The final consultation on the government’s plan to introduce off-payroll working reform to the private sector closed on 28 May 2019, the results of which will be used when drafting the legislation to be included in this year’s Budget and which will apply from 6 April 2020. Although this has not provided total clarity over the substantial changes that will apply in less than 10 months’ time, it gives a reasonable indication of how HM Revenue & Customs (HMRC) plan on implementing the reform.
Starting with some background; the intermediaries’ legislation (commonly known as IR35) was introduced back in April 2000 in an attempt to clearly differentiate between an employee and a contractor for tax purposes. It has since been the responsibility of the worker themselves to determine their status which, in HMRC’s opinion, has led to widespread non-compliance. Over the years HMRC have (regularly but unsuccessfully) pushed for reform, but achieved a breakthrough in April 2017, when major changes were introduced to the public sector. HMRC now see it as time for the private sector to follow suit.
Can we be confident about HMRC’s figures?
It is estimated by HMRC that the cost of non-compliance in the private sector will reach £1.3 billion by 2023/24 if no action is taken. This is a considerable amount of underpaid tax, but, HMRC have previously been found to exaggerate and make false claims in an attempt to sway public opinion so it is difficult to have any faith in this headline figure. From their perspective however, here is however no doubt that it sounds good when attempting to justify the changes.
Are contractors being disadvantaged?
The other side of the ‘employee or contractor’ issue is: “are contractors being disadvantaged by not receiving the rights and benefits that they would otherwise receive as an employee?” Tellingly, the proposed reforms will notdeal with this, with plans for these changes only to come “in due course”. It is therefore a concern for many that the reform is purely about collecting as much tax as possible, rather than actually ensuring workers are being correctly classified.
What exactly are the new rules?
Based on the May 2019 consultation, it is intended that the rules implemented in the public sector will apply, subject to some minor changes. Presently the public sector applies the following rules:
- The client (end-user of the service) provides a ‘status determination’ to the party they are contracting with, prior to the contract beginning. The status is decided by the client, and HMRC recommend using their Check Employment Status for Tax (CEST) tool to do so.
- The party contracting directly with the client (an agency or the personal service company)then has the legal right to ask for the reasons the client came to their determination. There is no formal appeals process for changing the determination, meaning that unless incorrect information was used by the client to make their decision, this is unlikely to be adjusted.
- If the worker (individual providing the service) is determined to be an employee, the client (or agency making the payment) must deduct tax and national insurance from payments as though the worker was an employee.
Under the public sector rules, there is no requirement for the actual worker to directly receive the ‘status determination’ but HMRC are considering ways for this to be done. It is likely to consist of the determination being passed from the client, to the agency, to the worker / their business. Where there are multiple parties involved, this could inevitably create issues with delays.
The reform will only apply to clients that are medium or large organisations. Companies size will be determined under the existing definition in the Companies Act, with similar rules intended to be applied to unincorporated organisations. Where the client is a small organisation, the responsibility will still be on the worker to self-determine if they are a worker or employee.
What are the issues?
The most substantial issue of this reform is it puts the responsibility on the client to determine the status of the worker. This in itself can be a complicated area and is not helped by HMRC’s suggestion that their CESTtool should be used as a guide. The CEST (Check Employment Status for Tax) tool has been devised “to find out if you, or a worker on a specific engagement, should be classed as employed or self-employed for tax purposes.”
The problem is that although HMRC claim that the CEST is able to correctly determine employment status in 85% of cases, and they intend to make further changes to improve the system, this is highly contested by agencies and the accountancy profession. The biggest criticisms of CEST is that the tool does not ask for enough details about the contract, and completely ignores some of important ‘tests’ for employment status established under case law, which means it is far more likely to classify (or potentially misclassify) a worker as an employee rather than a free-lance contractor.
The issue of misclassification is compounded as there is no formal appeal against the ‘status determination’. Despite the many concerns voiced by contractors, you haveto use the CEST tool. Although the recent consultation document does discuss the possibility of an appeals process, it puts the responsibility for this on the client rather than HMRC having any official involvement. Undoubtedly, the danger here is that clients are likely to err on the side of caution and classify workers as employees in order to ensure that they do not have any compliance issues with HMRC. The worker will only have the chance to rectify their position as part of the year end process (details of which are not yet available), by which point they will have potentially incurred significant deductions from their income and most likely incur significant costs and delays in rectifying matters.
What can be done?
Workers are likely to find themselves in a position where they have to meet HMRC’s definition of a contractor, rather than the actual law’s definition, or face deductions from their income. The first recommendation would therefore be to use the CEST tool as an initial determination of how HMRC would classify any contracts you currently have or are planning on undertaking. If the tool determines you to be a contractor, then you are likely to be unaffected by the reform, but if it determines you as an employee, you may want to consider making changes to your contract and working practices.
The CEST tool is currently heavily weighted towards certain ‘tests’ in the IR35 legislation, and it is therefore worth ensuring that as many as possible of the following conditions are reflected in your contract and the work you carry out:
- You are able to send a substitute (that you pay for) to carry out the work, and have made use of this where possible. In some organisations there may, in theory at least, be the possibility of doing this but practical issues of having the client accept a substitute may prove difficult. If, however, this can be achieved then, based on outcomes of previous court cases to use substitutes, there should be no classification of a worker as an employee.
- Ensuring a contract only covers one project, and a new contract is taken out for any different work that needs to be carried out. A series of shorter-term contacts with different clients should also help, although it is acknowledged that this may be at the expense of financial security.
- You have a high degree of controlover how you carry out your work, the schedule you keep to and where you carry out your work (that is not determined by the task itself).
Another area that HMRC put a lot of emphasis on is the financial risk you are taking, so if you incur substantial costs to provide your service (that you are unable to recharge to the client), or provide your own specialist equipment, or are financially responsible for correcting any mistakes you make carrying out your work then these are all major factors in ensuring you will not be classed as an employee.
It is important to note that just changing the wording of contracts on its own is not enough, as the contract must accurately represent the facts of the working relationship. If it does not, then any contract will be ‘looked through’ (i.e. blown out of the water!) for the purpose of determining your status. However, by making these changes to both your contacts and the way you carry out your work, it will ensure that you are meeting both HMRC’s definition of a contractor, and the tax legislation’s definition, which should help to keep you outside the current IR35 proposals.
Stewart McKinnon, Director, M&S Accountancy and Taxation Ltd.