IR35 and the off-payroll rules
Updated on 9 June 2022
As a result of an increase in umbrella company related queries coming into the REC Legal Helpline lately, we have put together this factsheet for members working with umbrella companies. The guide brings together the most frequently asked questions into one factsheet and includes guidance for members on how the REC Code of Professional Practice applies to umbrella company arrangements.
Download the REC Guide to working with umbrellas here. HMRC has prepared guidance for agencies and businesses using temporary labour specifically on tax avoidance schemes involving umbrella companies, the risks/consequences of becoming involved in a tax avoidance scheme and steps you can put in place to help reduce their risk. Please see here for more details.
Updated on 14 May 2021
Last minute technical changes to the off-payroll (private sector) legislation – updates to REC contracts and supporting documents.
The off-payroll rules will apply to the private sector from 6 April 2021. Since the 2021 Finance Bill government introduced some technical changes to the off-payroll rules for workers who provide services through intermediaries where the clients are public authorities or medium or large in the private sector. The changes ensure that the off-payoll rules operate as intended.
HMRC has updated its guidance on how to use the Check Employment Status for Tax (CEST) tool to reflect the 6 April 2021 changes to the off-payroll working rules. (See Question 5 below for more details).
Download the supporting documents here
Here's a summary of the changes
Government has confirmed that there will be changes to the rules:
- the wider definition of an intermediary will be corrected so that umbrella company workers are not within the scope of the rules.
- currently the rules apply to contractors, who must have a material interest in the intermediary they work through. Material interest means owning more than 5% of the company; or being entitled to 60% or more of the profits in a partnership. But material interest will change only for companies to include cases where the contractor has less than a material interest meaning the rules will apply if they receive payment that is not deemed employment income and they have any interest in the company.
- a targeted, anti-avoidance rule will be applied to arrangements where the primary purpose is to gain a tax advantage by circumventing the rules.
- to make sharing information easier, instead of just the worker, the intermediaries will be obliged to confirm to persons in the supply chain whether the IR35 qualifying conditions are met (in terms of what the worker has been paid).
- extend the consequences for providing fraudulent information, so where fraudulent information is provided, the liability will be moved to the party in the UK supply chain that provided the fraudulent information.
As a result of these last-minute changes we have made some amendments to our template contracts and some of our supporting documents.
We advise members to use these versions of the contracts and template documents going forward and here is an explanation of the amendments we have made:
Contract Number |
Off-payroll rules apply or don't apply |
Amendment |
REC Combined Terms |
|
|
Off-payroll rules apply |
Definition of Conditions of Liability to include non-material interest and termination clauses. |
|
Off-payroll rules do not apply, as the clients are exempt |
Minor amendment to the introductory notes in the contract (not the contract), to simply highlight minor changes to the off-payroll rules from 6th April 2021. |
|
REC Non-combined Terms |
|
|
Private sector - Off-payroll rules do not apply
Public sector - Off-payroll rules apply |
As these contracts are used for umbrella company arrangements, amendments have been made to definition of Conditions of Liability to include non-material Interest and termination clauses, to reflect rules in the public sector. |
|
Public sector - Off-payroll rules apply |
Amendments have been made to definition of Conditions of Liability to include non-material Interest and termination clauses, to reflect rules in the public sector. |
If you require further guidance please contact the legal helpline.
Updated 9 June 2022
The off-payroll rules in the public and private sectors
The off-payroll rules (also known as IR35) aim to ensure that, where an individual works via an intermediary, they pay similar rates of tax to an employee if they work in the same way as an employee. The off-payroll rules apply where an individual (A) works through an intermediary and:
(a) where that intermediary is a company or partnership, A has a material interest in that intermediary i.e.:
1) where the intermediary is a company, A owns, controls or has a beneficial interest in more than 5% of the ordinary share capital; or
2) where the intermediary is a partnership in which A is entitled to 60% or more of the profits; or
(b) where the intermediary is another individual (B), A receives that payment directly from B and the payment can reasonably be taken to represent remuneration for services provided to a client.
The public sector: Changes came into effect on 6 April 2017 which affect the application of the IR35 rules where the client is a public authority – these are known as the off-payroll rules. In brief, the administration of IR35 tax moved from contractors and their intermediaries (e.g. personal service companies (PSCs)) to public authorities and 'fee-payers'. This means that the public authority must decide whether the engagement is 'inside IR35' - so taxed at employee rates - or 'outside IR35' - taxed at self-employed rates. Where it decides that an assignment is 'inside IR35', the organisation closest to the intermediary (the 'fee-payer') must deduct PAYE tax and National Insurance Contributions (NICs) before paying the intermediary/PSC net of employee rates of tax. Where the assignment is 'outside IR35' the fee payer can pay the intermediary/PSC gross so that they can deduct their own self-employed rates of tax.
The private sector: The off-payroll rules will be extended into the private sector on 6 April 2021 . From that date, private companies will make the decision about IR35 tax status instead of the intermediary/PSC (though small and overseas clients will be exempt). The rules will apply to payments made for work done on or after that date. Until then, intermediaries/ PSCs will continue to manage their own IR35 tax status. The final legislation is set out in Schedule 1 of the Finance Act 2020 (which amends Part 2, Chapter 10 of the Income Tax (Earnings and Pensions) act 2003).
See our infographics which explain the changes in detail. These include infographics that you can use with clients or contractors.
1. IR35 and the off-payroll rules - what do 'Inside IR35' or 'Outside IR35' mean?
You will not find the terms 'IR35' , 'Inside IR35' or 'Outside IR35' in any legislation.
IR35 refers to the 1999 communication from the former Inland Revenue which set out some new rules which would apply to limited company contractors. The rules were brought in to prevent contractors using intermediaries such as personal service companies (PSCs) or limited liability partnerships (LLPs) to avoid employment taxes where appropriate.
Since 6 April 2000, those contractors providing personal services must pay PAYE tax and NICs on income received from 'relevant' engagements. 'Relevant' engagements are those which would but, for the existence of that intermediary, indicate an employment relationship between the contractor and the client. In an 'Inside IR35' engagement the contractor is deemed to be an employee for tax purposes.
