Tax risks for UK companies engaging overseas contractors

Engaging overseas contractors can resolve IR35 tax issues for UK employers, as well as resourcing issues. However, the company may become exposed to non-UK tax risks, particularly in relation to creating a permanent establishment (PE).

IR35 risks

Broadly, under the ‘IR35’ off-payroll working tax rules, when a business engages with an individual through an intermediary such as a personal service company (PSC), if the individual would have been considered to be an employee for tax purposes if they had engaged directly, then the individual should be taxed as an employee. Since April 2021, most businesses are now responsible for assessing whether IR35 applies to engagements with off-payroll workers and collecting employment taxes if it does.

For IR35 purposes, no UK employment taxes should be payable by a company in respect of non-UK tax resident contractors engaged through PSCs if all their work is undertaken overseas, and the contractor does not enter the UK for their role.

IR35 only becomes relevant where a worker would be within the charge to UK income tax and National Insurance contributions (NICs). Generally, earnings that a non-UK tax resident worker receives should only fall within the scope of UK income tax if they relate to duties performed in the UK.

A non-UK tax resident worker could still fall within the scope of UK income tax if they undertook work in the UK that was more than 'merely incidental' to the work undertaken outside the UK. However, current HMRC guidance suggests that a worker should be physically present in the UK to perform duties in the UK. There is no indication that a worker would be performing duties in the UK by attending online meetings with UK-based attendees.

Similarly, NICs are generally only payable in respect of workers who are resident or present in the UK. Therefore, provided any non-UK tax resident worker remains overseas, NICs should not be payable.

Although IR35 should not apply, safeguards should be introduced to manage residual risks. IR35 policies should be updated to clarify that whilst overseas contractors can be engaged through intermediaries, they must not visit the UK to undertake work for the company. These policies should be documented and communicated across the business, particularly to those responsible for engaging contractors.

Notwithstanding that current guidance provides no suggestion that attending online meetings with UK attendees would constitute 'performing duties in the UK', it would be advisable to discourage attendance by overseas contractors and to minimise online meetings with UK-based personnel.

Prior to engaging with overseas workers, the company should obtain written confirmation, with supporting evidence, that they are non-UK tax resident and based overseas.

Permanent establishment risks

Although IR35 risks should be low, the company may be exposed to other tax risks by engaging overseas contractors in this manner – notably the risk of overseas taxes arising by virtue of a contractor creating a permanent establishment (PE), which would be a taxable presence for the company in the country where the contractor undertakes the work.

Assuming the company does not already have a PE in the location(s) where the proposed contractors are based, the company will want to avoid establishing a taxable presence by virtue of the contractors' engagements.

The risks of establishing a PE will depend upon the jurisdictions involved and the precise nature of the work undertaken by the overseas contractors for the company. However, it is useful to review the Organisation for Economic Cooperation and Development's (OECD’s) definition of a PE and when it may be established. This approach is usually comparable to overseas domestic PE rules.

Broadly, a company has a PE in a territory if either:

• it has a fixed place of business, such as a branch or office, through which its business is wholly or partly carried out; or
• a person acting on behalf of the company habitually exercises authority to conclude contracts in its name or has a key role in concluding such contracts.

It may be uncertain whether a person “habitually exercises authority to conclude contracts”.

An agent will not create a PE if they are an “agent of independent status acting in the ordinary course of business”. A PE will also be avoided if the activities undertaken are only of a “preparatory or auxiliary character”: for example, storing, displaying or delivering the company's goods; purchasing goods; or collecting information for the company.

To reduce the risk of creating an overseas PE, any work undertaken by overseas contractors should be restricted to being preparatory or auxiliary in nature.

Overseas contractors should not have authority to act on behalf of the company; or to conclude contracts for or otherwise bind the company. Any substantial negotiation of contracts by overseas contractors should also be avoided, even if the contracts are ultimately signed elsewhere.

Beyond addressing PE risks, the company should review the corporate tax residence rules in the relevant jurisdictions.

Overseas VAT rules should also be considered, and action taken to mitigate the risks of creating an overseas VAT presence.

Finally, the company should establish whether it must account for overseas payroll and social security taxes in respect of the contractors.

This guide is based on an article by Penny Simmons first published in Tax Journal on 21 January 2022.