The new rules will apply to both large and medium-sized businesses, with significant cost and compliance challenges for businesses which rely heavily on specialised contractors, according to tax experts at Pinsent Masons, the law firm behind Out-Law.com. These include infrastructure and energy businesses, as well as a broad range of companies across the financial services, IT, technology, retail, media and professional services sectors.
Once the new regime is in force, liability for determining employment tax status and ensuring the right amount of tax is paid will move from the contractor's PSC to the business engaging with the PSC. Businesses may also have to pay any tax underpaid, although in more complex supply chains the obligation may sit with an agency.
Tax expert Eloise Walker said that the new rules were being introduced at a "critical point for the UK"; given the potential impact of Brexit on recruitment and hiring of specialist contractors.
"Businesses are about to take on an unprecedented burden as they assume responsibility for ensuring contractors pay the right amount of tax," she said. "This represents a huge cost burden as well as a significant shift of risk which will hit businesses in certain sectors, such as infrastructure and tech, particularly hard as they rely on contractors to get projects over the line."
"Reducing the use of contractors will reduce market flexibility at a critical point for the UK, one year on from Brexit, when businesses will need all the help they can get. Many contractors have highly specialised skills and it is crucial that these skills can be easily circulated amongst businesses. However, these new rules may result in businesses scaling back their use of contractors, slowing this transfer of skills from one business to another," she said.
The government confirmed as part of the autumn Budget that it would, from April 2020, extend the off-payroll employment tax rules which came into force for public sector employers in April 2017 to the private sector. Small businesses will be exempt from the changes, and the reforms will not operate retrospectively.
Tax rules known as IR35 require that employment taxes be paid by people who provide services through PSCs if that person would otherwise have been regarded as an employee of the engaging 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. Once the new regime is in force, the engaging business will be liable for determining whether the IR35 rules apply and will also be required to operate PAYE and pay employers' National Insurance contributions (NICs).
In its new consultation, which closes on 28 May, HMRC is seeking views on a number of topics to help inform its final legislative proposals, which it plans to include in this summer's Finance Bill. Among the topics under consideration are the scope of the rules, including the definition of 'smallest' businesses which 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 off-payroll working 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 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 that 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 process will reduce the potential for disputes and disagreements, but it also intends to put a process in place to allow the contractor, and the fee-payer where relevant, to challenge the client's determination.
In its consultation, HMRC notes 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.
Employment tax expert Chris Thomas of Pinsent Masons said that although businesses would take "some comfort" from this wording, the proposed requirement that clients provide reasons for their assessment directly to the worker undermined this to some degree.
"That could be a big headache for engagers with a lot of off-payroll labour – especially where the engager is using an agency or managed service programme to source and manage the workers," he said. "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 a logistical nightmare and careful thought will be needed as to how this can be managed in conjunction with the agency/MSP," he said.
HMRC noted that private sector labour supply chains could be "long and complex". With that in mind, 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. Where HMRC is unable to collect from the first party or agency, it would ultimately be able to seek payment from the client, according to the consultation.
Chris Thomas said that this proposal "reinforces the critical importance of proper due diligence and supply chain oversight by the engager".
"Understanding the full supply chain, and building in the appropriate contractual protections and indemnification, will be key," he said.
"The other point worth noting from the consultation is the recognition that an engager only has responsibilities under the new rules where there is a supply of labour to it, meaning the worker is obliged to personally perform services for the engager, which will often not be the case in the context of contracted out services. This is a significant point that businesses need to bear in mind when assessing who actually has the responsibilities under the new regime – the ultimate engager or the business which is supplying it," he said.
"Looking at the wider picture, it is disappointing – though not surprising – that these changes are being introduced without much reference to the wider issues highlighted by the Taylor review of there being different tests for assessing status for tax and employment purposes, and the disconnect between the tax position and employment rights - all of which has been firmly kicked into the long grass," he said.