In contrast, in an outside IR35 arrangement, the contractor would not be deemed to be an employee for tax purposes.
There is no single checklist for assessing IR35 status and status on one engagement does not determine status in another engagement. The tests have developed over the last 20 years through case law.
· The original IR35 rules are set out in Part 2, Chapter 8 Income Tax (Earnings and Pensions) Act 2003 (ITEPA). Under these rules the PSC manages IR35 itself, i.e., the PSC assesses whether an engagement is inside or outside IR35 and applies tax and NICs accordingly. IR35 status should be assessed on an assignment by assignment basis - the contractor cannot decide at the beginning of a tax year that they will be outside IR35 for the whole of the tax year. In the private sector the original IR35 rules will continue to apply until 5 April 2021.
· The off-payroll rules are set out in Part 2, Chapter 10 ITEPA and have applied in the public sector since 6 April 2017. Under these rules, the responsibility for deciding IR35 status moved from the PSC to the public authority, which is the end user client i.e. the public authority client must decide whether an engagement is inside or outside IR35. If the client decides that the engagement is inside IR35, then the 'fee-payer' must deduct employee rates of tax and NICs before paying the PSC. From 6 April 2021 the off-payroll rules will also apply in the private sector unless the client is exempt.
If conducting an IR35 review, HMRC will consider whether an engagement is a 'relevant' engagement by looking at all the facts of the relationship between the contractor and the client, and the employment business (if they are supplied to the client through one). HMRC’s investigation will include a consideration of the terms of any contract(s) in existence, but will not be limited to the contract(s). If the facts of the relationship indicate employment, but a contract has been issued indicating a self-employment relationship, this will not protect an intermediary or contractor from any claim for unpaid PAYE tax and NICs on income received from that engagement. Therefore, it is vital that an employment business supplying an individual through an intermediary establishes what the individual’s IR35 status is before supplying the individual to a client and then supplies them on the correct contract. See the REC template document library for details of all our contracts and supporting documents.
Further detailed information on IR35 and UK tax law and practice - HMRC website.
2. Which clients will be exempt from the off-payroll rules from April 2021?
The off-payroll rules have applied in the public sector since April 2017. The rules will be extended to the private sector from 6 April 2021 and will apply to payments made for work done on or after that date. But a private sector client will be exempt from the off-payroll rules if they are:
1. a small organisation; or
2.a company with no UK connection.
Exempt small organisations:
A private sector client will be exempt from the off-payroll rules if it meets the definition of a small company set out in sections 382 and 383 of the Companies Act 2006, i.e. it is a company which meets two of the following three criteria:
· it has a turnover of not more than £10.2 million per financial year;
· it has a balance sheet of not more than £5.1 million per financial year;
· it has no more than 50 employees.
Unincorporated organisations (those not registered with Companies House) will also be exempt from the off-payroll rules if they have a turnover of not more than £10.2 million per year. There are also rules about groups of companies and joint ventures.
The new rules do not require a company that claims to be exempt, to proactively tell their agency suppliers. However, if asked by the worker or the deemed employer (the fee payer), they must respond within 45 days to confirm whether they are exempt or not. REC template contracts between employment businesses and end user clients include a provision requiring the end user client to inform the employment business whether it is exempt or not. We have created an exempt company declaration form which you can use to ask the client about their status - do not try to guess whether your client is small or not.
For more details on the small companies exemption see HMRC's Employment Status Manual at ESM 10006 to 10011A.
Please note that the small companies exemption only applies to clients - it doesn't matter if your agency is small, what matters if the size of the client - if the client medium/large it will not be exempt it will have to comply with the off-payroll rules.
Exempt companies with no UK connection:
A company will also be exempt if it is based wholly overseas, i.e. there is no UK connection immediately before the beginning of the relevant tax year either in the form of being UK resident or having a permanent establishment in the UK. This means having a fixed place of business which includes a branch, an office or a factory. It also includes having an agent that ordinarily operates on behalf of the client or an oil or gas platform within UK waters.
Again, do not try to guess whether your client is wholly overseas or not. You can use the exempt company declaration form to ask the client about its status. Note that, unlike the exemption due to size, the legislation does not require the client to respond to any queries about whether it is exempt because is wholly overseas.
For more details on the overseas companies exemption see HMRC's Employment Status Manual at ESM 10006 and 10025 to 10026.
3. What does a client have to do under the off-payroll rules?
Clients which must comply with the off-payroll rules must decide whether an engagement is 'inside IR35' or 'outside IR35'. This will determine whether the fee-payer must deduct tax and NICs before paying the intermediary/ PSC, or not. There is no single checklist for assessing IR35 status, and status on one engagement does not determine status on another engagement. The starting point is to consider all of the facts of the relationship between the client and the contractor in any proposed engagement.
The legislation does not say how the client must make its decision, but it does state that the client must take reasonable care when making its decision.
Reasonable care will depend on the resources available to a client but HMRC have said that they will expect much more from a large multinational organisation than from a smaller organisation. Reasonable care could include using HMRC's Check Employment Status for Tax Tool (CEST), using another tool or using an external advisor. The client can outsource the review and decision making process but it will remain legally responsible for the IR35 status decision made.
For more information on reasonable care see HMRC's Employment Status Manual at ESM 110014.
Passing the decision through the supply chain: The client must pass its status determination statement (SDS) to both the party it has a contract with (your agency in a short supply chain but probably not in a longer chain) and the off-payroll worker (i.e. the contractor). Each party must pass the decision down the chain until it reaches the fee-payer. A party in the chain will be deemed to be the fee-payer until it passes the decision down.
Format: The legislation doesn't require the client's IR35 status decision to be in a particular format but it must include the reasons for the client's decision to be valid. You can use our client status determination form to ask the client to confirm its status decision.
Disagreements about the client's status decision: If you or the contractor/ PSC are unhappy with the client's status decision do not simply replace it with your own status decision - you will be liable for the decision and not the client. Instead you can ask the client to revisit its decision. The client must respond within 45 * days of receiving a query and must:
· confirm that it has considered the representations made and decided that its SDS is correct, and give the reasons for that decision; or
· give a new SDS containing a different conclusion and state that the previous SDS is withdrawn.
