By Paul Mason, Head of Tax Partnerships at Markel Tax, a sister company to FSB
Controversial changes to how individuals operating through personal service companies are to be taxed will have implications for contractors and the businesses that use their services.
IR35 legislation was designed to enable HMRC to tackle the taxman’s belief that many individuals trading through their personal service companies (PSCs) were actually disguised employees. The typical contractual chain that HMRC looks to challenge from a tax status perspective looks like this:
- End-client engager to agency
- Agency to PSC
- The individual (typically shareholder/director of the PSC) undertaking the work
Currently, end-clients and agencies in the private sector have no status issues because you cannot “employ” a limited company. It falls upon the individual/PSC to make that status decision by creating a hypothetical contract which asks what the relationship would be between the individual worker and the end-client if there was a direct relationship.
If it looks like self-employment (‘not caught by IR35’), the contractor can remunerate themselves via a low salary and dividends. If it resembles employment (‘caught by IR35’), the contractor is given a notional 5 per cent allowance for running expenses and the remaining 95 per cent of the fees earned in that engagement is subject to PAYE and NICs.
The public sector experience
In 2014, HMRC calculated that only 10,000 PSCs had ‘caught’ engagements out of a contractor population of perhaps half a million, and so tax was being lost. In 2017, in the public sector, HMRC decided PSCs would no longer make the status decision.
From 6 April 2017, public sector bodies, as end-client engagers, became the decision-maker; agencies which were responsible for paying the PSC became the “fee-payer” and were responsible for the tax and NIC liability if the public sector made an incorrect IR35 decision. The PSC suffered the tax consequences of the decision handed down: taxed as an employee without employment benefits; unable to claim travel and subsistence costs; losing the notional allowance.
HMRC has hailed it as a success; an additional £550 million has been raised for the Exchequer, although this doesn’t take into account that many contractors moved into the private sector, and there is evidence that some bodies are having to pay more for the same resources.
Private sector changes
HMRC is working towards making the same changes in the private sector, and issued draft legislation in July. Small companies, as defined by s382(2) Companies Act 2006, are excluded; if your business is defined by two of the following:
- Turnover of no more than £10.2 million
- Balance sheet total of no more than £5.1 million
- No more than 50 employees
– then the status quo remains, and it is still the responsibility of a PSC to determine the status of an engagement. Medium and large companies will have to:
- Issue a Status determination Statement (SDS) – and take reasonable care in doing so
- Ensure this is passed down the chain
- Respond to written challenges to the SDS within 45 days (the “client-led disagreement process”).
Failure to do the above could result in the end-client being classed as the “fee-payer” and having the liability for the tax and NICs due if an engagement is incorrectly determined as ‘not caught’.
Agencies in the chain responsible for paying the PSC will be responsible for the tax liability (assuming the end-client has taken reasonable care) if a decision to pay gross is incorrect. Furthermore, agencies and end-clients could suffer the liability if entities below them in the contractual chain fail and have not paid HMRC tax and NICs due. Provision for debt transfer has been included in the draft legislation to keep the chain “honest”.
If PSCs can produce a body of evidence to demonstrate that their current engagement is ‘not caught’, they may persuade the end-client that any future engagements running past April 2020 should also be treated as ‘not caught’. PSCs should therefore seek an independent contract review of their engagements.
All parties need to talk to each other now. April is not far away, and leaving it until next year to address this will lead to confusion, incorrect decisions and the loss of the best contracting resources to businesses that have made preparations.