Cases where contractors and consultants can be paid gross of tax are restricted. There are nasty tax penalties for the end user clients not operating PAYE when they should. We assess the IR35 position for you.
The rules for IR35 are effectively re-written for many. Decent paper work will help but the facts do need to stand up. The number of PSCs will decline.
Contractors /consultants do look like a cost effective staffing solution. But, HMRC can demand tax from the end user or client years after the event when there may be no trace of the contractor/consultant. This causes unrecoverable costs for the business which may have been avoidable.
We review and provide solutions to cut down on risk. We work with all types of businesses in the contracting chain.
What is new for IR35 contractors
The original IR35 rules allowed the consultant/contractor to decide for themselves if they were self-employed and entitled to be paid gross of tax. Unsurprisingly, most decided they were self-employed as this was more tax beneficial. This wasn’t quite what HMRC had in mind so they changed the law.
What are the requirements for clients and end users?
If the end user/client is of a certain size (see below for details on the Small Company Exemption) the responsibility for reporting and paying tax now rests with the end user/client. The reforms increase the payroll costs as employer’s and employees’ class 1 national insurance will be due. HMRC is not concerned with who will pick up the additional costs. That will be a matter for negotiation.
Commercial agreements such as framework agreements do need a review to bring them up to-date.
Are you engaging a deemed employee?
The effect of these changes is that it is for the client/end user rather than the consultant/contractor to assess whether or not the personal service company (PSC) and the individual behind it are self-employed or applying the relevant HMRC tests would be “deemed employees” of the end user/client. If there is a “deemed employee” assessment, then the end user/client has to operate PAYE and NI and pay the consultant/contractor/PSC net of tax.
Exemption: The Small Company Exemption
There is an exemption from the obligation of the end user/client to operate PAYE and NI if it comes within the Small Company Exemption. The end user/client will fall within the small company exemption if it satisfies two or more of the following requirements:
- its annual turnover is not more than £10.2 million;
- its balance sheet total is not more than £5.1 million; and/or
- it does not have more than 50 employees (part time employees are included but any “deemed employees” aren’t).
In addition, a company will always be regarded as “small” for its first financial year. However, if the company is a member of a group, its parent must also qualify for the exemption to apply.
Employment status test
HMRC have a contractor/consultant employment status for tax test – the CEST test. But situations are often more nuanced and complex than as envisaged by the CEST test. Professional advice about employment status and how this needs to be reflected in the Consultancy or Contractor Agreement and what evidence you may need to have to hand if HMRC challenges will always trump an automated test. The fact you have taken professional advice may serve to mitigate tax penalties in the event HMRC find you are really an employee. Tax penalties can be up to 200% of the tax that should have been paid.
Status determination statement
Unless you are within the small company exemption the end user/client needs to provide a Status Determination Statement (SDS). The end user/client has to confirm that:
- it has decided that, but for the PSC, the individual who owns it and works through it would be a “deemed employee” (giving reasons), so IR35 applies and, accordingly you as the end user/client will be deducting PAYE and the employee’s NICs from the fees payable. The PSC will have to pay the employer’s NIC element itself; or
- it has decided that the individual/PSC is not within IR35 (giving reasons) and gross payments will be made.
Reasonable care in making the assessment is needed but the concept of reasonable remains untested. There is an appeal process.
When to operate PAYE and NI
Some of the main indicative factors pointing “deemed employment” and the need to operate PAYE and NI include but are not limited to:
- Is there a mutuality of obligation? Is the Client obliged to provide work to the Contactor/Consultant/PSC? Does Contactor/Consultant/PSC have to do everything they are asked to do? If the answer is yes, this would suggest a deemed employment relationship.
- Right of Substitution –Is the contract personal to the Contactor/Consultant/PSC i.e. does it have to be a named individual (usually the PSC owner) that provides the services? If it has to be that individual, then this suggests a “deemed employment” relationship. A right to provide a substitute/sub-contractor is likely to indicate self-employed status.
- Degree of control over how you do the work –If the work has to be carried out at a certain place at a certain time and as directed this would indicate employment. If the wording indicates that you can determine the time, place and manner in which the services are provided, that is indicative of self-employment.
- Equipment –If the Client is providing any equipment used in this services this may suggest an employment or deemed employment relationship – but this is not conclusive: it depends on the circumstances.
- Financial Risk –Someone who takes some financial risk in relation to the PSC business is likely to be self-employed. So, for example, the fact that they have to remedy any unsatisfactory work at their own cost might suggest self-employment.
- Are you in business on your own account? – Does the way the PSC operate suggest that the PSC is running its own business? For example, if it has its own website, office space, insurance and engages or employs others, this would suggest self-employment.
- The way payment is made –A fixed price for a job (rather than just a day or hour rate) is more likely to indicate self-employment but, again, it depends on the overall circumstances.
- Exclusivity –Does the Contactor/Consultant/PSC work for multiple clients at once, this would suggest you are self-employed rather than an employee.
- Is Contactor/Consultant/PSC “part and parcel” of the Client’s organisation? –If they are embedded into the client structure and, for example, manage Client staff, this may suggest a “deemed employment” relationship.
- Length of engagement and right to terminate other than for serious breach – As a general rule, the longer the engagement and notice period the more likely it is that the relationship will be regarded as indicating employment but this is not decisive other factors need to be taken into account.
- Employee-type benefits –If the Contactor/Consultant/PSC is entitled to benefits these are indicative of a deemed employment relationship, but the absence of these type of benefits does not mean that the Contractor/Consultant/PSC will be regarded as self-employed. It will depend on what the overall circumstances suggest.
- Intention of the Parties –This is not decisive but may be a factor it is not clear from the other indicators whether the relationship is one in the nature of employment or self-employment.
What changes for small businesses?
Businesses within the small company exemption do not need to deal with the status determination statement (SDS) (described above). But, HMRC still has the armory to pursue smaller clients. These powers are not new. If HMRC is of the view that the self-employed contractor or consultant is really a “deemed employee” then HMRC can recover PAYE and NICs from the Client (as it is an easier route for them than going after the contractor) – even though this should really be an issue for the Consultant or Contractor.
The starting point for any HMRC investigation is the paperwork surrounding the contracting agreement and the facts. We can help you get the position straight.
Limitation of CEST
HMRC does operate on online service called CEST that can confirm whether IR35 will apply. Providing the information submitted is accurate and there are no tax planning arrangements, HMRC will stand by the test result produced by CEST.
However, there are problems. CEST, being designed by HMRC, engineer the outcome falls on the side of caution, i.e. the contractor is caught by IR35. Despite improvements, the test continues to lack sophistication and does not take into account key employment concepts such as mutuality of obligation. There is no substitute for decent contracts supported by facts.
John solves commercial problems for SMEs and their investors. It is said that he is unbelievably practical and seasoned in finding the right solution without too much fuss. He has an established reputation in the technology, art and media industries.