If the client does not respond within 45 * days it will become the fee-payer.
(*The 45 day time limit will come into effect for private and public sector clients from 6 April 2021, until then, only public authorities are subject to the off-payroll rules and should respond within 31 days of receiving an enquiry about their decision).
4. How do you decide if someone is self-employed or employed for tax purposes?
4.1 Limited company contractors - what tests can I use to check whether a contractor is employed or self-employed?
There is no single checklist for assessing IR35 status and status on one engagement does not determine status on another engagement. The starting point is to consider all of the facts of the relationship between the client and the contractor in any proposed assignment. You will have to discuss with the client:
· the basis and method of payment;
· the type of work the contractor will do, and whether or how s/he is to be supervised, controlled or directed.
You will also have to discuss with the contractor whether:
· they work or have worked for other clients;
· whether they're prepared to quote a fee for the work;
· whether they'll provide equipment or facilities to do the work;
· what insurance they carry; and
· whether they expect to assign or sub-contract the work or supply substitutes (though clients may have an issue with this).
Once you have this information, it is then a balancing exercise to consider whether the arrangement amounts to employment or self-employment.
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4.2 Limited company contractors – what case law is there on employment versus self-employment?
The courts have looked at employment status issues for many years. They have held that there is no single test that can be applied to decide whether a person is an employee or self-employed but a person cannot be an employee unless:
· they offer their own work (and cannot delegate or send a substitute without permission (see below)); and
· there is mutuality of obligation, i.e. the employer is obliged to offer work and the employee is obliged to do it.
Substitution - contractors like to see a very wide substitution clause in a contract which allows them to send a substitute without the permission or authority from the client. But such an "unfettered" right of substitution in a contract will not guarantee that an engagement is outside IR35 if all other factors point to an inside IR35 engagement. The tribunals watch for "sham" substitution clauses. And of course there are sectors or roles where substitution could never happen because for example, of safeguarding or security reasons. So if a contractor asks for an unfettered right to substitute you must discuss with the client in what circumstances they would allow a substitute. and make sure the client and contractor contracts support each other.
Cases on self-employment for tax purposes are initially dealt with by the Special Commissioner. If either HMRC or the individual concerned bring a case, they do so via the Tax Tribunal. Decisions are then appealed to the Upper Tribunal. This contrasts with cases on self-employment for employment rights purposes which go to the employment tribunal. Unless stated otherwise, the following cases are all tax law cases.
Case 1: Christa Ackroyd Media Limited v HMRC [2018] UKFTT 0069 (TC)
In Feb 2018 HMRC won the first IR35 case which went to tribunal since 2011. Ms Ackroyd worked through a personal services company, CAM Ltd. through which she provided her services to the BBC as a journalist and presenter. HMRC pursued CAM Ltd.Ms Ackroyd for unpaid tax and NICs, dating back a number of years. The tribunal found that Ms Ackroyd was deemed to be a BBC employee for the following reasons:
· Substitution: she was prohibited from using a substitute.
· Control: she was not subject to BBC appraisals but the tribunal did not accept that she had day to day editorial control of her work – she was subject to the BBC Editorial Guidelines (though these were not incorporated into her contract).
· Mutuality of obligation: she had no set hours or days but the BBC had first call on her services for 225 days per year.
· Duration of contract: “the existence of a 7-year contract meant that her work at the BBC was pursuant to a highly stable, regular and continuous engagement. It involved a high degree of continuity rather than a succession of short-term engagements. That was a pointer towards an employment contract.”
· Entitlements: not entitled to holiday or sick pay. However, the tribunal did not consider this to be significant. Nor did they consider it significant that fees were paid monthly (like an employee might be paid). She was entitled to additional travel and subsistence expenses plus a clothing allowance.
· Equipment: she worked at home a lot and provided her own mobile and laptop but the tribunal said that so did a lot of employees. Otherwise she used BBC equipment.
· Financial risk: she was not running a business from which she could make a profit or loss (instead she performed her significant role in the team to a high standard). She was economically dependent on the hypothetical contract with the BBC which took up most, if not all of her working time.
The Tribunal held that:
“The stated intentions of the parties … cannot prevail over the true legal effect of the actual agreements”.
It is not appropriate to adopt a mechanistic or checklist approach. Different factors will have different significance and weight in each case. The tribunal must “stand back from the detail and make a qualitative assessment of the facts as found”. If there was a “hypothetical contract” between Ms Ackroyd and the BBC, she would be deemed to be an employee for tax purposes. Therefore, she was inside IR35.
Note: at the time of writing there are a number of ongoing cases where HMRC are pursuing TV and radio presenters for unpaid tax and NICs. We will update this section when we have more judgments.
Case 2: MDCM Ltd. v HMRC [TC/2017/01591]
Mr Daniels was a director and employee of MDCM Ltd. which provided construction management services including night shift management. MDCM engaged with SRL (a recruitment business) which in turn had contracts with construction clients, in this case STL.
When working for STL, Mr Daniels was a contact point for contractors. He wore a high visibility jacket and a hard hat to be identifiable but he did not take part in STL meetings or functions. He also had access to an STL computer on site but used his own mobile phone. He had to work shift hours, though could leave early if all tasks had been done. He was not entitled to sick pay, holiday pay or other employee benefits from STL (he would have had to claim them from MDCM). He had to cover his own travel, hotel and subsistence expenses from his daily rate. There was no notice period.
In summary:
· Substitution: Mr Daniels could not provide, and STL was not required to accept, a substitute. The hypothetical contract would be one of personal service, with no right of substitution and there would be mutuality of obligation between STL and Mr Daniels.
· Financial risk: in the hypothetical contract Mr Daniels would receive his day rate and would pay his own expenses. However, the tribunal did not find this a significant financial risk factor.
· Equipment: STL provided safety equipment to Mr Daniels.
· Notice: no notice was required. In a hypothetical contract there would be no entitlement to notice, severance pay or pay in lieu.
· Duration of contract: open-ended with no notice.
