Following on from the recent cases on employment status there has been much discussion regarding how individuals should be appointed. Whilst some commentary has suggested that companies should consider appointing their contractors through Personal Service Companies (PSC’s), is this an ideal solution?
Currently, where a private sector employer appoints a contractor who operates through a PSC, the client company does not have to deduct income tax or NICs under PAYE from payments made to the PSC or pay employer’s NICS. The individual typically receives a small salary and dividends from the PSC and it is up to the individual to account for tax accordingly. If the individual operating through a PSC would have been an employee if engaged directly by the client, then the payments made by the client to the PSC would, by reason of regulations enacting the principles set out in IR35, be effectively treated as employment payments by the PSC to the individual. The PSC would be required to operate PAYE and pay NICs, with the result that the individual would be required to pay, broadly, the same amount of tax and NICs as if they were employed. From the client companies’ perspective appointing someone through a PSC was to their advantage, as the risk of IR35 applying fell on the PSC. However, various proposals may now limit the effectiveness of such structures.
Already we have seen the risk of those PSCs which are being used for tax evasion, being identified as a potential criminal offence under the Criminal Finances Act 2017 as a failure to prevent the facilitation of tax evasion. In addition, recent case law has shown that where the tribunal believes that the agreement is a sham then they will look behind the circumstances to determine the true employment status. Now, HMRC and the Treasury have published a consultation document considering options for improving compliance with the IR35 rules in the private sector.
The proposal being put forward by the Government is to extend the off payroll rules in the private sector in the same way as they now apply in the public sector. This means that client companies or agencies engaging contractors through the PSC would have the responsibility for assessing the status of the contractors and would be primarily liable for unpaid tax if their determination is wrong. An alternative approach discussed is to require the private sector company or the agency engaging with the PSC to undertake due diligence to ensure that off-payroll workers comply with IR35 by checks or requiring the worker to fill out an employment status test and comparing that with what is happening in practice. A third option mooted is to require client companies to gather and retain certain information on the worker, such as details of contracts, shift rotas and line management reporting, allowing HMRC to speed up the enquiry process.
There are various issues which arise as a result of these suggestions:
- Some companies within the private sector will not have the administrative capacity, knowledge and resources to enable them to implement the changes.
- What action should be taken where an agency doesn’t act on the client company’s conclusion and chooses not to operate PAYE? Under the existing public sector rules, the consultation notes that some employment agencies have disregarded the public authority’s determination about the worker’s employment status and chosen not to operate PAYE.
- Businesses may have to adopt new systems and processes to implement the new rules. This may be appropriate for employers with large payroll or HR teams, but would be more difficult for smaller companies.
- How will client companies make such a determination? Should there be a requirement for certain checks to be carried out, or should it be a requirement for the PSC to provide a completed determination on the HMRC checker (CEST) showing the conclusion given. Whilst CEST may work more effectively for public sector contracts, it may not cover all scenarios in the private sector.
- Even if the company receives all factual documentation from the PSC, the contract terms may not reflect the reality of the working arrangement.
- What penalty should apply for those who fail to comply with the checks?
- What contractual protections should client companies seek on engaging contractors?
The consultation paper makes reference to the fact that there is much being discussed regarding the issue of employment status. The Taylor report and the government consultation are considering this issue, but it is clear that the interaction between the employment status tests for employment rights and tax is an important and complex issue.
If the government does decide to introduce the suggested changes the burden on businesses will be increased. In light of this and in light of the line of employment tribunal cases, client companies may determine that the contractor is employed or may consider it preferable to insist on employing the contractor directly.
This post was co-written with Susanna Brain, Senior Knowledge lawyer in the London tax team.