On 18 May 2018, HMRC published a consultation document entitled “Off-payroll working in the private sector” with the aim of tackling what it perceives as high levels of non-compliance in the private sector with the existing off-payroll working regime (HMRC predicts the costs of such non-compliance will reach £1.2 billion in 2022/23 if this issue is not dealt with).
The consultation document outlines a number of proposals that could have a very significant impact on private sector clients which contract extensively with individual service-providers. In particular, it contemplates shifting responsibility from service-providers to clients for payroll compliance and associated income tax and National Insurance liabilities in circumstances where a deemed employment relationship is found to exist between the client and the service-provider. This occurs most commonly when the service-provider contracts directly with the client or via a personal service company (“PSC”).
Practitioners and business alike have been expecting this move from the government, as it follows hot on the heels of similar reforms directed at the public sector. As the use of arrangements involving PSCs is widespread in the private sector, in particular in industries such as media and IT, the additional compliance and tax costs for businesses could be very considerable.
Businesses likely to be affected may wish to review any relevant arrangements with service-providers now and consider what steps to take before any of the proposals in the consultation document are implemented.
For many years, it has been commonplace for individual service-providers contracting with businesses and organisations (“clients”) to do so by way of PSCs. In such an arrangement, the client contracts with a company (the PSC) which is owned and operated by the individual to supply the individual’s services. This is often entirely representative of the reality of the engagement, for example when contracting with a company set up by a genuinely self-employed sole-trader. In some cases, however, the relationship between the client and the individual would, but for (or ignoring) the existence of the company (PSC) in between them, be regarded as an employment relationship.
In 2000, the off-payroll working rules, also known as “IR35”, were introduced to legislate for such situations. Broadly, the rules provide that where an individual performs services for a client under a contract between the client and an intermediary such as a PSC, if that contract would make the individual an employee of the client had it been made between them directly and the individual receives from the PSC a payment or benefit representing remuneration for the work done for the client, then the individual is treated as receiving employment income that is chargeable to income tax and National Insurance contributions (“NICs”).
As originally formulated, IR35 deemed the employment income to be paid by the PSC to the individual, so that the PSC was responsible for determining whether IR35 applied and for the tax payable if it was.
This is still the position in respect of businesses and organisations in the private sector, but the rules were reformed for the public sector in 2017. The rule change made the public-sector client, not the PSC, responsible for determining whether IR35 applies and for any payroll taxes that are due.
The new consultation document notes that the public sector reforms have been effective in improving compliance with IR35 in the public sector, and considers options for improving compliance in the private sector, where HMRC estimates that only 10% of PSCs that should apply IR35 actually do so. The three options considered by the consultation are:
- Extending the public sector reform to the private sector so that the compliance and tax burdens fall on the client rather than the PSC – in particular, clients would be responsible for determining whether IR35 should be applied and for accounting for income tax and employee National Insurance liabilities and paying associated employer National Insurance liabilities;
- Encouraging or requiring businesses to secure their labour supply chains – clients would have to carry out due-diligence to satisfy themselves that the service-providers they use are compliant with IR35; or
- Requiring clients to keep additional records to assist HMRC in policing compliance with IR35.
Impact on clients
The measures considered above could significantly alter the risk profile for clients which use off-payroll working arrangements. In particular, if the public sector reforms are extended to the private sector, HMRC may decide to investigate a greater proportion of arrangements involving intermediaries. This is because recovery from clients is likely to be more straightforward than pursuing PSCs or individual service-providers. Moreover, if these investigations result in adverse findings, then the liabilities that arise will represent an additional cost for clients of engaging service-providers through intermediaries.
The measures could also entail significant added administrative and compliance burdens for clients, which will be reinforced by a penalties regime. Even clients who do not currently contract with service-providers by way of PSCs may be affected as they may need to consider the compliance with IR35 of any off-payroll work they source. All measures would necessitate additional record keeping (for example, with clients being required to retain certain information relating to the service-provider, such as contracts, timesheets, line management reporting).
The experience of public-sector bodies following the public-sector reforms provides a useful benchmark. In the wake of those reforms some public bodies have reportedly struggled to implement the changes necessitated by the reform and to manage the increased administrative burden. There is also evidence, which the private sector consultation document acknowledges, that some public bodies have found it more difficult to fill off-payroll roles or have had to offer increased rates to candidates for such roles following the reforms, presumably due to candidates’ wariness of the impact of the reforms on them.
While the proposed reforms are currently only at the consultation stage, it seems likely that at least some of the measures outlined in the consultation document will be progressed in view of the precedent public-sector reforms and the apparently very high levels of non-compliance with IR35 in the private sector. This should prompt businesses and organisations to begin reviewing relevant arrangements and taking steps to mitigate their exposure – or at least avoid increasing it – in the interim. Indeed, whatever the outcome of the consultation, HMRC’s focus on tax compliance where PSCs are used indicates that HMRC will be increasingly more active in enforcing compliance with IR35.
Stakeholders can respond to the consultation, which is open until 10 August 2018. We will of course be monitoring the progress and outcomes of the consultation in order to keep clients informed.