· Benefits: Mr Daniels would not have been entitled to sick pay, holiday pay or other employee type benefits under a hypothetical contract.
· Integration into the organisation: Mr Daniels was not invited to meetings, functions or other employee events and would not have been under the hypothetical contract.
· Payment: HMRC accepted that a daily rate pointed towards self-employment (though this contradicts what they said in Jensal - see case 3 below).
· Control: Mr Daniels was not controlled any more than any other contractor and could refuse to work on another site.
Conclusion:
The Tribunal agreed that the requirement for personal services and lack of financial risk pointed towards employment. They rejected HMRC’s argument that Mr Daniels was controlled by STL. They did find that the nature of the payment arrangements, a flat rate per day with no notice period and no entitlement to any employment benefits were inconsistent with employment. He was also not treated as an employee. A hypothetical contract between Mr Daniels and STL would not be a contract of employment. Therefore, the engagement was outside IR35.
Case 3: Jensal Software Limited v HMRC [TC/2017/00667]
Mr Wells provided his services through his personal services company, Jensal Software Limited. He was engaged via Capita to work on DWP’s Universal Credit programme. He had 4 contracts between May 2012 and June 2013. He was paid a daily rate and the number of working hours was not stipulated but he was paid for a “professional working day”. That said, the work was goal orientated and focussed on delivery to projected timescales, so hours varied.
In summary:
· Mutuality of obligation: though Mr Wells provided his services for payment, the mutuality of obligation does not of itself demonstrate a contract of services. The DWP paid Mr Wells a daily rate for the work carried out in accordance with the agreed rate as invoiced. There was no contractual obligation beyond that. DWP paid the daily rate irrespective of hours worked. Each contract lasted a short duration and DWP was not under an obligation to provide work. Mr Wells terminated the contract early when a better paid one became available. This pointed away from employment.
· Substitution: Mr Wells had a right of substitution, though it was never used. The right to substitute was restricted in that DWP needed to agree the proposed substitute but the tribunal held that was not of itself a sign of employment and in fact pointed away from employment.
· Control: the framework agreement between DWP and Capita stated that “Interim Personnel … shall be under the supervision and control of [DWP] and [DWP] shall be responsible for the operational direction, supervision and control of Interim Personnel assigned … “. The tribunal considered that although two DWP managers were ultimately accountable for Mr Well’s work, this related to the delivery of the project and held that he was subject to minimum checks. The control to which he was subject was “substantially less and clearly distinct from that over employees”. Therefore, Mr Wells was not subject to the degree of control which would be necessary to constitute a contract of employment.
· Financial risk: though there was no scope for W to increase his profits (as he was paid a daily rate) he was exposed to financial risk in a wider context, e.g. he had to fix defective work at his own expense.
· Integration at the client: DWP provided him with a laptop and a password protected profile, but the tribunal considered this a neutral factor given the security protections required by DWP.
· Insurance: Mr Wells had to take out public liability and professional indemnity insurance – the Tribunal considered this was not a particularly strong indicator but pointed towards a contract for services.
Conclusion: “Looking at the overall picture and making a qualitative assessment … the relationship [was] consistent with a contract for services and not a contract of service.” Therefore, this engagement was outside IR35.
Case 4: JLJ Services Ltd. v HMRC [2011] UKFTT 766 (TC):
Mr Spencer worked though his own company, JLJ Services Ltd. Between 1994 and 2000 he worked for 6 different clients on engagements of various lengths. He had various periods without work. In May 2000 he started a 6-month contract with Allianz. This was repeatedly extended until Dec 2003 with specific projects to be undertaken. In December 2003 Allianz tried to engage Mr Spencer on an indefinite basis, he declined, but took on a number of long terms assignments with them until he retired in 2007. HMRC pursued Mr Spencer and JLJ for unpaid PAYE tax and national insurance.
The Tribunal looked at personal service, control, the consistency of the contractual terms, whether Mr Spencer had his own business and whether there was mutuality of obligations between him/ JLJ and Allianz.
· Personal services v substitution: the contract between JLJ and Allianz contained a substitution clause. Mr Spencer never asked to use it and the Judge commented that even if he had, Allianz were interested in Mr Spencer’s qualifications and expertise and would have been equally interested in the skills of a substitute i.e. they would not want him to make a substitution without their consent. The Tribunal stopped short of saying that the substitution clause was a sham but said that it was one of the type always inserted in cases of this nature, having very little reality – it was probably only included to “sustain non-employee status” and to achieve “the desired tax purpose”. That said, the judge said that the substitution clause would play no part in the Tribunal’s decision.
· Control: the Tribunal accepted that when Mr Spencer worked on a number of different projects for Allianz they had little control over his work. However, from 2004 when he was available to work for them indefinitely and not on specific projects, they had more control over his work.
· Own business: the Tribunal felt that although Mr Spencer took some risks in his early contracting days, and indeed, had significant periods without work, this changed from December 2003. From that point he would fail the “own business” test because he had no opportunity to make more or less profit according to how efficiently he worked. He was simply paid for hours worked. (This contrasts with a different decision (Primary Path, July 2011) by the tribunal (a different judge) who felt that hourly rates were a feature of the charging structure of professional firms and skilled trades people.)
· Mutuality of obligation: the Tribunal gave a mixed message on this point. On the one hand it said that case law was paying less regard to this yet noted that prior to 2004 there was no mutuality of obligation between Mr Spencer and Allianz, whereas post 2004 there was a continuing relationship between them.
In summary:
The Tribunal considered that the following would point to self-employed status:
· an individual has a particular area of expertise;
· that expertise has not enabled him to get full time employment and indeed, s/he obtains most work through placement agencies (i.e. recruitment businesses);
· that expertise is required by companies but on an ad hoc, project basis rather than on an indefinite basis;
· the type of work performed by the individual is likely to be outside the core area of the client’s business;
· the pattern of work is ad hoc, with assignments of varying lengths with different clients, sometimes with unwanted gaps between assignments;
· the client would not expect to control or supervise the individual because they were an expert in their area and were performing work outside the expertise of the client company;
· having engaged an individual on a project basis the client would consider it inappropriate to provide employment benefits.
