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IR35 – Extension of tax rules for individuals working via their own companies for a medium or large business
From 6 April 2020, new tax rules are bring introduced for individuals who provide their personal services via an ‘intermediary’ to a medium or large business. An intermediary may be another individual, a partnership, an unincorporated association or a company. The most common form of intermediary is where services are provided via your own company (PSC).
If you provide personal service via an intermediary, then these changes may affect you. We have summarised the new rules below and in our next article we will set out the potential tax effect if these rules apply to you.
The new rules are similar to those that were introduced in 2017 for public sector organisations receiving services from PSCs. The 2020 rules will use the 2017 rules as a starting point which means, in practical terms, that the principles have already been decided and draft legislation has been published which will, subject to consultation, be included in the next Finance Bill.
The effect of these rules, if they apply to you, will mean:
- the medium or large business (or an agency paying the PSC) will calculate a ‘deemed salary payment’ based on the fees the PSC has charged for your services
- generally, the entity that pays the PSC for the services must first deduct PAYE and employee National Insurance contributions (NICs) as if the deemed payment is a salary paid to you as an employee
- the paying entity will have to pay to HMRC not only the PAYE and NICs deducted from the deemed payment, but also employer NICs on the deemed payment
- the net amount received by the PSC can be passed onto you without paying any further PAYE and NICs.
The practical effect of these rules is that you will no longer benefit from the potential tax advantages of receiving such income via your own company, as you will not receive a deduction for any costs incurred by the company, such as travel costs, administration costs etc.
There may also be pressure from your customers to renegotiate contracts due to their increased cost of employer NICs that they will be liable for.
The new tax rules apply to amounts paid from 6 April 2020 and so may affect your current contracts.
What is a medium or large business?
The government intends to use an existing statutory definition within the Companies Act of a ‘small company’ to exempt small businesses from the new rules. Therefore, the rules will exempt businesses meeting any two of these criteria:
- a turnover of £10.2 million or less;
- having £5.1 million of assets on the balance sheet or less;
- having 50 or fewer employees.
If the business receiving the work of the individual is not a company, it is only the turnover test that will apply.
Who will decide if the rules apply?
The medium or large business will decide, i.e. your customer. The business needs to form an opinion as to whether, if the personal services of the individual were provided under a contract directly between the individual and themselves, the individual would be regarded as an employee of the business. This is the same kind of employment status test based on case law that businesses and agencies have to consider when they hire staff directly.
It is a matter of judgement whether the nature of and manner in which the services provided point to employment or self-employment. HMRC has a Check Employment Status Service tool (CEST) to help businesses decide the status of individuals providing personal services to them. HMRC is currently working ‘to identify improvements to CEST and wider guidance to ensure it meets the needs of the private sector’.
For reasons which are explained below, the business may be tempted to err on the side of employment particularly if CEST indicates employment.
The link to the Employment Status Service tool is www.gov.uk/guidance/check-employment-status-for-tax.
Why have these rules been introduced?
The 2020 rules will replicate many of the effects of the ‘intermediaries’ legislation enacted many years ago (often called the IR35 rules). This legislation requires, for example, a one-person company to judge whether the IR35 rules apply. If IR35 applies the PSC would then treat the relevant fees received by the company as deemed salary payments to the worker and thus account for PAYE and NICs.
HMRC have found it difficult to enforce their view of the applicability of the IR35 legislation to many PSCs. Many view the risk of being ‘caught’ by IR35, and thus being required to pay PAYE and NICs, is outweighed by the benefit of company profits being paid out under a ‘low salary, balance as dividends’ regime.
The new legislation; therefore, shifts the responsibility to the business receiving the services of the individual. This means that the risk of non-compliance falls onto the business. If the business decides the new rules do not apply they may have to have a protracted dispute with HMRC which ultimately may go to a Tax Tribunal. If the Tribunal decides against the business, the business will have to pay over PAYE and NICs to HMRC, having already paid the gross fees to the PSC.
For details on the new rules, please see our earlier blog.
What can you do if you disagree with the business deducting PAYE and NICs?
The government will require the medium or large business when it makes a status determination to:
- communicate the decision to you in a Status Determination Statement (SDS), and
- give the reasons for that determination if requested by you.
This will be in addition to communicating the decision to the party with whom the business has contracted; for example, an agency.
The business must take ‘reasonable care’ in coming to its conclusion.
If you disagree with the decision you can use the CEST tool to see if you obtain a different conclusion. If you obtain a result which confirms self-employment you can discuss the results with the business or you can contact us to discuss the matter.
Even if you obtain an employment result, this does not necessarily mean the result is correct. HMRC state that the current tool is ‘able to determine employment status in 85% of cases’ which, of course, means it is not correct in 15% of cases. Many commentators consider the accuracy of the tool to be much lower.
HMRC is currently working with stakeholders to enhance the service and guidance on the use of CEST but many commentators consider that the law on status is too complicated for a yes/no checklist to provide the right answer in all cases.
The government will introduce a ‘client-led status disagreement process’ where you can make a representation to the medium or large business where you believe that the conclusion mentioned in the SDS is incorrect. The medium or large business has 45 days, from when the representation is received, to review the decision and either confirm that the decision or give the worker a new SDS with a different conclusion. If the business confirms the decision it must give its reasons for deciding that the conclusion is correct.
In our next article, we will cover the potential tax effects if you are caught by the new rules.
Should you wish to discuss the effect of the above in more detail or discuss your tax affairs in more details, please contact us for a FREE initial consultation.
This article provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore, no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this article can be accepted by the author or Essex Abel Ltd.