Many construction businesses are about to be faced with new responsibilities and liabilities in a major change to the way they engage with individual subcontractors trading through their own limited company. Tax and insurance expert, Paul Mason, explains the new IR35 rules.
The new off payroll working rules – better nown as IR35 – will require medium and large sized construction businesses to determine the IR35 status of each and every engagement and will take precedence over the Construction Industry Scheme requirements when engaging limited company subcontractors.
What is off payroll working/IR35?
The Intermediaries Legislation (IR35), was introduced in April 2000 to tackle ‘disguised employment’; contractors engaged through an ‘intermediary’, in the form of their own limited company (often referred to as a Personal Service Company or PSC) or through a partnership, but providing services indistinguishable from work undertaken by an employee.
This was causing a loss of tax and National Insurance Contributions on engagements deemed equivalent to an employed relationship.
IR35 requires you to disregard the intermediary and ask the question: “If we were engaging that person as an individual, would the relationship look like employment or self-employment?”
• If employment, the relationship is ‘inside’ IR35 and from 6 April 2021 PAYE will need to be deducted at source by the ‘fee payer’.
• If it is ‘outside’ and a self-employment relationship, the subcontractor’s company can be paid gross.
IR35 was always the responsibility of the PSC (and this can remain the case), but from 6 April 2021 clients assume the responsibility for decision-making, for what is now referred to as ‘off payroll working’.
IR35; decision-makers and fee payers
From 6 April, relevant end client engagers (the company obtaining the services of the PSC contractor), must decide whether the contractor is working inside or outside of IR35.
When this legislation came into force in the public sector in April 2017, it introduced the concept of the fee payer, which is the entity responsible for paying the PSC.
The fee payer is responsible for paying the PSC gross or deducting PAYE based on the IR35 decision made by the end client and can have the liability if that decision is incorrect.
Where end clients engage PSCs directly, they are both decision-maker and fee payer; but where there are recruitment agencies in the supply chain, the agency sitting immediately above the PSC will be the fee payer.
The legislation makes an exemption for small companies (as defined by the Companies Act), businesses which meet at least two of the following requirements:
• turnover of less than £10.2m a year;
• balance sheet assets of less than £5.1m; and
• fewer than 50 employees.
However, if a larger entity is thinking of setting up a small company to engage subbies; don’t! HMRC will consider the whole group when assessing business size.
This means that medium and large sized end clients will be responsible for:
• making an IR35 decision;
• creating a Status Determination Statement (SDS), which states whether IR35 applies and they must give the reasons for the decision based on the contractual terms and working practices;
• communicating that decision to the relevant parties: always the individual worker and the recruitment agency below the end client in the contractual chain if an agency has been used to find the subcontractor; and
• creating a ‘client-led disagreement process’ to deal with any contractor challenges to the SDS – the end client must give a reasoned response within 45 days.
HMRC guidance states that reasonable care must be taken when making the status decision. This means assessing engagements on a case-by-case basis.
Failure by the end client to take all of these steps and do to so without reasonable care will mean that ‘the responsibility for the deduction of tax and NICs and payment of apprenticeship levy and paying these to HMRC is the client’s.
This is the case even if another party has already made deductions in line with the original determination. Corrections for that other party can be made as the client will be required to meet the liability.’
(HMRC’s Employment Status Manual at ESM10014)
Where there is an agency in the supply chain which sits above the PSC, then if reasonable care has been taken by the end client, that agency has the fee payer status and liability, even though it is only carrying out the payment decision made above it.
The new legislation also contains transfer of debt provisions; if an agency fails to meet the tax liability, that liability can be transferred up the chain to the end client.
Fee payer liability is a key concern for agencies which are looking for insurance against the potential tax loss, and end clients should be keen for them to have the cover because it mitigates the risk of any debt transfer where a policy like Markel Tax’s ‘Fee Payer Protect’ is meeting the liability.
What your business needs to do to meet the changes
Contractual terms with PSC subbies must genuinely reflect a contract for services (self-employment) and be supported by robust working practices. If the contract says that the subbie can provide a substitute; he must have a genuine right to do so. If the contract denies you the right to control how he does his work; you need to let him get on with it. Everything must point to a genuine independent contractor relationship. If it doesn’t, then as a medium or large-sized business you are running the risk of a large tax bill.
Apply the legislation sensibly, and you should have nothing to fear. For years, Markel Tax has been working with construction companies to ensure that their contracts, processes and working practices reflect self-employment and are IR35 compliant: take specialist advice to ensure that you have the correct procedures, and that they are maintained.
There will be challenges. You may come under pressure from subcontractors who consider their engagement with your business as outside IR35 and want to avoid the tax hit of an inside determination. You may find your disagreement processes will need to swing into action, so take advice to ensure that they are fit for purpose.
If you want to retain the subbie’s service, you may need to look at negotiating rates and if you don’t want them as full time employees, you’ll need to consider engaging them on fixed term employment contracts or engaging them via umbrella companies.
But take care about the status decision; you will lose access to the best talent if you just opt for inside because it carries less tax risk. The off payroll changes are unquestionably another burden for the construction industry, but as a sector well versed in dealing with status, you should be better prepared than most.
Nevertheless, get ready for the changes NOW!