Conclusion: The Tribunal considered that Mr Spencer met the above criteria up to the end of 2003 and thus was outside IR35 until this time. However, post 2004 he was engaged across a range of projects at Allianz and their control over his work increased. From this stage he did not meet all of the above criteria and was caught by IR35.
Weight Watchers (UK) Ltd v HMRC FTC/57-59/2010:
Issue: Looking at the whole picture.
This was an appeal from a decision by the first tier tax tribunal which found that leaders (who ran the Weight Watchers (WW) meeting) were employed by WW for tax purposes. The upper tribunal upheld that decision.
Leaders were members of WW who had successfully lost weight and maintained that loss. They were trained to present the WW programme to other WW members in weekly meetings. Their training was covered by a Memorandum of Agreement (MOA) for Student Leaders. The MOA contained a confidentiality clause, non-solicitation provisions, provisions relating to WW’s intellectual property and provisions relating to meetings with WW’s Area Sales Managers (ASM).
The MOA was supplemented by “Conditions relating to Weight Watchers Leaders” which provided that the agreement between WW and the leader could be terminated by either party on notice. The leader would be paid fees for taking meetings, such fees were paid on a commission basis, the commission being calculated in accordance with how many members attended that meeting and the sales of merchandise such as food products and books. The leader was required to maintain her weight loss. Leaders were also required to comply with provisions set out in Policy Booklets, which set out for example, how to promote, sell and store merchandise. The Conditions described the leader as an independent contractor who was required to discharge her own national insurance and income tax liabilities.
· Substitution: Both the first and upper tribunals spent considerable time looking at this. Leaders were expected, though not obliged, to hold not less than 2 meetings per week. Condition 10 was a substitution clause which stated “If the Leader does not propose to take any particular meetings on any particular occasion and is unable to find a suitably qualified replacement, Weight Watchers will if so requested by the Leader, attempt to find such replacement and for this purpose the Leader will give the Area Service Manager as much prior notice as possible”. The upper tribunal also noted that if the leader did find a replacement to hold one of her meetings, that person would not be her substitute or delegate but would have their own direct contract with WW. WW argued that the leader’s right not to take a particular meeting was unrestricted. Both tribunals rejected this and held that the right of substitution was restricted by implication by the need to show some good reason not to take a meeting (and not just that the leader was unable to take a meeting). It was also restricted by the continuing obligations to find a suitably qualified replacement, to notify the ASM if unable to do so and to conduct all other meetings agreed to.
· Control: The leader retained the initiative to arrange the time, date and venue for meetings but this was ultimately controlled by WW. These meetings followed a standard format set out in the various contractual documentation. Together with the weight maintenance requirement, and WW’s ability to terminate the agreement without cause, WW exerted ultimate control over the leaders.
· Financial risk: Whilst leaders might occasionally spend their own money on ingredients for cookery demonstrations during meetings, their financial risk was minimal and in any event, they were not contractually obliged to incur such expenses.
· Did the leaders look like employees? The upper tribunal noted that the leaders were not integrated into WW’s workforce the way ASMs were. They did not have defined career structures, receive benefits or undergo performance reviews, so they looked less like employees than other WW staff. However, “the fact that one group of a company’s employees are less integrated into a typical modern employment structure than another group is of no significant weight towards a conclusion that they first group are not employees at all. It is, again, a matter of fact and degree.”
· Looking at the reality of the relationship: The upper tribunal held that contracts of this nature had to be looked at purposively with regard to the realities of the relationship. Although the leaders were called “independent contractors” this label did not reflect the reality of the relationship with WW, which could only be established by looking at the contractual documentation together with their practical implementation.
5. Updated Check Employment Status for Tax (CEST) tool and the Employment Status Manual
HMRC has updated its guidance on how to use the Check Employment Status for Tax (CEST) tool to reflect the 6 April 2021 changes to the off-payroll working rules.
HMRC has rewritten its CEST tool guidance following the changes to the off-payroll working rules which came into force in April 2021.
The CEST tool can be used to help hirers, agencies and workers decide on the employment status of an individual and, where appropriate, to decide whether the off-payroll rules apply to a contract.
The guidance notes that HMRC will stand by all status determinations given by the tool so long as the information provided was accurate.
For more information on CEST see HMRC's Employment Status Manual 11000.
Clients do not have to use CEST when making their IR35 decisions. They can use any tool or bring in external help but they remain responsible for the decision even if they outsource the decision making process.
HMRC's Employment Status Manual contains HMRC's guidance on matters relating to employment status for tax purposes. It is not the law but is a good indicator of HMRC's policy and how it intends to enforce tax law. See in particular:
ESM 8000 for the IR35 rules which apply when the contractor works in the private sector to 5 April 2021 or from that date where they will provide their services to clients who are exempt from the off-payroll rules.
ESM 9000 for the off-payroll rules which apply in the public sector until 5 April 2021.
ESM 10000 for the off-payroll rules which will apply to pubic sector supply and supply to medium/large private sector clients from 6 April 2021
ESM 11000 for guidance on CEST.
6. Who is the fee-payer and what does it have to do under the off-payroll rules
· Who is the fee-payer?
The fee-payer is the party who has the contract with the intermediary/personal service company (PSC). This will usually be the agency but some agencies do not use their own payroll and instead use another intermediary, such as an umbrella company to engage and pay workers. So, you must be clear who is in the supply chain and who has what type of contract with whom e.g. if it's an umbrella company, you want to know that they employ the worker and pay them subject to PAYE tax and NICs rather than pay a PSC gross if the client has determined that an engagement is inside IR35.
Please note that if there is an overseas agency in the supply chain, it cannot be the fee-payer. Instead, the fee-payer will be last entity in the supply chain which is based in the UK.
· What does the fee-payer have to do?
If the client decides that an engagement is outside IR35, the fee-payer can simply pay the intermediary/ PSC gross and the PSC will manage its own tax affairs.
When an engagement is inside IR35 the fee-payer must:
(a) calculate the ‘deemed direct payment’ due to the intermediary/ PSC, and then
(b) deduct PAYE tax and NICs from that payment before paying the intermediary/ PSC. Employer’s NICs will also be due.
