The UK government is considering reform of the "IR35" regime; a move which could have significant tax implications for private sector organisations that engage individuals through intermediaries, such as personal service companies ("PSCs").
What is the "IR35" Regime?
Where a direct employment or worker relationship exists, HMRC requires the employer to deduct mandatory income tax and employer/employee national insurance contributions ("NICs") from the employee or worker's remuneration at source, through pay-as-you-earn ("PAYE") arrangements. Intermediary companies have, in the past, been used in an artificial attempt by "end users" of an individual's services to avoid a direct employment arrangement between the "end user" and the individual and thereby avoid PAYE liabilities. End users would make gross "off-payroll" payments to the relevant intermediary without employment tax deductions. Remuneration would then trickle down to the individual through more tax-advantageous mechanisms, such as dividends.
The IR35 regime was introduced to try to limit this type of employment tax avoidance arising out the use of intermediary companies, such as PSCs. It applies where: (i) an individual is engaged by the end-user of their services through an intermediary; and (ii) but for the existence of that intermediary, the relevant individual would be regarded as employed by the end-user for UK tax purposes.
Whether or not HMRC would consider an individual to be de facto employed by an end-user for tax purposes, notwithstanding the presence of an intermediary company, depends on a multi-factorial and flexible test. Key features will generally include a requirement for the individual to provide their services personally, a right of control on the part of the end-user and mutual obligations to give and undertake work as between them.
Where IR35 applies, an individual will be treated as "employed" by the relevant intermediary for tax purposes. Unless that intermediary and the end user are under the control of the same person, or one has control of the other, the intermediary is therefore responsible for making all relevant deductions of employment taxes and national insurance under PAYE arrangements with the individual. In this situation, save in very limited cases, the end user bears no responsibility for outstanding employment taxes which HMRC deems payable by such an individual.
What is the government proposing?
In April 2017, the UK government reformed the IR35 rules as they applied to public sector end users, citing evidence which seemed to show widespread abuse of the regime. These changes shifted the burden for determining employment status for tax purposes, and the consequent liability for any underpayment of income tax and NICs, away from the intermediary and onto the end-user public authority. Early indications suggest that this has led to increased compliance with tax rules within the public sector.
In light of such perceived success, the UK government is now consulting on extending this new approach so as to apply to all private sector end users. For many organisations engaging workers through intermediaries such as PSCs, this would represent a significant shift in tax risk allocation. In many cases, private sector end users would ultimately bear responsibility for assessing the status of these relationships and, where necessary, building the necessary tax and NIC payments into their payroll processes. This could represent a very significant additional cost for some businesses.
The government is also considering ancillary reforms, including legislative changes to provide more clarity as to when the IR35 regime will apply and a potential increase in HMRC's enforcement powers, including enhanced rights to access information and documentation (along the labour supply chain) as part of their assessments.
What should end-users do?
Views are sought on this potential development until mid-August, and it likely that the Government will hold off on any decisions until the Spring Budget of 2019 at the earliest. In our opinion, however, an extension of the current public sector IR35 rules to private sector end-users is probable and businesses who use significant numbers of PSC service providers should proactively consider contingency plans and assess their potential financial exposure, should PAYE deductions / employer's NICs have to be made in respect of staff who are currently paid gross via an intermediary.
Organisations which depend on workers engaged through intermediaries will need to consider the prospect of fundamental changes to their engagement models, on-boarding processes, payroll systems and – possibly - their ability to retain talented individuals in flexible roles, where such individuals have historically benefited from tax advantages in receiving their remuneration though a PSC.
Furthermore, if end-users become responsible for risk-assessing IR35 status with each "hire", deducting tax at source and accounting to HMRC for both income tax and NICs, the primary tax advantage of using a PSC for many individuals will be taken out of their hands; and more may seek direct engagement as employees as a result. This may disrupt a well-trodden and relatively flexible engagement model and, from an employment perspective, force end-users to accommodate a suite of more onerous rights.
Developments in this area should be closely monitored. We will provide updates as and when more information is available.