1. What are the Off-Payroll Rules?
The Off-Payroll Rules may apply where a contractor provides his or her services via an intermediary, such as a limited company or a partnership, normally referred to as a personal service company or PSC. The Off-Payroll Rules require that all UK public authorities and all medium and large sized private sector organisations who engage PSCs, whether directly or via a recruitment agency, undertake a status assessment to determine whether or not that PSC contractor is genuinely self-employed for tax purposes.
The Off-Payroll rules were implemented in the public sector in April 2017, and in the private sector (for medium and large-sized organisations only) in April 2021.
The framework is designed prevent “disguised employment”, whereby a client engages PSC contractors who work in the same way as employees, but who, through using a PSC rather than being engaged as an individual, pay less tax and national insurance contributions.
PSC contractors who are determined to be genuinely self-employed for tax purposes are referred to as being “Outside IR35” and those who are determined to be employed for tax purposes are referred to as being “Inside IR35”. Where a PSC contractor is determined by the client to be Inside IR35, then the client, or the agency supplying that PSC, must make appropriate deductions for tax and national insurance contributions before making payment to the PSC.
It is important to note that the Off-Payroll Rules only apply to contractors who operate through their own limited company or a partnership. The rules do not apply to temporary workers who are being paid on a PAYE basis (including via a compliant umbrella company) or sole traders.
2. What must clients do to comply with the Off-Payroll Rules?
All public authorities and medium or large-sized private sector organisations are legally responsible for assessing the tax status, or IR35 status, of each assignment where a PSC contractor is utilised.
When deciding the IR35 status of an assignment, clients must use reasonable care. If the client decides – without using reasonable care and having sufficient evidence to prove the appropriate standard of care has been applied – that a PSC contractor is Outside IR35, HMRC can investigate the circumstances of the assignment. If HMRC believes that the PSC contractor should have been classified as being Inside IR35, the client is primarily responsible for paying HMRC the tax and national insurance (NI) shortfall.
Clients must communicate the status determination of each PSC assignment, with reasons, in a Status Determination Statement (SDS). The client must pass the SDS to any agencies it engages with and the individual PSC contractor to whom the SDS applies. The SDS must be issued before the first payment is made to the PSC for any new assignments.
If an assignment is assessed to be Inside IR35 then income tax, Employee’s NI and Employer’s NI becomes payable on all income derived from that assignment and must be deducted at source – before payment is made to the PSC.
Whoever pays the PSC (referred to as the ”fee-payer” in the legislation) must therefore ensure that any PSC contractor deemed to be Inside IR35 is PAYE compliant. This could mean moving the contractor to a PAYE umbrella or other PAYE solution, or continuing to pay the PSC but making appropriate deductions for income tax and NI before making payment, and remitting those deductions to HMRC along with the Employer’s NI (and Apprenticeship Levy if applicable).
Assignments that are assessed to be Outside IR35 mean that the fee-payer can pay the PSC without any deductions for employment taxes and there is no obligation to pay any NI contributions on the assignment income.
Furthermore, clients must implement a status disagreement process (see Question 7 for more detail).
3. How is IR35 status determined?
The criteria that dictates whether a PSC contractor is genuinely self-employed (or not) for tax purposes is not written into legislation. There is no statutory definition of what it means to be Inside IR35 or Outside IR35.
Instead the factors that determine IR35 status derive from case law – the outcomes and rulings of judges in tax tribunals over the course of many decades. The multi-factorial “test” used to determine status is therefore continually evolving, complex, and often case-specific.
The main factors that determine IR35 status are:
- personal service: whether that PSC contractor has a genuine right to substitute him or herself with an equally qualified and skilled replacement
- mutuality of obligation: whether there is an obligation or expectation for the client to offer work and/or for the PSC contractor to accept that work
- control: the degree to which the end client supervises and oversees the work being undertaken by the PSC contractor
- a range of other factors: including how much financial risk the PSC contractor is taking; whether he or she is genuinely in business on his or her own account; and the degree to which the contractor is integrated into the client’s business.
Assessing IR35 status is notoriously difficult; it’s a niche area of law, the “test” is highly subjective and even the experts, like HMRC, often get it wrong. Many clients have therefore turned to third-party IR35 specialists to ensure that they are truly taking reasonable care and that each PSC contractor’s status is assessed as accurately as possible. However it’s important that clients carry out due diligence on any external experts that they engage since it is the client who is ultimately responsible for the status determinations. Allen Recruitment Consulting has partnered with the best providers in the market to support clients in undertaking status determinations. The government has also released its own status assessment tool called CEST to help determine IR35 status. However the results are not legally binding and the tool itself has been widely criticised for its lack of alignment with established case law, leading to unreliable results. The majority of the public authorities who have been fined by HMRC since April 2017 (the total fines currently exceed £140 million) for not properly applying the Off-Payroll Rules used the CEST tool.
4. What does “reasonable care” mean?
Clients are required to exercise “reasonable care” when making IR35 status determinations.
