Extension of IR35 reforms to the private sector: Government shifts compliance burdens to business

HMRC is consulting on the extension of IR35 reforms to the private sector from April 2020.

As previously announced, the rules introduced in April 2017 in relation to off-payroll workers in the public sector will be rolled out to off-payroll workers of large and medium-sized private sector businesses from next year.

But HMRC’s most recent consultation document proposes significant additional compliance obligations for businesses that engage these services (the clients or “end users”).

In particular:

• even if the end user is not responsible for accounting to HMRC for income tax and NICs if the rules are engaged, it will have a secondary liability: HMRC will have a right to recover unpaid tax and NICs from the end user even if it is not the primary obligor;
• the end user will be required to provide the individual worker with its conclusion on whether the rules apply (a “status determination”) and, if requested, the reasons for that conclusion; and
• the end user will be required to establish and operate an internal process for workers to challenge status determinations (a new forum for attempting to resolve complaints raised by workers who are unhappy with the end user’s status determinations).

The consultation closes on 28 May 2019 and confirms that, after considering responses, HMRC will publish draft legislation in the summer.

The background to and purpose of the reforms

The UK rules on off-payroll working (known as IR35) aim to ensure that individuals who work for end users through a personal service company (PSC) but work under the same terms and conditions as an employee are taxed as employees rather than as self-employed individuals.

Historically, responsibility for determining the status of the engagement of the worker and for compliance with IR35, including obligations under PAYE and liability for NICs, has rested with PSCs.

The current reforms are intended to shift these responsibilities, including liability to operate PAYE and pay NICs, from the PSC to the end user. In the case of a supply chain of contracts between the end user and the PSC, the liability to operate PAYE and pay NICs shifts to the person closest to the PSC in the chain (provided that the person is resident in the UK and is not under common control with the PSC).

In 2017, these reforms were introduced in the public sector (including all Government departments and the BBC).

Last year, the Government announced that it would extend the reforms to the private sector, with effect from April 2020. While this move came as little surprise in view of the public sector precedent, it is potentially very significant for private sector end users, who now face considerable compliance burdens and liabilities.

The stated aim of these reforms is to address what the Government regards as widespread non-compliance by PSCs.

Arguably, a contributory factor in the disappointing tax yield for HMRC under IR35 has been the complexity of the statutory test, which posits a hypothetical direct contract between the end user and the worker and asks whether the worker would be an employee or office holder. Determining whether IR35 is engaged requires the application of a highly fact-sensitive question (whether a contract is for services or is of service) to a contract which does not exist, and is therefore likely to cause confusion and difficulty in many cases. This is evidenced by a number of recent IR35 decisions, including the First Tier Tribunal decision released last week concerning the status of Lorraine Kelly’s engagement by ITV (Albatel Ltd v HMRC [2019] UKFTT 195 (TC)), in which HMRC were unsuccessful.

The Government launched a consultation process to refine the details of the reforms, and the most recent consultation document was published on 5 March 2019 (the consultation document can be accessed here).

The new consultation

Following the government’s announcement, in Budget 2018, that it would extend the new public sector off-payroll working rules to the private sector, two consultation documents have been published discussing the ways in which the rules could be rolled out. Our previous bulletins on these developments can be accessed here and here.

The most recent consultation document, which takes into account responses to the earlier consultation, sets out a number of proposed changes to the private sector reforms, the legislation for which is due to be published in July 2019.

The main changes and developments discussed in the consultation document are as follows:

Scope of the private sector reforms:

As already announced, the new off-payroll working rules will extend to medium and large-sized private sector end users but not to small private sector end users.

To determine whether a private sector corporate end user falls within the scope of the new rules, the Government will use the statutory definition of a small company in the Companies Act 2006. This means that companies will be within scope if they exceed any two of three thresholds (£10.2 million for revenue, £5.1 million of assets and 50 employees).

However, the Government considers the asset test to be inappropriate for non-corporates (such as partnerships), and proposes to use one of the following two options:

• apply the reforms to unincorporated entities with 50 or more employees or turnover exceeding £10.2 million (which would put non-corporates in a worse position than companies); or
• apply the reforms only to unincorporated entities that have both 50 or more employees and turnover in excess of £10.2 million (which would put non-corporates in a better position than companies).

Providing status determination and reasons to workers:

The consultation proposes that as from April 2020, end users (including those in the public sector) will be required to provide the outcome of a status determination (i.e. whether a worker should be regarded as employed or self-employed under the new regime) to the off-payroll worker directly and, on request, the reasons for that determination. The current public sector rules only require the end user to provide this information to its contracting party.

