The rules relating to providing your services to customers through a company, LLP or unincorporated partnership, known as the “Personal Service Company” (PSC) rules have existed for a number of years and are commonly referred to as “IR35”. For convenience, the term “company” is used throughout this document to refer to any of the structures regarded as a PSC.
Historically, if you worked through your own company, it was your decision and your responsibility to decide if these rules applied to your PSC. In 2017, this changed with regards to those working in the public sector. The ‘public sector’ in this context broadly meant any government body such as a local council, the NHS, Ministry of Defence, the BBC, Channel 4 and certain other organisations.
The change was not in the rules themselves but, in the responsibility for both making the decision as to whether IR35 applied to a contract and, for paying the resulting liabilities.
It is proposed (barring unforeseen changes arising from Brexit or a General Election) that from 6 April 2020, the same change will apply to private sector work, as well.
Nothing has yet been legislated but, in summary, the following changes will apply from 6 April 2020 :-
- The responsibility and liability of IR35 passes from the contractor to the agency (or party paying the contractor – including consultancies or direct work). This means the agency will have to assess each engagement and make a decision as to whether it is outside or inside IR35. So, whereas each contractor has until now, taken responsibility for deciding if they were within IR35, going forward the decision will rest with the entity paying them.
- Most agencies will not be in a position to form this judgement without the input of the end client, as clearly, it is the client that can assess the nature of the work being performed. The end client (the “engager” will issue a “Status Determination Statement” (SDS), which it will pass to its supplier (the agency) and, it will pass down until it reaches the party making the payment to the PSC.
- The new IR35 rules will allow either the worker or the deemed employer to challenge the SDS and make representations to the engager who originally issued the SDS. The engager then has 45 days to either confirm, with reasons, why it upholds the SDS or to withdraw and replace the SDS with a revised decision. The draft law does not say that such representations have to be in writing.
- If the engagement is deemed to be outside IR35, the agency can pay the contractor gross but, would face having to pay the PAYE liability, if the decision was questioned and overturned by HMRC.
- If the engagement is within IR35, the agency will have to deduct PAYE and NI prior to paying the contractor. Confusingly, the contractor will still operate through their PSC but will essentially be taxed as an employee at source. There will then be various tax credits to ensure the contractor does not pay tax twice once the income is received into the PSC.
- In terms of the calculation, this is the same as usual but, with the following changes. Income Tax and NI will be calculated after allowing only expenses that are available to everyday employees, so travel and subsistence relief will be lost. Also, the 5% flat deduction will not apply.
- The tax deductions will then be paid by the agent to HMRC together with the employer’s NI. This employer contribution is the liability of the body paying the PAYE, i.e. the agency and, will be an additional cost to the agency itself. Contracts will have to be renegotiated at the earliest opportunity to attempt to either pass this cost on to the end customer or, reduce the rate paid to the contractor. Both will, of course, be subject to fierce resistance.
There is an exemption to the rules where the end client receiving the services (not the payer) is a “small company”, although at present, it is not clear that “small” partnerships would benefit from this exemption. A company will meet the definition of ‘small’ if it meets 2 out of 3 criteria:
- Annual Turnover < £10.2m
- Balance Sheet Total < £5.1m
- Number of Employees < 50
Agencies supplying these types of PSC workers will have to be careful not to fall foul of the new rules. Contracts with clients and PSCs will need to be reviewed and updated. Price pressure could depress margins, or even send these entities out of business. The nightmare scenario will of course be if they get a huge bill for PAYE and NICs that they should have withheld because they have misunderstood or misapplied the new rules.
The end result of these changes will be a reduction in net income for contractors, which in turn would be expected to lead to an exodus of contractors from their respective industries. However, if it leads to the expected increase in PAYE revenues to HMRC or, a simple return to PAYE employment, then it will have achieved its intended purpose. For older contractors, employment opportunities may be limited and, for those consultants, continuing to operate through their own company or, switching to an “Umbrella” company (under PAYE) may be their only options.
At present, HMRC guidance on this subject is limited. The consultation document which explains the proposal can be accessed here: https://www.gov.uk/government/consultations/off-payroll-working-rules-from-april-2020