Who is affected?
The rules relate to contractors who provide services through a personal service company (PSC), typically a company personally owned and managed by the contractor. The current legal position is that it is for the PSC itself to determine whether there is an obligation to pay income tax or National Insurance Contributions on earnings. This requires PSCs (in practice, usually the contractor themselves) to determine whether 'deemed employment status' (DES) applies.
Under the new rules, it will be for the 'client' (i.e the end-user of the service) to determine whether DES applies. There is an exemption for small businesses.
The new rules also introduce the concept of a 'fee-payer', who will be required to operate PAYE in the event that the client has determined DES applies. In circumstances where the client contracts directly with the PSC, the client and the fee-payer will be one in the same. However, in practice it is quite common for PSCs to be contracted through an agency. In that case, the obligation to determine whether DES applies will remain with the client, but the agency will be the fee-payer.
So how will it work?
For example - Mrs Smith is a contractor working under a PSC, Mrs Smith Ltd. Mrs Smith Ltd enters into a contract with an agency, Middle Man Ltd to provide services to a client, Client Ltd.
Client Ltd is required to determine whether Mrs Smith has deemed employment status. Client Ltd is then under an obligation to inform both Middle Man Ltd and Mrs Smith of their determination and the reasons for this. Middle Man Ltd and Mrs Smith have a right of appeal back to Client Ltd if they disagree with the determination.
If Client Ltd has determined that DES applies, Middle Man Ltd is obliged to operate PAYE in respect of payments to Mrs Smith Ltd.
While the obligation to operate PAYE rests with Middle Man Ltd:
- If Client Ltd doesn't carry out a status determination or fails to notify Middle Man Ltd and Mrs Smith of its determination, Client Ltd could be obliged to operate PAYE.
- Further, if Middle Man Ltd does not comply with its PAYE obligations, HMRC will have the power to pursue Client Ltd for payment of tax and NICs.
Mrs Smith (Contractor) > Mrs Smith Ltd (Personal Service Company) > Middle Man Ltd (Agency/Fee-payer) > Client Ltd (Client/End user)
Planning ahead for April 2020
Businesses should start planning ahead as soon as possible and the key steps will be:
Identify who is affected - you should carry out an internal audit of all contractors to identify who is operating via a PSC (whether through an agency or otherwise). This is likely to involve approaching agencies for further information on who is engaged to provide services, how they are engaged and whether PAYE is already in operation in respect of their services.
Consider how employment status determination will be carried out - HMRC has created an online tool called CEST, which can be used to determine deemed employment status (although it is not a requirement to use this tool and other options can be considered). The tool is still being refined and HMRC recently promised that an enhanced version of the CEST tool will be launched before the end of this year.
Establish a communication chain - in the first instance, you are likely to require detailed information from the contractor, PSC and/or agency in order to allow you to carry out the deemed employment status determination. Thereafter, you will require to have a mechanism in place to appropriately communicate the outcome of your determination and then receive, consider and communicate the outcome of any appeal.
Review commercial contracts - it is worth reviewing commercial contracts to identify any gaps in your protection. Are your agencies and contractors obliged to provide relevant information timeously? What is your remedy against the agency in the event that they fail to appropriately operate PAYE? Etc.
Finally, it is important to note that the employment law test for 'employment status' and the tax test for 'deemed employment status' are not the same, although similar factors are taken into account. It is therefore possible for a contractor to have 'deemed employment status' for the purposes of IR35, but remain a self-employed contractor under employment law. Of course, it is also possible that someone you have historically engaged as a contractor in fact has worker or employee status under employment law, having potentially significant legal implications. Carrying out a contractor audit for the purposes of IR35 may therefore also be a good opportunity to carry out a fuller 'employment status' check.
If you require any assistance in this area, please do not hesitate to contact one of our team for advice.