It is essential that if there is another party between the agency and the PSC, e.g. an umbrella company, that the agency knows that that party will comply with the client's inside IR35 decision, i.e. if the contractor continues to work through their PSC, the umbrella company should not pay the PSC gross. If the umbrella company disappeared, then the agency would be liable for unpaid tax and national insurance. See the FAQ "Transfer of lainbility for unpaid tax and national insurance".
How to calculate the deemed direct payment:
Section 61Q ITEPA sets out how to calculate the deemed direct payment:
Step 1 – identify the gross sum claimed by the PSC (i.e. by invoice). Disregard VAT for the time being. Step 2 – deduct the direct cost of any materials used in the provision of the individual’s services. Step 3 – deduct any expenses that would have been deductible from the individual’s taxable earnings if (a) the individual had been employed by the client and (b) had met those expenses out of those earnings. Step 4 – the balance is the deemed direct payment. If nil, or negative, there is no deemed direct payment. Add back any VAT disregarded at Step 1 and make payment. The balance from Step 4 is the sum which is subject to PAYE tax and NICs and on which employers’ NICs are calculated (subject to any thresholds). |
The fee-payer must report this through Real Time Information.
The fee-payer will need the off-payroll worker’s PAYE tax code and National Insurance number so that it can make the correct deductions. The legislation does not oblige the contractor or the PSC to provide this information, but if they don’t, the agency will have to apply emergency tax. Please see the FAQ, ' Should I include VAT in the calculation for income tax and national insurance?' for a more information on how to account for VAT when making the deemed direct payment.
For more information about how to manage PAYE for contractors see HMRC's Employment Status Manual from ESM 10019 onwards.
Alternatives to payrolling PSCs: Although the steps above may seem straightforward on paper, it is quite difficult to payroll a PSC - there isn't any commercial payroll software at the moment that can do that. Also, a contractor may decide it is no longer financially beneficial to work through their PSC for inside IR35 engagements. So, agencies may decide to engage contractors directly on payroll or through an umbrella company - if you decide to pay contractors through an umbrella company use our due diligence checklist 7A (umbrellas) to make sure they are compliant.
7. Inside IR35 - Should I include VAT in the calculation for income tax and national insurance?
For VAT, something is either a taxable supply, an exempt supply or a supply outside the scope of VAT. If a personal service company (PSC) is VAT registered, it must charge VAT for its services. The fact that the PSC has to pay income tax and national insurance contributions on that amount does not change the fact that VAT is also due – i.e. there are no deductions for VAT.
If a PSC is deemed to be inside IR35 under the new IR35 rules from 6 April 2021, they'll be taxed employee rates of income tax and national insurance.
If you're the fee-payer you will have to calculate the 'deemed direct payment' from which you can then deduct the appropriate income tax and national insurance.
Follow these steps to calculate the 'deemed direct payment'. Assume that the services have been invoiced at £6,000 plus VAT £1,200. Assume that no deductions are made for materials or expenses for this example.
1. Invoice the contractor for the services at £6,000 plus £1,200 VAT (20%).
2. Put the VAT amount to one side. You'll calculate steps 3 to 6 based on the VAT exclusive amount of £6,000.
3. Deduct the direct costs of any materials used in the provision of services from the VAT exclusive amount;
4. Deduct any expenses from the VAT exclusive amount that the contractor would have been able to claim if they were employed by the client and had met the expenses out of their earnings;
5. The remaining amount is the 'deemed direct payment', i.e. £6,000 in this example;
6. Calculate the income tax and national insurance - £1,200 income tax at 20% basic rate and £413 national insurance.
7. Pay the contractor the remaining amount £4,387 plus the VAT of £1,200 = total payment of £5,587.
If the fee-payer is outside of the UK the rules are different.
For more information about how to calculate the payment to the PSC see HMRC's Employment Status Manual.
8. Transfer of liability for unpaid tax and National Insurance
The government has published 2 statutory instruments to support the off-payroll changes in April 2021 and in particular to allow for the transfer of liability for unpaid tax and NICs. They are:
1. The Income Tax (Pay As You Earn) (Amendment No. 3) Regulations 2020 and
2. The Social Security Contributions (Intermediaries) (Miscellaneous Amendments) Regulations 2020
The Income Tax (Pay As You Earn) (Amendment No. 3) Regulations 2020
The regulations will come into effect 6 April 2021. They amend the Income Tax (Pay As You Earn) Regulations 2002 and set out the circumstances in which HMRC will pursue unpaid PAYE tax and what HMRC must do to pursue the debt.
Initially HMRC will pursue the fee-payer or the deemed employer (e.g. if the fee-payer is overseas). If HMRC cannot recover, then it will look to transfer the debt.
· Transfer of liability for unpaid tax – see Regulation 3(3) states that
“A PAYE debt may only be received from a person described in section 688AA(3) ITEPA if an officer of Revenue and Customs considers there is no realistic prospect of recovery of all or part of it within a reasonable period of time from a person described in section 688AA(3)(b)” (our emphasis)
Section 688AA(3) sets out that HMRC will pursue the following:
· The first agency (Agency 1) in the chain i.e. the agency the client contracts with and the second highest person in the contractual chain; and
· The client (the highest person in the supply chain)
Note that there is no personal liability for directors or officers of relevant persons.
HMRC will pursue other persons in certain circumstances e.g. contrived arrangements where the intention is to avoid tax and NICs liabilities or there Is a liquidation deliberately to avoid paying tax and NICs. HMRC will not seek to recover from other persons where there is a genuine business failure of the fee-payer/ deemed employer. See HMRC's Employment Status Manual 10031. See also 10032 (basic principles: recovery from other persons – steps clients and agencies can take to secure labour supply chains).
Of course even if HMRC pursue Agency 1 (and not an agency further down the chain) then Agency 1 will probably rely on an indemnity from an agency further down the chain. But always question the value of an indemnity - It will be worthless if the party giving the indemnity is insolvent or dissolves.
Process for the recovery of unpaid PAYE tax
HMRC must follow a specific process for transferring debt for unpaid tax.
