New off-payroll tax rules for the private sector

It has been confirmed that, from April 2020, new tax rules on off-payroll working will apply in the private sector, where contractors or consultants are engaged through companies or partnerships rather than put on the payroll as employees.

As a result businesses need to:

• analyse whether any contractors or consultants they engage through companies or partnerships could in fact be regarded as their employees for tax purposes, and
  
• if they could be caught, assess relevant risks and the information flows required under new legislation and consider the need to change payment or contractual arrangements.
  

Failure to take appropriate action could lead to businesses facing significant liabilities for tax and national insurance contributions (NICs) as well as potential contractual disputes.

Background

Contractors and consultants often provide their services to clients through a "personal services company" (PSC) and indeed clients and contractors/consultants can often gain favourable tax treatment through doing so. While there is already considerable tax anti-avoidance legislation in place to remove these benefits in cases of disguised employment, it is currently the PSC's responsibility to pay the correct tax and NICs. The business for which the individual works (the client) does not have to concern itself with this. 

However, HMRC is concerned that PSCs are being used inappropriately by individuals in order to reduce their tax bill (i.e. they are treating themselves as self-employed consultants rather than employees and consequently paying too little tax). The Treasury estimates that about one-third of people using a PSC are not genuinely self-employed. 

HMRC will, therefore, move responsibility for determining the tax status of the underlying arrangement, and the responsibility for tax deduction and reporting requirements, from the PSC to the client or elsewhere in the supply chain. 

This approach has already been introduced in the public sector and will now apply in the private sector from April 2020. 

Draft legislation containing the detail of the new regime has recently been published.

How will the changes work?

There are two aspects to the new regime: determining an individual's employment status for tax purposes and then accounting for the correct income tax and NICs.

Determining employment status

It will become the responsibility of the client to decide whether the individual would be regarded for tax purposes as an employee if they were engaged directly (see "Determining employment tax status" below). 

Having reached a decision, the client must set out whether the answer is yes or no in a "status determination statement" (SDS), giving reasons for its conclusion. The client must take reasonable care in coming to its decision. If it fails to do so, the SDS will not be valid. 

The client must then give the SDS to the individual. If the individual is engaged through one or more agencies or other intermediaries, the client must also pass the SDS to the first agency in the chain for onward transmission. 

Either the individual or the person in the chain deemed to be their employer can make representations to the client that the conclusion in the SDS is incorrect. Within 45 days from receiving those representations, the client must respond, saying either that it stands by its original decision (giving reasons) or else issuing a new SDS with a different conclusion. 

Accounting for income tax and NICs

If the decision is that the individual should be regarded as an employee, then the liability to deduct the appropriate income tax and NICs (and pay employers' NICs) will fall on the client if:

• it pays the PSC directly;
• there is a chain involved and the client fails to give the SDS to the first agency in the chain (see more below);
• the client fails to give the SDS to the individual (even if it has passed it down the chain); or
• the conclusion in the SDS is challenged and the client fails to respond within the time limit.

If a chain is involved, the SDS should be passed from agency to agency down the chain until it reaches the agency responsible for paying the PSC (the fee-payer). The fee-payer must then deduct and account for the income tax and NICs due. However, if one of the parties in the chain above the fee-payer fails to pass on the SDS, then the buck stops with that party i.e. it becomes liable to account for the tax and NICs.

Because of the way in which the legislation is drafted, the client may retain liability to account for the income tax and NICs due if it bypasses the first agency in the chain and gives the SDS directly to the fee-payer or other intermediate agency. Even if it is aware of the identity of lower links in the chain, therefore, the client should ensure that it gives the SDS to the first agency in the chain. 

If HMRC is unable to collect the tax and NICs payable from the fee-payer or other responsible agency, liability may rebound back up to another party or agency in the chain, including the client, even where it has fully performed its own responsibilities and dealt only with reputable agencies. 

Secondary legislation (not yet published) will contain details of how this transfer of liabilities will operate. HMRC has indicated that the proposals are not intended to transfer liabilities in cases of genuine business failure, where deliberate tax avoidance has not occurred, but it is unclear whether this will be a statutory exception or merely contained in guidance.

Determining employment tax status

The key plank of the new rules is that the client needs to assess whether, ignoring the PSC or other intermediary, the individual would be an employee of the client for tax purposes rather than self-employed.

There are a number of factors which clients need to take into account, such as:

• must the individual do the work personally or can they appoint a substitute? A right to appoint a substitute suggests self-employment but this is not conclusive;
• is the arrangement exclusive or can the individual also work for other organisations? The latter suggests self-employment;
• how much control does the client have over what the individual does and when? Generally speaking, the greater the level of control the more likely the individual is to be an employee; and 
• does the individual provide their own computer or IT equipment? A self-employed person is more likely to provide their own.

None of these factors is likely to be conclusive in itself and there will often be grey areas where it is hard to reach a conclusion – and, under existing arrangements, clients may not know the full facts. What is important is the reality of the situation and not just what the contract says. We would of course be happy to help you with the analysis and any assessment of risks. 

Tempting as it may be to err on the side of caution by treating all contractors as employees, taking such a blanket approach is not advisable. Not only are clients obliged by the rules to take reasonable care in assessing an engagement, which should be done on a fact-specific basis, but contractors would also be unlikely to find such an approach acceptable.

The CEST tool

To help both clients and individuals work out employment status, the government has provided an online tool called CEST (Check Employment Status for Tax). The tool requires users to answer a series of questions the answers to which are used to indicate the correct status. The CEST tool has its shortcomings in that it does not necessarily ask the right questions and may give too much significance to certain factors. Nevertheless, it can be helpful (if saved) as HMRC will accept the CEST result provided that the information inputted was accurate.

Note that a finding of employment status for the purposes of the off-payroll working rules will not mean in itself that the individual is an employee or worker of the client (or any other person) for employment law purposes with the attendant rights.

Liability for employers' NICs

Where an individual is to be taxed as an employee, the shift in responsibility for paying tax and NICs from the PSC to the client or other agency will include them bearing the extra cost of the employers' NICs liability. They will not be allowed to recover this cost directly. In order to maintain the same economic position, therefore, the cost of the employer's NICs would have to be passed on (if at all) by way of an agreed reduction to the headline rate of remuneration.

Which clients are in scope?

Only clients which are "small" will escape the new rules. There is a statutory definition of a small company in the Companies Act 2006 i.e. a company which satisfies two or more of the following requirements:

• annual turnover not more than £10.2 million;
• balance sheet total not more than £5.1 million; and
• number of employees not more than 50.

To be outside the scope of the new rules, UK-incorporated companies, unregistered companies, overseas companies which are required to produce accounts under the UK Companies Act and LLPs must fall within this definition (tweaked for non-corporates). A subsidiary which meets the smallness test will not be small if its parent company or undertaking does not qualify as small.

Any other undertaking (such as a partnership) or person will count as small if its annual turnover is not more than £10.2 million. The other two limbs of the statutory definition are not relevant.

Planning ahead

Although there is some breathing space until April 2020, businesses which use a significant number of consultants or contractors engaged through intermediaries such as PSCs should nevertheless start to plan ahead and project manage the integration of HR, tax and procurement input. Some suggested action points are set out in the box below.

Contacts

For more information, please speak to your usual contact at Ashurst or one of the following.