Personal service companies (“PSCs”) are commonly set up by freelancers (particularly those operating in the technology sector) as a vehicle through which they provide their services to clients. There are various reasons why an individual may wish to establish a PSC, but often perceived tax advantages are a key factor in the decision. Rules were introduced in 2000 to ensure that individuals using PSCs were paying the correct amount of tax, known as the off-payroll working rules or “IR35”. These rules require an individual working through a PSC to self-determine whether they are an employee of the “client” for tax purposes and for the PSC to account for any tax accordingly. The existing rules have been widely criticised as ineffective and HMRC has acknowledged that non-compliance is widespread.
In response to the misuse of PSCs in the public sector, the Government reformed the rules in April 2017. The effect was to place the onus on the public sector entity engaging the PSC to determine the employment status of the individual working through the PSC and pay the relevant tax.
Non-compliance was, of course, not limited to the public sector and so, in May 2018, the Government initiated a consultation to explore the introduction of similar reform in the private sector. It was confirmed in the Budget 2018 that from April 2020 medium and large businesses would become responsible for determining an individual’s employment status and paying any relevant tax when engaging them through a PSC.
HMRC estimates that around a third of people working through their own company should be taxed as employees; however, only 10% of this group actually determine they should be taxed in this way. The new rules effectively help HMRC to police non-compliance with IR35 principles by ensuring that the ‘end user’ (likely to be a larger, more risk averse corporate) is responsible for the worker status determination and related tax.
The corporate criminal offence of failing to prevent the facilitation of tax evasion that was introduced through the Criminal Finances Act 2017 (“CFA”) is also relevant to this issue. Given the seriousness of the consequences under the CFA, reviewing and assessing the risk of tax evasion in a supply chain is more important than ever.
The new rules
The draft legislation (expected to form part of the Finance Act 2020 and implement changes with effect from 6 April 2020) is targeted at businesses that engage workers through intermediaries, such as PSCs. The rules will apply where a worker provides services via an intermediary, but had the worker been engaged by the business directly, the individual would have been considered to be an employee of the business for tax purposes.
HMRC have confirmed that the private sector rules will only apply where the ‘engaging entity’ is a medium or large business. The draft legislation states that a corporate entity will be medium or large if it (or if it forms part of a corporate group, the group) meets at least two of the following criteria:
- Annual turnover of £10.2m or more;
- A balance sheet total of £5.1m or more; or
- More than 50 employees.
Please note that the legislation is in draft form and the above tests may be subject to further change or clarification. Also note that a slightly modified test applies to non-corporate entities.
Where the rules apply, the business engaging the intermediary will be responsible for PAYE, NICs and any Apprenticeship Levy deductions required in relation to the worker’s services. This essentially means that the business will be treating the worker in the same way that it treats employees for tax purposes. There will also be a requirement for businesses to pass the status determination to workers along with the reasons behind it.
The CEST tool
HMRC’S online Check Employment Status for Tax tool (the “CEST tool”) can be used to help determine a worker’s status. To date, the CEST tool has received a lot of criticism, particularly in relation to the tool’s assumption that a contract automatically gives rise to a mutuality of obligation (despite such an assumption being contrary to recent case law on the topic). HMRC have also acknowledged that the CEST tool only gives an answer in 85% of cases.
HMRC have confirmed that the CEST tool is currently being enhanced and developed, and in their latest announcement have stated that the revised tool will be launched before the end of 2019. HMRC have confirmed that they will not provide an arbitration or dispute resolution service since it will be for the business and the worker to determine the worker’s status (with the help of the enhanced CEST tool). Given the difficulties inherent in determining employment status in accordance with the current law, there are arguments for undertaking a longer-term project to introduce a clearer statutory employment test.
Next steps for affected businesses
It is difficult for businesses to prepare fully for the new rules without further clarity as to how determinations should be made and an opportunity to test the revamped CEST tool.
As a minimum, businesses should consider the extent to which the new rules could apply to their current operations. Businesses should explore whether they constitute a medium or large business for the purpose of the new rules and undertake an exercise to identify any areas of the business that engage workers through an intermediary.
For any workers identified as part of that exercise, it may be helpful to run some initial fact patterns through the CEST tool (although bearing in mind that the tool is subject to change). This will give businesses a better idea of the level of risk.
We also suggest that businesses ensure that policies and processes are put in place with regard to new contractual arrangements that may go beyond 6 April 2020. Businesses should ensure that payroll and accounts payable systems are set up to deal with the changes where needed. On-boarding processes are likely to require a determination process prior to entering into any new contractual arrangements. The methodology for such determinations should be consistent, although it is likely to depend on the awaited guidance in relation to the CEST tool.