Umesh Modi and Vinku Shah explain how independent contractors could be affected by the latest changes to the off-payroll working rules…
In April 2017, IR35 reform was introduced to the public sector by the government. From 06 April 2021, these reforms will extend to the private sector. For many, IR35 legislation is complicated and confusing and a lack of clarity from HMRC does not help matters, the controversial HMRC Check Employment Status for Tax (CEST) tool being one example. Below we simplify what IR35 is and how it may affect community pharmacies and contractors (locums) that provide their services to the private sector.
What is IR35
IR35 was introduced in 2000 and is essentially anti-tax avoidance legislation designed to ensure that individuals who provide their services through an intermediary such as a Personal Service Company (PSC) pay the same tax and National Insurance Contributions (NICs) as those that are in full time employment. IR35, otherwise known as off-payroll working rules is designed to determine whether a contractor would be classed as an employee if they provided their services directly to the end user client instead of through their PSC.
In 2017, the responsibility of determining the employment status of the contractor was shifted to all public sector authorities and from 06 April 2021, medium and large size private sector companies (end user client) will also have to decide on the employment status of each contractor that operates through a PSC. Before 06 April 2021, the responsibility to determine the status of employment of the contractor was on the PSC.
The government has indicated that it intends to use the same criteria as Companies Act 2006 to define a medium or large business. Under current legislation a business that breaches two or more of the following limits would be classified as medium or large sized:
- turnover of more than £10.2m;
- balance sheet total of more than £5.1m;
- 50 employees or more.
Do note that in case of a group, the above limits will apply to the entire group.
Most community pharmacy businesses will fall within the small company category therefore if engaging with contractors who operate through a PSC, the responsibility of determining the status of the contractor’s employment and paying the right amount of tax and NICs rests with the PSC.
The end user client will have to give a Status Determination Statement (SDS) to the contractor if it is a medium or large sized company.
Medium and large businesses engaging with contractors operating through a PSC will have to ensure processes are in place to review each individual contract as though the contract was between the company and the individual providing the service i.e., a hypothetical contract where there is no PSC. They will also have to ensure there is an appeal process and sufficient record is maintained throughout the process so that they can demonstrate they have taken reasonable care.
It is recommended that the contract should be put through HMRC’s own CEST tool and HMRC have indicated that they will stand by the outcome of the CEST tool if the questions have been accurately answered. The CEST tool has been known to have issues in the past but it is important that you keep a record of the tool’s outcome as it will be an important piece of evidence to demonstrate you have taken reasonable care in determining the status of a contractor. HMRC have confirmed that they are making further improvements to the CEST tool and the changes are expected to be delivered by the end of 2021.
The SDS is a document that states the decision of the employment status that has been arrived at by the end user client i.e., if within IR35 or outside IR35. There is no specific template from HMRC for this, but it should include the name of the contractor, contract start and end dates, person who has undertaken the determination, and most importantly detailed reasons as to why the decision has been reached. The reasons for the decision will have to be as detailed as possible.
The SDS must be issued to the contractor and the next entity in the supply chain and a record maintained that the end user client has done so. The next entity in the supply chain could be an agency or the fee payer to the contractor or an umbrella company. If it is proven that the client has not passed on the SDS to the contractor and/or the next entity in the supply chain, the tax liabilities will fall on the end user client.
The contractor can appeal the SDS at any time during the contract and it is the responsibility of the end user client to address this within 45 days. The end user client will have to review the SDS and either confirm the original decision or a new SDS with a revised decision. In both cases, it must be documented with detailed reasons of the decision.
Right of substitution – This is one of the most important criteria and there should be an unfettered right to provide a suitable substitute for the contractor. The contractor should be able to provide a suitable substitute at their own cost. HMRC have now qualified the criteria within the CEST question on substitution, which states that a client’s need to be satisfied that the substitute has the skills and experience required or to ensure the substitute is approved under their security processes does not negate the right of substitution.
Control and direction – The written contract as well as the working practices should be able to demonstrate that the end user client has no control over how the contractor performs his/her service. Most skilled work may not fall foul of the rules as the contractor may be better placed than the client on how they provide the service.
Mutuality of obligation – This is an obligation between two parties to provide and accept the work and is easier to demonstrate in an employer/employee relationship. It is less clear under an end user client and contractor relationship.
HMRC maintains that for any contract to exist, some mutuality of obligation must exist and could be the reason why HRMC’s CEST tool does not take this into account and therefore it is advisable not to rely solely on HMRC’s CEST tool.
In practice, the end user client should be under no obligation to provide further work and the contractor should be under no obligation to work for that client.
Integration – HMRC will seek to see how well the contractor is integrated into the client’s business for example is the contractor involved in staff meetings, do they have a client email address, are they subject to internal processes and procedures?
The more embedded the contractor is in the client’s business, then it is more likely that they will fall within IR35 rules.
Other factors – Some of the other factors that will be considered, but not limited to, are whether the contractor has their own website, do they work in a way that can generate more profit for their own business, does the contractor have their own employees, is the contractor responsible to remedy any substandard work at their own time and cost.
If a contractor is w ithin IR35 i.e., status is that of an employed person, the fee payer will have to deduct tax an NICs and pay these to HMRC. This can be done via the current payroll or the fee payer can opt to use a separate payroll for this purpose.
The tax and NICs will have to be calculated on the amount before VAT (if the contractor is registered for VAT) and the payment net of deductions pus any VAT to be paid to the contractor. The contractor will then have to include these details in their self-assessment tax return.
P45 should be issued at the end of the contract and if the contract runs over the end of a tax year, then a P60 should be issued.
HMRC have stated that they will be lenient with companies for the first 12 months if reasonable care has been taken but there were mistakes including mistakes in status determinations as long as it can be demonstrated and therefore, we emphasise the importance of documenting and maintaining proper records throughout the process.
This article is based on current practice and is for guidance only. Specific professional advice should be taken before acting on matters mentioned here. Umesh Modi BA ACA is a Chartered Accountant and Tax Advisor, and a partner at Silver Levene LLP. He can be contacted on 020 7383 3200 or [email protected]. Vinku Shah FCCA is a Chartered Certified Accountant and Manager at Silver Levene LLP. He can be contacted on 020 7383 3200 or [email protected].