This development in the rules, and the related proposal for end users to operate a status disagreement process (see below), means that end users will be forced to engage directly with individuals who are unhappy with status assessments.

Where a supply chain is involved, each party making a status determination will be required to pass the determination on to the next person in the supply chain as well, down to the person who is primarily responsible for operating PAYE and paying NICs (the person who is deemed to be making a payment of employment income to the worker, if the rules apply). This system is intended to secure that information cascades down supply chains so that parties in the middle of supply chains are aware of the status of the worker and can comply with their obligations under PAYE and NICs.

Secondary liability for end users:

The consultation recognises the possibility of non-compliance with the new regime, in particular where a supply chain is involved and a status determination may not find its way to the entity in the supply chain responsible for operating payroll. In such circumstances, it is proposed that, if HMRC are unable to collect tax due as a result of an employment relationship arising under the new regime, then the liability for the outstanding amount should travel back up the supply chain until it can be recovered.

An end user may become liable for uncollected liabilities even where a lengthy supply chain involving multiple agencies is present and the end user is neither primarily liable for operating PAYE nor in a direct contractual relationship with that person.

This potential for secondary liability exposes end users to credit risk in relation to agencies that they deal with directly and to agencies further down the supply chain. It is likely to increase the pressure on end users to err on the side of caution when making a status determination, and may also make it more difficult for smaller and start-up agencies to operate in the market (as the consultation recognises, saying, “This approach would also encourage all parties to contract with reputable and compliant firms”).

Requirement to establish a status disagreement process:

The consultation recognises that workers may disagree with status determinations made by end users and proposes a dispute resolution mechanism led by end users, which would be governed by parameters set out in the legislation.

It is envisaged that the status disagreement process will require the end user to consider evidence provided by the individual workers and by the “fee-payer” entity in the chain which is responsible for operating PAYE and NICs (if that entity is not the end user).

There will often be a natural tension between the views of risk-averse end users (who want certainty over tax treatment) and those of the individual workers for whom the status determination is most significant. This proposal for a status disagreement process, mandated by statute is yet another way in which the Government is looking to shift the burden of managing these complex rules to business. It is notable that the additional red tape that this proposal brings is dismissed in the consultation with the following sentence: “Public sector and medium/large-sized private sector organisations are likely to already have relatively sophisticated HR processes in place either in-house or sub-contracted to relevant service providers for managing workplace disputes”.

There is no suggestion that the proposed status disagreement process will be binding on HMRC, or that there will be any independent arbitration of these disputes. An end user which decides to change its status assessment following such a process may ultimately find that it was mistaken to do so, and is liable to HMRC for unpaid income tax and NICs. It seems unlikely that the proposed process will result in many changes of assessment.

HMRC’s Check Employment Status for Tax (CEST) tool

HMRC launched their CEST tool (an online service for determining whether IR35 rules apply) in 2017. The consultation states that HMRC will make enhancements to the tool and test them with stakeholders before the private sector reforms are implemented, and that HMRC will improve their CEST guidance and develop a new education and support package.

The CEST tool is essentially a relatively crude questionnaire which purports to assess whether the IR35 rules apply. In reality, it seems ill-equipped to deal with the complexities of such a fact-sensitive question. Nevertheless, HMRC will continue to recommend strongly that the tool should be used in the status determination process, and one would expect HMRC to accept that end users who rely on the tool should be able to demonstrate that they have taken reasonable care in making a status determination (and so potentially mitigate the risk of penalties). The danger of course is that there may be significant differences of view between end users who rely on the CEST tool and the individual workers.

Impact on business

As noted in our previous bulletins, the IR35 reforms are likely to have a significant impact on private sector businesses that engage off-payroll workers. Not only could these businesses incur payroll obligations and NIC costs, but they will also have to deal with increased record-keeping and reporting requirements.

The changes proposed in the latest consultation will add to the burden on business (for example the requirement to establish a status disagreement process, and the potential exposure to secondary liability) and highlight the complexity of the arrangements targeted by the reforms, which often involve multiple parties along lengthy supply chains.

The IR35 reforms are consistent with other recent moves by Government to shift regulatory compliance obligations to corporates, including the new SMCR financial services regulatory regime, and the shifting of responsibility for immigration work permits from the Home Office to business.

It will be necessary for businesses to scrutinise the draft legislation closely when it is made available in the summer, in order to understand fully the obligations and potential liabilities of parties along supply chains, which could be greater than expected.

Parties that could be affected by the proposed IR35 reforms should consider:

• participating in the new consultation, responses to which are due by 28 May 2019; and
• if not already commenced, beginning to consider any measures they might want to introduce in response to the reforms.

We will continue to monitor developments in this area and keep clients updated.