IR35 consultants and contractors

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Self employed contractors do look like a cost effective staffing solution. But, self employed contractors can create tax problems. The tax exposure often comes to light long after the contractor has left with either no trace and/or with few assets worth pursuing. This causes unrecoverable costs for the business which may have been avoidable.

Based on past experience, we highlight the likely exposure to self employed contractor tax issues, how to guard against risks and the responsibilities for end-user clients.

We work with both consultants and contractors and their clients or end users.

The tax risks caused by self employed contractors?

The law is currently a mess. This is why self employed contractors or consultants create tax problems.

There are three categories of staff in this country and the changing working pattern is blurring the distinction.

1. Employees

On the one hand we have employees – not a problem in terms of tax exposure for the employer as PAYE applies.

2. Self employed contractors

At the other extreme we have the genuine self employed – not a problem for the employer. This is because under current tax rules the employer has no exposure as the self employed contractor is responsible for his or her tax.

3. Problem cases – the muddle and a growing number

It is in the middle where we find the problems.
  • The middle comprises workers – entitled to certain statutory rights such as holiday pay but not subject to PAYE. Many contractors in the gig economy are workers.  There has been a spate of cases where workers successfully claimed employment rights.
  • Will HMRC now pursue PAYE assessments on the employers – remains to be seen.  But if the client or end user does not have a tax indemnity in place giving them the power to pursue the contractor it is fair to say there is not much hope.
The middle also includes contractors operating via personal service companies. If HMRC cannot assess the personal service company the risk is HMRC assess the employer under the disguised remuneration rules.  Again if no means of recovery have been reserved the client or end user is out of pocket.

Self employed contractors and IR35 reform

The policy of HMRC is to shif the responsibility for reporting and paying tax away from Personal Service Companies (PSC’s) operated by contractors to big business end-users. Changes have already been implemented for contractors to the NHS. In April 2021 the IR35 reforms are expected rolled out for the private sector.
The reforms will 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.

2021 IR35 Reform – New responsibilities for end-user clients

End-user clients will, from April 2021, be responsible for determining employment status and deducting tax where appropriate. End user clients will need to:

  • Take “reasonable care” to assess whether a contractor is employed or self-employed for tax purposes.
  • Confirm their decision in a status determination statement (SDS)
  • Provide the SDS to the individual contractor and PSC before making the first payment to the contractor

A contractor is entitled to make representations to the end-user if they disagree with the SDS determination. The end-user then has up to 45 day period to either maintain that the SDS determination was correct or issue a new one. Ultimately, the end-user has control in the decision making process.

Implications upon a contractor being re-assessed as employed

The re-assessment of a contractor’s status for tax purposes usually comes to light following a PAYE audit or random inquiry. HMRC have sector focuses such as the IT and tech sector. Personnel involved in the TV and media industries are a current HMRC focus sector.

Another avenue for re-assessment arises is if an Employment Tribunal decides a worker or contractor was employed. The status for tax purposes and status for employment law purposes are distinct tests. However, HMRC will no doubt agree with the Employment Tribunal’s judgement.

HMRC does not have to give credit for any income tax and National Insurance paid by the worker under self-assessment when calculating the employer’s liability arising when the status was re-assessed by the Employment Tribunal.

Self employed contractor tax penalties

Even if the business can set off income tax/national insurance paid by the worker against its own tax liability, the business still faces penalties for failing to operate PAYE or make national insurance contributions.

HMRC calculates penalties for lodging inaccurate PAYE/national insurance returns as a percentage of the total amounts that should have been paid for up to six years. HMRC does not take account of income tax or national insurance paid by the worker under self assessment during this six year period. The penalty percentage will depend upon the level of intent and concealment. We can argue a reduced penalty percentage with the right evidence.

HMRC IR35 assessments

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, will fall 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 professional advice.

In addition to this, if the result cannot be backed up with a fully documented contract with bespoke terms, a HMRC investigation may nevertheless determine an exposure to PAYE.

The cause of some problems

Despite the risk of significant tax liabilities when engaging contractors we do see many cases where there is no written documentation. This causes much of the problems that self employed contractor tax creates. Whilst written documentation will not finally determine the status of a problem, an agreement setting out what you thought the position was will assist.

Ultimately, both HMRC and an Employment Tribunal will examine the facts and if the documentation does not stack up the documentation may not be of much assistance.

Agencies

If an agency is part of a contractual chain between a PSC and an end-user, the end-user is responsible for determining. Any agency paying the fee to the PSC will be responsible for operating PAYE and deducting NICs.

An end-user may be liable for making PAYE deductions and NICs if they do not comply with status determination obligations.

Exemptions

“Small” private sector end-user clients will be exempt from the new rules. PSC’s will remain responsible for status determination in these cases.
An end-user client will be treated as small for a tax year if it satisfies two of the following:
  • Annual turnover is not more than £10.2 milliams
  • The balance sheet total is not more than £5.1 million
  • Employee headcount does not exceed 50
This exemption may not be available to businesses which are part of a large group.

Addressing IP Risks

The usual rule in an employment relationship is that the employer owns what the employee creates. However, this is not always the case in consultancy/self employed contractor relationships.

Issues can be particularly acute for contractors involved in software related engagements where copyright and patents are involved.

Addressing intellectual property use and creation

We find most problems result from a lack of bespoke terms addressing intellectual property use and creation. If there is no contract, employers cannot stop contractors walking off with intellectual property such as:
  • Customers lists;
  • Employee contacts;
  • Software coding;
  • Inventions or works created during the course of the engagement;
  • Know-how; or
  • Source code.
The risk is that you may find an intellectual property dispute emerges when the relationship ends. The contractor may refuse to co-operate or cannot be found.  Another risk time is when the business is up for sale and the buyer is seeking warranties and indemnities.
If you are a client, end user worried about the tax and or commercial risks and not sure how to solve them please do get in touch.  You can call us on 0207 438 1060.