Understand and prepare for changes to the off-payroll working rules (IR35)

Shortly, there is a significant change to way in which some companies will have to deal with individuals who provide services to them on an off-payroll basis – often referrred as “contractors”.

We all know why it is done, to reduce taxes for the company (employers’ NI) and for the “consultant” who usually pays themselves (and their spouse/mother/etc) dividends.  You will recall a few years ago when several BBC celebs and public sector folk hit the headlines for this kind of tax planning, to notable public uproar; HMRC subsequently introduced some new rules.  Those rules will, from 6 April 2020, apply to Medium and Large companies. So, if you are two of the following they will apply to you:

  • You have an annual turnover of more than £10.2 million
  • You have more than 50 employees
  • You have a balance sheet total of more than £5.1 million

Balance sheet total means the total amounts shown as assets in the company’s balance sheet before deducting any liabilities.

However, even if you have small company, the rules still need to be understood. If you think you may be bought by a Medium-to-Large company, the the price paid for the business may be impaired as a consequence of the purchaser applying the  new rule and needing to pay your staff more to keep the now employee’s income the same.

Let’s recap on what IR35 is.  It is a set of rules to deal with off-payroll workers.  These rules were introduced to address perceived tax avoidance by individuals seeking to avoid paying employee income tax and national insurance contributions by supplying their services through an intermediary and paying themselves in dividends. 

IR35 requires workers who, for all intents and purposes, work like payroll employees but provide their services through an intermediary, so pay similar taxes to other employees.  It is currently for the contractor to decide and the risk sits with them.

So what has changed?  If you are a medium or large-sized company (or you have clients you provide labour to) the company will become responsible for deciding a worker’s status and if the off-payroll working rules apply to them.  It will need to:

  1. Decide the employment status of a worker providing services through an intermediary and document this in a status determination statement (SDS) – this must be done for every contract agreed with an agency or worker
  2. Pass the SDS (which must include the determination and the reasons for it) to the worker and the person or organisation contracted with
  3. Make sure detailed records of employment status determinations, including the reasons for the determination and fees paid, are retained
  4. Implement a process to deal with any status determination disputes.

HMRC have provided a useful tool called  the Check Employment Status for Tax (CEST) to help you with your determination.  The CEST will look at may matters including:

•    The nature of the duties being undertaken – is the role one that would be expected to be done by an employee? Are there current employees performing a similar role? A  “yes”  increases the likeliness that the assignment falls under IR35 rules.

•    Substitution – does the provider (Limited Company, LLP or even sole trader) who provides the worker have the right to send a substitute to carry out the role without requiring approval from you? 

•    Mutuality of obligation – does the worker have the right to reject work from you?  Or are you obliged to provide the worker with work? 

•    Supervision, direction and control – to what level is the worker dictated as to how they should perform the day-to-day tasks for the assignment? Are working hours mandated?  Considerable control increases the likeliness of the role to fall inside IR35.

•    Integration into the business – to what extent is the role integral to your business.  Does the provider present themselves to customers as representing you? Does the worker have managerial responsibilities?  If yes the worker is behaving more like an employee.  We have sold businesses worth >£50 million where the MD was contractor.  This practice will need to stop.

•    Is the worker in the business on their own account – does the worker bear financial risk in the performance of the duties? Who supplies any equipment required for the role? If they do bear financial risk or provide their own equipment, they are less likely to fall under the scope of IR35.

•    Is the worker entitled to employee benefits such as pension contributions, paid holidays, sick pay? If the answer is yes, they are being treated like employees and are more likely to fall inside IR35 rules as a result.

If the rules apply, you the will be responsible for deducting the tax and National Insurance contributions and paying these to HMRC.

If a party in the labour supply chain receives the employment status determination, but does not pass it on, they will become:

  • The fee-payer
  • Responsible for deducting the tax and National Insurance contributions and paying these to HMRC

Why do we, as a corporate finance adviser, care?  

Well, firstly we do of course want our contacts to be properly informed, but also a failure to comply with this could have far reaching effects when you come to do a deal.

For instance, your FD may be a “contractor” and you, as an employer, may be saving £15k p.a. on employers NI.   A buyer may look at the situation and say they want six years coverage (so 90k off the price), then may seek to adjust the the EBITDA by the employers’ NI plus any increase that the contractor may need to keep their income the same when they go on payroll.  Let’s say that equates to a total cost of £40k p.a. and you are being bought for a multiple of 10x EBITDA. That is now about half a million off of the price.  

Furthermore, increasingly we see buyers looking for a culture of compliance as much as they look at the direct financial impact of non-compliance; a buyer may get spooked by the culture of the business and reduce the price they will pay disproportionately.  And, being an altruistic bunch, we want the best for our clients and clearly live to maximise the pound in their pockets – the pound in our pocket is also affected, given we are on a share of the overall price!

Next steps? Get specialist advice, whatever the size of your company.  We have one client who, whilst small, is going to take the pain of compliance now so there are no surprises at exit. She has half a million good reasons to do so.

Our advice is get specialist advice whatever size company you are. We have one client who whilst small is going to take the pain of making a senior team member an employee now so there are no surprises at exit.

She has half a million good reasons to do so.

By Charles Whelan on 27/02/2020