· Recovery of PAYE debt:
HMRC must give a recovery notice to the relevant person during the relevant period.
HMRC cannot pursue a PAYE debt relating to tax payable in a tax year commencing before 6 April 2021 (i.e. no retrospective application)
The relevant period begins on the expiry of the 30 day period beginning with the issue of a Regulation 80 notice. (HMRC must issue a Regulation 80 notice to collect unpaid PAYE)
The relevant period expires 12 months after the start of the relevant period.
· The recovery notice:
HMRC must issue a recovery notice which includes:
The name and address of the deemed employer to whom the PAYE debt relates
The name of the worker to whom the PAYE debt relates
The amount of the PAYE debt
The tax periods to which the PAYE debt relates
The apportionment of the PAYE debt across different tax years if relevant
The date on which the “relevant period” in relation to the PAYE debt began
The relevant person’s name and address
Whether the relevant person is described in section 688AA(3) (a) or (b) ITEPA
A statement that the [HMRC] officer believes that there is no realistic prospect of recovering the PAYE debt within a reasonable period from (a) the deemed employer or (b) the person mentioned in section 688AA(3)(b)
· Paying the PAYE debt:
The relevant person must pay the PAYE debt to HMR within 30 days of the date of the recovery notice.
Interest will accrue on PAYE debts not paid within the 30 days
· Appeals:
A person can appeal the recovery notice within 30 days of the date of the notice but must give the grounds of appeal which are specified i.e.
The PAYE debt is not due
There is a realistic prospect of collecting it from the deemed employer (or from the person is section 688AA93)(b) ITEPA) within a reasonable period
The person who received the recovery notice is not a relevant person
The recovery notice was not given in the relevant period
The recovery notice does not contain the information it should contain
The tribunal will upgoild or quash the recovery notice
· HMRC can withdraw the recovery notice if appropriate .
The Social Security Contributions (Intermediaries) (Miscellaneous Amendments) Regulations 2020
The regulations deal with unpaid national insurance contributions (both employee and employer contributions). They come into effect immediately after the PAYE amendment regulations above and incorporate text from new Chapters 8 and 10 ITEPA into the Social Security Contributions (Intermediaries) Regulations 2000 and the Social Security Contributions (Intermediaries) (Northern Ireland) Regulations 2000. HMRC will follow the same process and principles to pursue unpaid national insurance.
9. Inside IR35 - additional costs to consider
Employers' national insurance contributions
Employers' national insurance contributions:
Employers’ national insurance will be due on the inside IR35 contractor’s pay. Agencies will have to negotiate with both clients and contractors about how this will be covered, whether in existing charge and pay rates or whether there will be an increase in rates. Note, the employment allowance can only be used to offset the employers’ national contributions relating to its directly employed staff - it cannot be used to offset the costs of payrolled temporary workers/ contractors.
Apprenticeship levy:
Agencies who bring inside IR35 contractors onto their own payroll will see their apprenticeship levy bill increase or they may be brought into scope of the apprenticeship levy for the first time. Either way, the agency will have to decide how it will pay its apprenticeship levy bill, e.g. by increasing its charge rate to the client or covering it in the existing margin. Read the apprenticeship levy section of the REC's Legal Guide and the REC’s campaign for reform of the Apprenticeship levy for more information.
Key Information Document:
Since 6 April 2020 agencies have had to provide a Key Information Document (KID) to all work-seekers before they agree terms with the agency. In particular this will require detailed information about pay and deductions. Clearly the net rates of pay will differ significantly between an inside and an outside IR35 decision. If you decide to payroll contractors through an umbrella company you will need additional information from the umbrella about the deductions they make.
Further information on the KID is available in the Key Information Document section of the REC’s Legal Guide including templates for PAYE agency workers, umbrella workers and self-employed personal service companies.
10. IR35 and the off-payroll rules - are payrolled contractors entitled to employment rights?
Being employed for tax purposes is not the same as being employed for employment rights purposes. It does not automatically follow that because a contractor pays PAYE and NICs, that they are employed for employment rights. The government has agreed to look at closer alignment of status for tax and employment rights purposes but haven’t given a timeframe for that. So, for the moment, an individual’s entitlement to worker rights will depend on how they are engaged:
· If an individual continues to work through a PSC (after the appropriate deductions have been made) the PSC will still be responsible for any worker rights, including holiday pay and sick pay.
· If an individual is engaged on a contract for services directly with the agency and the agency then payrolls them, the agency will be responsible for worker rights.
· If they are engaged through an umbrella, the umbrella will be responsible for their worker rights.
Pensions auto-enrollment:
An agency will not have to auto-enrol an off-payroll worker for pensions purposes if they continue to pay their PSC (after the appropriate deductions). Nor will the agency have to deduct or contribute to an individual’s private pension. However, if an agency moves an off-payroll worker onto a contract for services and directly payrolls them, then that individual will be a worker for employment rights purposes and will be entitled to be auto-enrolled for a pension when they meet the relevant criteria. The agency will also have to pay the employer’s pensions contributions, thus increasing the charge rate to the client. If an agency worker is engaged by an umbrella, the umbrella will be responsible for pensions deductions and payments (though that may also require an increase in charges).
11. Other supply models - PEOs and Statements of Work
We mention in another FAQ that instead of payrolling PSCs (when an engagement is inside IR35) that agencies could also engage contractors directly as PAYE workers or engage them through an umbrella company. But some other models are being promoted - there are risks associated with these so take care before agreeing to supply contractors under either of these arrangements.
11.1 What is a Professional Employer Organisation?
There is no legal definition of a Professional Employer Organisation (PEO) in the UK - the label 'PEO' is used in different circumstances in the UK. PEOs are widely used in America, where they are regulated.
PEOs:
· provide outsourced services such as payroll functions and HR functions to their clients.
· enter into arrangements to jointly employ their clients’ staff, meaning that that they act as the employer of record for tax purposes.
