Companies Using Contractors in the UK: Watch Out—HMRC Is After You
What's the issue?
Many of our clients engage contractors who provide their services through a personal services company. The typical model involves a contractor, (let's call him John Day), who sets up a limited liability company, (let's call it John Day Limited), to provide John Day's services to clients. Until now, for the client, the system was pretty risk free: if HM Revenue and Customs (HMRC) considered that John Day was an employee of the client in all but name, it would normally come after John Day Limited for the income tax and national insurance that should have been paid under legislation known as IR35. In 2017, the government changed the rules in the public sector. In essence, public sector clients were obliged to assess whether, but for the wrapping of the personal services company, the contractor would have been properly classed as their employee: if the answer was yes, then in most cases, the "fee payer," normally the public sector client, came under a duty to payroll the contractor. From 6 April 2020, the government is now proposing to roll out the same scheme to the private sector. The legislation is still in draft form, but there is no sign that the proposed law will not be implemented. That could mean significant penalties and interest charges for companies that are not aware of the new law, or fail to prepare for its implementation.
Overview of the new private sector regime
The onus will be on the client, not the contractor, to determine if the contractor is an employee of the client in all but name. The client will have to provide each contractor with a Status Determination Statement recording its decision before the contract begins. The client must exercise "reasonable care" in carrying out the determination.
An appeal process
The government is proposing an appeal process for disgruntled contractors: if the contractor disputes the determination, the client must respond in writing within 45 days either revoking its earlier decision or confirming it with reasons.
What about contractors who provide their services through an agency?
If the client contracts with an agency for the contractor's services, then the client still has to provide the Status Determination Statement, but it is the agency, rather than the client, who then has to operate PAYE and make the correct tax and national insurance deductions.
How does the client make the determination?
The starting point is to consider the contract between the contactor's personal services company and the client. On its proper construction, does it look like a genuine contract for services, or an employment contract?
Even if the contract has all the hallmarks of a self-employed arrangement, that is not the end of the matter: tax and employment tribunals will also consider whether the reality on the ground matches what the contract says. For example, if the contract states that the contractor can sub-contact—a strong indicator of a true, self-employed arrangement—is that what actually happens in reality? There are also a host of other factors to consider derived from decisions of the courts and tribunals. Some of the most important which point to an employment relationship include:
- Mutuality of obligation: is there an obligation on the part of the client to offer paid work and on the contractor to accept and complete the work offered, even if it goes beyond the initial agreed project?
- Control: does the client exercise control over the work provided, as opposed to the contractor operating fairly autonomously?
- No right to sub-contract: is the reality, whatever the contract says, that the contractor is expected to perform the services personally and not delegate or sub-contract?
- The contractor does not appear to be in business on its own account: it does not have other clients, does not market its services, does not bear any risk if things go wrong.
There are of course a host of other factors to consider and ultimately the client will have to decide whether the contractor should be payrolled. HMRC has produced its own online test known as Check Employment Status for Tax (CEST) to help clients make the determination, but the current test seems to ignore the legal test of mutuality of obligation, often asks for information that the client may not possess and more likely than not will steer the outcome in favour of a determination that the contractor is really an employee, or that the position is unclear. That said, HMRC has said it will be coming up with an enhanced test before the law goes into effect and will abide by the results clients are given.
Are all clients caught?
No, there is a small company exemption. The old regime will continue to apply if a company meets two or more of the following tests:
- It has an annual turnover not exceeding £10.2 million.
- Its balance sheet does not exceed £5.1 million.
- It employs over a period of a year not more than 50 employees on average.
We await clarification from the government as to what happens in a group structure, where the client itself may meet the small company exemption, but it is part of a larger group where other group companies would not. We do not yet know if the government will step in to introduce anti-avoidance measures to prevent, for example, larger businesses engaging contractors through newly formed subsidiaries that qualify as small companies.
What should clients be doing now?
- Determine if you meet the small company exemption. If not, read on.
- Establish a team to review the position of your contractors. This may involve members of your finance, business and HR teams with support from outside counsel.
- Due diligence. Check if you are using contractors who contract in their own name or who operate through personal services companies. Are there agencies involved in the chain?
- Carry out an initial assessment of employment status. Applying the various legal tests, does the arrangement look more like an employment contract than a genuine contract for services? We can assist reviewing your contractor arrangements and give you an initial view.
- Carry out HMRC's CEST test. Not perfect, but it may give you an inkling as to how the Revenue may view the position. Redo the test when the enhanced test is published.
- Work out how you will demonstrate that you have taken reasonable care in making your determination of the contractor's status. What questions will you ask; who is responsible for creating the paper trail that might eventually be shared with HMRC?
- Decide how your appeal process will be operated.
- Work out how risk averse you are going to be. If the position is not entirely clear, will you payroll all your contractors? Some larger financial institutions have indicated that this is what they will now do. That "risk averse" approach might be the right solution for very large companies with hundreds of contractors who do largely the same kind of work, but might not be the correct solution for smaller businesses more at risk of contractors walking to competitors if they lose their self-employed status. Will you change contractors' terms of engagement to try and improve your score on the CEST test? Will you introduce intermediaries? Will you reorganise the services so that the contractor is contracted to deliver a project for which he is paid on results, rather than a regular monthly fee?
- Decide how and when to engage with contractors. Upfront communication with contractors is important, particularly if you are planning to change their status. However, act too early or precipitously and you may find that unhappy contractors jump ship to your competitors.
|ADVANCE NOTICE: If you would like to learn more about this or other employment law topics, save the date for one of our Employment Update seminars which will take place in the Boston area in February and London during March 2020. The seminars will cover IR35 and a host of other UK employment topics. Additional information and invitations will be available as the dates near.
4 February 2020
5 February 2020
Waltham, Massachusetts—in conjunction with North Eastern Human Resources Association
5 March 2020
If we can assist your business address any of the issues raised in this Advisory, please contact the author.
© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.