Changes to off-payroll tax rules
New rules due to be introduced in April next year will affect many charities which engage consultants through a personal service company but confusion about how and when the rules will apply risks leaving medium and large sized charities exposed to unexpected increases in costs and a shortage of skills.
Which charities will be affected?
Small companies which satisfy two of the following requirements will be exempt from the rule changes: (1) annual turnover of not more than £10.2 million; (2) balance sheet total not more than £5.1 million; (3) not more than 50 employees. Unincorporated bodies will only have to meet the turnover requirement (i.e. less than £10.2m) for the exemption to apply.
This exemption will mean that most charities will be unaffected by the changes and, for these organisations the IR35 rules will continue to operate in the same way as they do now. However, all charities need to ensure that they take note of the anti-avoidance measures contained in the new rules relating to group structures. These measures require charity subsidiaries to check that their parent charity or company also qualifies for the small company exemption. If it doesn’t, the new rules will apply to the charity subsidiary, regardless of its size.
Charities which are not covered by the small company exemption need to start planning now to be ready for the changes.
The individual supplying services
The rules in question are known as the “IR35” rules, taking their name from the number of the news release in which they were first proposed, but they’re also commonly referred to as the “off-payroll” or “disguised employment” rules. This is because the aim of the rules is to curb avoidance of tax and National Insurance Contributions (NICs) when individuals provide employment-type services to a client through an intermediary, usually a company owned by them.
For the IR35 rules to apply, three conditions need to be present. Firstly, the individual must personally perform services for a client. This is a straightforward question of fact and should be easy to answer.
Secondly, the services must be provided via an intermediary. The IR35 rules contain a definition of intermediary, which includes certain partnerships and work arranged via other individuals, but by far the most common type of intermediary is a company referred to as a “personal service company” or “PSC”.
The classic PSC is one in which the individual worker is the sole director or shareholder, or one which is established as a family business with the worker’s spouse, civil partner and/or children holding shares in the company. While charities might need to do a bit of research, it should be possible to arrive at a clear conclusion as to whether or not a company falls into the intermediary definition set out in the rules.
The third condition is the one that causes the most difficulty. The IR35 rules only apply where the individual would have been regarded as an employee of the client charity if the arrangements had been made directly between the individual and the charity. As anyone involved in HR knows, making a judgment about someone’s employment status can be a tricky task.
When the conversation turns to employment status, many people think of the recent ‘gig economy’ cases such as those brought by Uber drivers and Deliveroo couriers. Although the tests are very similar, the way that HMRC assesses employment status for tax purposes is not exactly the same as the way that a court or employment tribunal determines the question.
In some cases, this can lead to the confusing situation in which an individual is deemed to be an employee or worker under employment law but is classed as self-employed for tax purposes, or vice versa.
In recognition of the challenges that organisations can face when trying to determine someone’s employment status, HMRC has introduced an online tool – the Check Employment Status for Tax (CEST) tool. Unfortunately, CEST has been known to give some unexpected results and HMRC has acknowledged that the current version of CEST fails to give the correct answer in around 15% of cases. CEST is being updated and HMRC has committed to launching the improved tool before April 2020.
Charities need to remember that, since 2013, the IR35 rules have expressly applied to office holders. The definition of office holders includes statutory appointments (such as registered company directors or secretaries), appointments under an organisation’s internal constitution (such as charity trustees), and appointments under a trust deed. If an office holder provides services to a charity via a PSC, they automatically fall within the scope of the IR35 rules. There is no need to carry out an assessment of their employment status.
If the IR35 rules apply
Under the current rules for the private sector, it is the intermediary PSC that is responsible for deciding whether IR35 applies. If it does, the PSC has to deduct appropriate tax and NICs from any fees received before making a payment to the individual. However, HMRC estimates that only 10% of PSCs that should apply IR35 actually do.
The rules changed for off-payroll workers in the public sector in April 2017. It is now the public body that is responsible for determining whether the IR35 rules apply and, if they do, the public body pays the appropriate tax and NICs through PAYE. Evidence suggests that this change has improved compliance and HMRC now plans to roll out a similar scheme for private sector organisations from April 2020.
When the new rules come into effect, charities and other private sector clients which aren’t covered by the small companies exemption will assume responsibility for assessing IR35 status. If the rules do apply, the charity will need to deduct tax and NICs from any fees paid to the individual via PAYE.
Preparing for the changes
The IR35 changes will affect all contracts with consultants, regardless of when they were entered into, so charities need to start by reviewing any existing agreements that require individuals personally to provide services to the charity via an intermediary.
Charities also need to review their supply chains as responsibility for determining whether the IR35 rules apply will rest with the charity if it is the “end client”. This means that, even if a charity outsources some services to a third party, the charity must still decide whether the IR35 rules apply to individuals engaged by the sub-contractor. This is an important step as liability for failure by a subcontractor to deduct appropriate tax and NICs can flow back up the contractual chain to the charity client.
Where services are being provided to the charity via an intermediary such as a PSC (either directly or through an arrangement with a subcontractor), the charity then needs to make an assessment of the individual’s employment status and must produce a new “status determination statement” saying whether or not it believes the IR35 rules apply as well as the reasoning behind its decision.
Using HMRC’s CEST tool is still a good place to start, although charities should check the result against HMRC’s guidance and should keep the result under review once the new, improved CEST tool is launched.
Charities also need to remember to consider any arrangements they have with paid office holders, such as trustees. If those office holders provide services to the charity through a personal services company or other intermediary the IR35 rules will also apply to them.
This is where trustees are paid for carrying out their office holder (i.e. trustee) duties. For a charity this will only be the case where the charity’s governing document permits such payments. This isn’t intended to refer to payments that may be made to trustees for services carried out in addition to their trustee function.
Once these steps have been completed, the charity should have a good understanding of the likely impact that the new IR35 rules will have on it. It will then need to consider how to budget for the costs of additional tax liabilities and, potentially, requests from consultants to increase their fees in order to offset the impact of the changes.
The new status determination statements need to be provided for each individual. If the individual disagrees with the employment status decision, the new rules give them a right to appeal by writing to the charity client with details of their reasons for disagreeing. The charity will then have 45 days to respond.
Preparation is crucial
For many charities, this process is likely to take some months to complete, particularly if the rules will necessitate changes to the charity’s workforce which will require board oversight and approval. Preparation is crucial and, if charities use the time available between now and April 2020 to review their arrangements with contractors and subcontractors, they will be able to mitigate the negative impact on costs and access to skills that many public sector bodies experienced when similar changes were introduced in 2017.