Coming changes to off-payroll rules are a major challenge for building firms
The building sector has traditionally relied on alternative employment models, such as agency workers, the self-employed and personal service companies (PSC). These allow flexibility while enabling the individual to benefit from advantageous tax treatment as a self-employed consultant.
IR35, when it was introduced back in 2000, was intended to wipe out the tax benefit for those who were working in a form of disguised employment. Contractors who fell inside IR35 were required to withhold their own tax and pay employer’s NIC. This rendered any advantage negligible, particularly given that such contractors were excluded from the employee benefits and protections afforded to regular employees.
Despite IR35 the contractor model is still in widespread use today. The reason for this, according to HMRC, boils down to rampant non-compliance. HMRC estimates that putting compliance with IR35 in the hands of the contractors themselves has resulted in only around 10% actually adhering to it, leading to annual losses of around £420m in tax and NIC receipts. It is little surprise therefore that a change in this approach is imminent.
In the 2018 Autumn Statement the government announced it intended to bring large and medium-sized private companies into line with the public sector with effect from 6 April 2020. This means end-user companies receiving services from a contractor will need to decide whether or not that contractor should come within IR35 and, if so, it (rather than the contractor) will be responsible for withholding PAYE and paying employer’s NIC.
Who will be affected?
All medium to large private sector employers who use contractors will be affected, but small companies are likely to be excluded. To count as a small company, a firm must demonstrate two or more of the following attributes:
- Annualised turnover under £10.2m
- Balance sheet assets of up to £5.1m
- Average number of employees of up to 50.
What is the likely impact?
Reviewing the repercussions for public sector employers when the same change was brought in for them back in April 2017 highlights the potential issues ahead and underlines the need for firms to prepare well ahead of time:
- The rates for public sector contractors who were adopted into IR35 increased on average 20%
- Authorities struggled to complete projects
- Cost overruns occurred as a result of rate increases and the additional 12% average employer NIC payments
- IR35 contractors became entitled to equal treatment with permanent employees after 12 weeks, leading to further increased cost
- There was a heightened risk of employment claims
- Discontent was rife among genuinely self-employed workers who were unable to challenge their IR35 categorisation without leaving the public sector.
How can firms prepare?
Firms must begin tackling the potential issues. This involves:
- Identifying the risk: IR35 does not apply to contractors who are genuinely self-employed. Categorisation is key. As a general rule IR35 applies where the end user is responsible for the supervision, direction and control of the services being performed. However, a careful factual analysis is required.
- Contract rates: Consider redrafting service contracts to take account of PAYE deductions and the need to pay employer’s NIC on top of contract rate.
- Agency staff: Agency companies are likely to be responsible for IR35 compliance and will need to deduct PAYE and pay employer’s NIC. As a result the cost of agency staff is likely to rise. Building firms do need to be aware of these costs when negotiating future service agreements with temp agencies.
- Employment status: Consider whether to switch contractors onto employment contracts reflecting their genuine status to avoid the risk of claims and sanctions. This does require the agreement of the contractor and should involve a consultation process. It is important to plan this carefully to coincide with a pay review or contract renewal.
- Gathering evidence of self-employment: The optimal position for firms is to avoid IR35 altogether, but the risk of HMRC sanctions makes it important to be realistic. Firms will need to work with contractors to gather evidence of genuine self-employment and, if required, alter their working arrangements well ahead of 6 April 2020.
A consultation on the new measures is expected imminently, with the final bill being published alongside the Autumn Statement in November.
Building firms that plan ahead and put in place adequate compliance practices will reap the benefits by minimising their risk, while ensuring they remain an attractive proposition for contractors.
Michael McCartney is a partner in the employment department at Fladgate