The use of PSCs also generates tax savings. Currently, a private sector business which contracts with a PSC does not deduct tax under PAYE from payments made to the PSC, and importantly, does not have to pay employer’s national insurance contributions (NICs). Employer’s NICs are currently payable at 13.8%, so engaging contractors through a PSC can give a business a significant tax saving on its payroll costs.
However, IR35 requires that employment taxes and NICs be paid in respect of a person who provides services through a PSC, if that person would have been regarded as an employee of the engaging business if it had engaged directly with the business. Currently, where a private sector business engages a contractor through a PSC, liability to decide whether IR35 applies and to pay any employment taxes rests with the PSC.
This is in contrast to the public sector, where following changes to the rules in April 2017, public authorities and other public sector engagers are now responsible for accounting for tax and NICs, if the contractor would have been regarded as an employee for tax purposes under the IR35 rules.
Proposals for change – what we can expect
In the Budget last October, the UK government confirmed it would extend the changes to IR35 to the private sector from April 2020. Consequently, once the new regime is in force, the engaging business will be liable for determining employment tax status and whether the IR35 rules apply.
Businesses may also have to deduct income tax and employees’ NICs and bear the added cost of employers’ NICs, although in more complex supply chains the obligation may sit with an agency. HMRC has confirmed that small businesses will be exempt from the changes and the reforms will not operate retrospectively.
In its latest consultation, which closed on 28 May, HMRC sought views on a number of issues, to help design the rules and draft legislation, including: the definition of ‘smallest’ businesses that will be excluded; the responsibility of each party in the labour supply chain, including agencies and other intermediaries; and how disputes over contractor status determinations should be resolved.
HMRC has proposed using the public sector rules as its ‘starting point’, albeit tweaked to take into account the different needs of private sector organisations and the lessons learned since the public sector regime change.
This means that engaging companies would be required to determine the contractor’s employment tax status and communicate that determination. The ‘fee payer’ who pays the PSC will then need to make deductions for income tax and NICs and pay any employer NICs. The government intends to legislate to ensure the decision on the contractor’s employment tax status is ‘cascaded to all parties within the labour supply chain’, including any agencies.
It is proposing to do so by requiring clients to provide the determination to the contractor directly, as well as the reasons for that determination on request. The government’s view is that this system will reduce the potential for disputes and disagreements, but it also intends to introduce a process to allow the contractor, and the fee payer where relevant, to challenge the client’s determination.
In its consultation, HMRC noted that it may be appropriate for clients to apply the same determination to a group of off-payroll workers with the same role, terms and contractual conditions. However, such ‘blanket’ determinations must take account of individual contractual terms and the contractor’s actual working arrangements. Although the ability to make group determinations will provide some comfort to businesses, the proposed requirement that they provide reasons for their assessment directly to the worker is likely to undermine this to some degree.
Providing reasons directly to a contractor could pose a big headache for a business with a large off-payroll labour force – especially where the engager is using an agency or managed service programme (MSP) to source and manage the workers.
The prospect of having to provide reasons to thousands of workers, and deal with multiple objections from individuals who will frequently not understand the complexities of the law, has the potential to be an organisational nightmare and careful thought will be needed as to how this can be managed in conjunction with the agency/MSP.
HMRC notes that private-sector labour supply chains can be ‘long and complex’. On this basis, it is encouraging respondents to share information about the number of parties in the ‘typical’ labour supply chain. It is proposing that liability for unpaid tax should initially rest with the party in the supply chain that fails to fulfil its obligations – for example, to pass on the client’s determination, or to make the necessary deductions – but that liability should transfer back to the first party or agency in the chain where a party ceases to exist or is otherwise unable to pay.