In terms of their use in the UK, the model would have particular benefits for a business/organisation principally based overseas but with workers working in the UK. Having an employer entity based here could simplify tax arrangements and the application of relevant employment laws - e.g. ensuring that there is an understanding of and application of the relevant rate of NMW. PEOs are also used to reduce VAT bills (where clients cannot offset their VAT costs) or may even be an umbrella arrangement by a different name.
Can co-employment be used in the UK?
The concept of PEO co-employment is relatively new to the UK.
In the UK, to work out who the employer is you’ve got to look at not only the contracts agreed by the parties but also legislation and case law.
For example, if a temporary worker has a claim about a breach of any of their employment rights a tribunal will decide who is the responsible employer for the breach. The contract terms are an important part of deciding where the employer liability lies. However, if the terms do not reflect the reality of the working arrangement, the contract can be disregarded - the tribunal can then decide who the employer is based on the facts.
What do I need to check if I’m offered a PEO arrangement?
Members supplying temporary workers or limited company contractors are being offered various types of arrangements including:
· Employer of record
· Joint employment
· PEO
· Outsourced payroll
· Combined factoring facilities; and others
Before you work with an intermediary or third party who:
· pays or is involved in paying your workers, or
· enters into contracts with your temporary workers, or
· enters into contracts with your clients;
it is important to understand exactly what service is being offered to you and why.
You should consider:
· Will you simply be outsourcing your payroll function, i.e. you remain the employer of your workforce but take on assistance to manage your payroll?
· Will you pay for the PEO’s service or will costs be passed onto your temporary workers?
· How will you ensure compliance with the Key Information Document and Written Statement of Particulars requirements and the IR35 changes?
· If the PEO is the employer of your temporary workers will they have a direct contract with the workers?
- What do the terms say?
- Are they consistent with your client contracts?
· How will a temporary worker know who their employer is? Who should they contact if they’re not getting their employment rights?
· If you supply staff in a regulated sector, how will you deal with issues like safeguarding?
Do not focus on the 'PEO' label - there are different models serving different purposes - you must understand what the arrangements are and why you might agree to use a PEO model - or whatever it is called by the organisation offering the 'solution'.
11.2 Statements of work - what are they and should I use one?
Increasingly clients want agencies to agree to statements of work as a way to avoid being the 'end client' for the IR35/ off-payroll rules. When a service is outsourced, the outsourced service provider becomes the end client, which will have to make the IR35 status decision (if it isn't exempt from the off-payroll rules). But delivering an outsourced service, e.g. an IT project, is very different from supplying IT contractors. If an agency is involved, HMRC will assume that it is a labour supply and not a statement of work, so the agency will have to persuade HMRC otherwise, i.e. you can't disguise a supply of labour by simply calling it a 'statement of work' arrangement.
What to think about before agreeing to a statement of works contract
There is quite a lot to think about before agreeing to provide an outsourced service to your client rather than just supply labour. You should get independent legal advice on this type of work from both commercial and specialists - our legal business partners can help you at discounted rates.
Some considerations are:
· You will take responsibility for the delivery of a service or product.
· You become the end user client and so you will have to make the IR35 status decision. Therefore, you need to be very sure of what you are doing.
· It is a limited solution – HMRC have made it clear that parties relying on them need to overcome the presumption that it is a labour supply contract. That is, you can't disguise a simple supply of labour by simply calling it a 'statement of work' arrangement.
· Appropriate client terms are key:
- It must be clear that you are responsible for the delivery of the service/ output of the project – the agreement cannot be on the basis of time and materials (though you may require a contractor to confirm time spent but the final client shouldn’t see this). For example, what would it take for you to develop the website for the client? (10 hours at £500 per hour = fixed price of £5000. If it is done in less time, you (and ultimately the contractor will benefit but if it takes longer, there is a loss somewhere).
- Do you invoice the client at fixed stages or at the final delivery of the project?The contracts with both the contractor and client need a clearly defined sign off process with suitable penalty clauses for failure to deliver/pay on time.
- There cannot be any notional mention of who will do the work not even a substitution clause i.e. the client should not know who is doing the work. However, this can be problematic because clients may want to know who is doing the work, for security reasons, ensuring sufficient skill and qualifications etc.
- Key commercial terms must be defined – scope of work, delivery terms, personnel requirements, price, payment times and methods, address potential performance issues e.g. is client solvent? Can you limit risk e.g. limit payment terms, require up-front payment etc.?
- Appropriate warranties must be included to protect yourself.
Some other key points:
- Will you set up another company to run statement of work projects or will you use your existing recruitment business? Remember HMRC will presume labour supply where there is a recruitment business. But, a new company will have no trading history and may require a parent company guarantee to be able to attract finance or credit.
- Clients will have to pay more – you probably won’t be able to use invoice discounting or factoring to finance projects delivered by statement of work and so you would need to charge a contingency to cover increased risk they take on and also lack of finance.
- You will also need new (probably more expensive) insurance as your standard insurance will not cover statement of work.
- Different skill sets - agencies who want to offer statement of work will need additional skill sets. They need project managers rather than salespeople.
- So, though the client avoids making the IR35 status decision and maybe increased employers’ NICs charges, they have to pay more for a different service for the reasons set out above.
12. What is the MSC legislation?
In 2007, HMRC introduced the “Managed Service Company” (MSC) legislation which applies to individuals providing their services through an intermediary which meets the definition of a Managed Service Company. An intermediary must first consider whether the MSC legislation applies, if it does, then it does not need to consider IR35. If the MSC legislation does not apply, then the intermediary must consider IR35.
This section looks at IR35 only. For information on the MSC legislation, see here.
13. Considering the Off-payroll rules in relation to group companies
In order to establish whether the Off-payroll rules apply to the end user, if the end-user/client is part of a group of companies, the parent company is what determines the size of the companies as a group. In order to establish the size of the parent company, the figures from all member companies must be taken into consideration. Figures from all members of the group are included irrespective of whether group members are resident in the UK or not, so the world-wide group is considered and the outcome will apply to all members in the group. Therefore in a large-sized group, all the companies within it will be large for the purposes of the Off-payroll working rules. Similarly, small companies in a group which are exempt from the Off-payroll rules, will be considered exempt in the overall group.
For further information, please see the Employment Status Manual (ESM) 10007.