HMRC explains reasonable care as acting “in a way that would be expected of a prudent and reasonable person in the client’s position”. Essentially, the client should do everything that is reasonably possible and conceivable to manage its obligations appropriately and make determinations that correctly evaluate whether an assignment is Inside IR35 or Outside IR35.
Reasonable care is a variable standard. Every client will have a slightly different threshold of whether reasonable care has been taken. That’s because every company has slightly different abilities, experiences and circumstances. For example, larger companies with lots of PSCs will be expected to take more care, and demonstrate they have implemented and followed a more thorough and rigorous process, than a smaller company who uses few PSCs and has limited internal resources.
If a client fails to take reasonable care (or does not comply with its other obligations under the rules), then it is the client who is responsible for any unpaid tax and NI, and could be subject to additional penalties for non-compliance.
If a client determines that all its PSC contractors are Inside IR35 without undertaking a proper assessment of each role or assignment, that will also not be considered reasonable care. Even if the appropriate taxes and NI have been paid by another party in the chain, HMRC will still pursue the client for those liabilities since the rules require an individual or role-based assessment process, not a “one size fits all” approach.
5. Can clients engage PSCs without an SDS?
Where a client is exempt from applying the Off-Payroll Rules, it can engage a PSC contractor without having to issue an SDS (please see Question 6 for more detail).
Furthermore, even where a client is not exempt, the Off-Payroll Rules don’t apply to PSC contractors who are not UK tax resident, because they live permanently in another country and provide services to UK clients remotely. This is because the contractor is not subject to UK income taxes or NI, so their IR35 status is irrelevant.
Many clients have turned to international markets to source contractors to overcome the complexities of operating the Off-Payroll Rules and the ever-increasing problem of talent shortages in the UK.
Recruitment agencies who have an international reach and presence can be very helpful in sourcing lower cost, high-quality contractors who reside outside the UK. Clients should ensure that any agency they use to source and payroll such contractors are fully compliant with the relevant laws of the country in which the contractor is resident. This is particularly true since the implementation of the Criminal Finances Act 2017, whereby companies can be held criminally liable for a failure to prevent tax evasion, whether such evasion takes place in the UK or abroad.
6. Do all private sector companies have to comply with the Off-Payroll Rules?
No. Small private sector companies – as defined under the Companies Act – and wholly overseas companies are exempt from applying the Off-Payroll Rules.
Where a client is exempt from the Off-Payroll Rules, a previous piece of legislation applies (confusingly called the “original IR35” or Chapter 8 rules) apply instead, whereby the PSC contractor determines his or her own status for tax and holds all the liabilities for mis-classification. Neither agencies nor end clients hold any responsibilities or liabilities under the original IR35 rules.
Even where a client organisation is small, there are particular rules relating to groups, connected companies and joint ventures which may affect that exempt status, so clients should ensure they understand these additional considerations when deciding whether or not they are in scope of the Off-Payroll Rules.
7. What are the requirements of the status disagreement process?
When a client issues an SDS, the PSC contractor or the fee-payer (or both) can challenge the outcome if it believes the determination is incorrect or the client has not considered all the necessary variables to make an accurate assessment.
There is no prescribed format of the disagreement process, but there are some minimum requirements that the client must do or implement for the process to be considered valid.
The client must consider the representations made and respond within 45 days of receipt of the challenge. The client must then inform the PSC contractor or fee-payer agency that it has considered the arguments but decided the original SDS was correct (and give reasons), or confirm that as a result of the challenge, the client has changed its mind, in which case the previous SDS must be withdrawn and a new one provided.
Evidence of managing challenges should be retained by the client to show to HMRC it has properly implemented a suitable process that meets these minimum standards.
8. Summary of a client’s responsibilities under the Off-Payroll Rules.
Clients who are not exempt from applying the Off-Payroll Rules are required to:
- Make IR35 status determinations for all assignments where the contractor works through a PSC;
- Take reasonable care when deciding whether a PSC contractor is Inside IR35 or Outside IR35, using established case law and considering all the relevant factors for each assignment;
- Produce an SDS for each PSC assignment that must include the IR35 status and the client’s reasons for coming to that conclusion;
- Pass the SDS to any agencies it engages with and the individual PSC contractor before the start of any assignment, or at the latest before the PSC is paid for any services;
- Ensure any PSC contractors working directly for you who are deemed Inside IR35 are PAYE compliant; and
- Implement a process for status disagreements that complies with the minimum standards.
Here at Allen Recruitment Consulting we have in-depth knowledge of IR35 and the Off-Payroll Rules. We also have a strong overseas presence, with offices in 8 countries in Europe. Call us for a confidential discussion about how we can support you with all your contingent workforce needs.
Would you like further information?
Please contact Paul Martin (UK Country Director and Head of Contract Recruitment) via email to [email protected] or phone +44 3303351721. You can also book time with him at calendly.
Posted in: UK