, where you do not have two individuals working side-by-side doing the same job with one being taxed as an employee and one being treated as an independent contractor.
HMRC had estimated that only 10% of the contractor population was treating engagements as “inside IR35” and if that wasn’t properly addressed it would cost the Treasury up to £1.3bn per year by 2023-24. Their target is to increase the 10% to a third of all engagements being deemed inside IR35.
HMRC believed that the changes would affect approximately 60,000 medium and large-sized end-client engagers and potentially 20,000 agencies. In terms of contractors, the changes were being sold as 170,000 contractors having less of an admin burden – presumably because a lot of them would be closing their PSCs.
Why? Because it made no financial sense for contractors to continue trading on ‘inside’ engagements though their PSCs because they lost the notional 5% allowance, which left them unable to set off the expenses of running their own company.
Now that the allowance will also disappear in the private sector from April 2021, the same will be faced by contractors, although the move by contractors to close their PSCs has also been accelerated by the actions of private sector end clients.
It seems highly likely that due to some of the reactions of end clients and the general antipathy of many of the 60,000 to address the legislation, that HMRC is well on its way to achieving its target, but probably not in the way that it intended.
End clients: choices to be made
It is clear that many end clients (and fee payer agencies) were not fully prepared for the March 2019 introduction date and were saved when the Government announced the deferral of the legislation.
Yet where end clients did take action, they fell into two camps:
Camp 1 is the end clients who were prepared to embrace the changes because they recognised that they would need to retain the best resources and some of the best talent will want to remain as independent freelancers and continue to trade through their limited companies.
Camp 2 are those – particularly in the banking sector – which sought to side-step the issue and only offer “employed solutions”, as below:
- Take contractors on as staff
- Offer fixed-term contracts
- Engage individuals as agency employees
- Engage via umbrella companies
There has been no doubt that this resulted in increased business for umbrella companies and it also meant a significant loss of take-home income for contractors who generally were not able to negotiate increased rates to compensate.
Also interesting is that many organisations which made their decisions prior to the deferral, continued down that path irrespective of the fact they could have waited another year. This poses a question – by limiting the options to employed outcomes, will these end clients lose out on the best talent?
Even where businesses were addressing IR35 status, it became evident ‘inside IR35’ decisions were being favoured in the majority of engagements and where we did see status determination statements that had been issued. These did not seem to meet the requirements of reasonable care.
Remember, failure to take reasonable care would mean the client has the responsibility for the deduction of tax,NICs and payment of apprenticeship levy and paying these amounts to HMRC. This would be the case even if another party had already made deductions in line with the original determination.
More recently, we have become aware of a trend in construction for end clients to favour engaging contractors on a self-employed basis,- typically with a commercial contractor (sometimes incorrectly referred to as an ‘umbrella company’) sitting between the end client and subcontractor or even between an agency and the subcontractor.
This is not new, Markel Tax has plenty of experience of auditing processes and even insuring the NICs liability that can arise from these labour supply chains.
Defining the end client
When considering the practicalities of the legislation, the starting point is to ask the question:
”Who is the end client?”
The answer to this determines where the responsibility for making the status determination lies and may affect where the tax liability exists. Identify who the end client is can be difficult due to issues around outsourcing, small companies and Statements of Work.
Outsourcing and defining the end client
Where an end client genuinely outsources a project or complete service (e.g. IT, HR, facilities management, security, catering or to a third party) then the third party becomes the end client for the purposes of IR35. If they engage contractors, they will have all the responsibilities of an end client in respect of the Off-Payroll legislation.
However, if the end client is using the consultancy to fill “vacancies”( i.e. to find a project manager, a business analyst, a tester, etc) then the consultancy would not be the end client for the purposes of the legislation. It would assume the role of a fee payer because it will be paying the freelancer’s company. In this scenario of filling roles, the original end client is the decision-maker.
Small companies off-payroll legislation criteria
The legislation exempts small companies from making IR35 status decisions. Small companies are defined by s382(2) of CA2006 as meeting at least two of the three following criteria:
- Turnover of no more than £10.2 million
- Balance sheet total of no more than £5.1 million
- No more than 50 employees
HMRC have stated that this will exclude 1.5 million small companies, but please note that HMRC have also clarified that where a small company is part of a group, the group situation must be considered, i.e. no setting up a small company to engage all of your contractors.
Already there have been moves by contractors to come together to create small consultancies to undertake project work. If the work is of a genuine outsourced nature, then there is absolutely nothing wrong with that. However, a by-product of a small company consultancy being inserted into the contractual chain is that the original end client loses its responsibility for making IR35 decisions, as well as any potential liability.
Moreover, the small company is exempt, which means that the decision-making and liability now falls to the individual PSC contractor.
It would be no surprise to find HMRC focusing compliance effort on the contractual chains containing small company consultancies to ensure that they are not being used to avoid the end client’s obligations. Having robust contracts throughout the supply chain and ensuring that the working practices match these will be key.
Statements of Work (SOW)
Some seem to view the issuing of statements of work (SOW) as an IR35 solution. Whilst it is absolutely the correct approach to define project work by its deliverables; on its own, an SOW may not be enough to make an engagement fall outside IR35 – even clear deliverables won’t be a great help if the contractor is expected to provide their personal service and can be moved from deliverable to deliverable.
Furthermore, it is also highly unlikely that an SOW involving one contractor will turn the filling of a role into an outsourced project.
Recruitment agencies: an opportunity beckons
Again, agencies were also slow to react, although a lack of end-client engagement would not have helped them with their preparations. Nevertheless, this legislation does present the more proactive agencies with a fantastic opportunity, and still does, to approach their end clients, not only with a solution where the due diligence on contracts and working practices has been undertaken. But also one which would give the end client all the information needed to create a valid Status Determination Statement to issue to the relevant parties.
The future of contracting
Many contractors will see a deterioration of their tax position and may feel aggrieved at the way their end clients have approached the changes. There will be contractors who find themselves forced to take employed roles (which is realistic) and some will be engaged by umbrella companies.
However, the UK economy depends upon a flexible labour force and thriving small businesses. So contractors and freelancers are a cornerstone of that labour force, although the number of self-employed may fall and the number of employed may rise in certain sectors.
If we look to the experience of legislative changes in the self-employment market, the immediate reaction to avoid engaging the self-employed soon began to be reversed when engagers realised that their competitiveness was being damaged by this initial risk averse outlook.
Some have asked: whether the expectation that end clients will massively reduce their contractor engagements would result in the off-payroll legislation being self-defeating? Presumably, more contractors engaged as employees means lower corporation tax receipts and less VAT collected by HMRC. One can only assume that HMRC expects increased PAYE to counteract this.
In summary, the legislation represents a difficult change which will bring unwanted cost and administration to end clients and agencies as well as a greater tax burden for many contractors.
Furthermore, as HMRC’s recently issued Resources and support for off-payroll working makes clear, they will not be discouraged from the implementation in April 2022.
However, as this newsletter hopefully demonstrates, there is also help, guidance and protection available for all parties in the contractual chain from Markel Tax. Designed to ensure that your business can sort out its compliance obligations and take advantage of these changes.