20 Nov 2017

Using Ltd Co Contractors?

0 Comment

There have been many reports that a change is on the horizon for companies that pay limited company subcontractors.

Companies could soon be liable for the tax and national insurance due to HMRC if the limited company contractors they engage should have in fact been employed.

As it currently stands in the private sector, if an individual provides their services via their own limited company, they will be the ones responsible for considering employment status and whether they are caught by IR35. If HMRC deem that the individual should have been an employee of the client, the limited company (not the client) will be the one liable to HMRC. This effectively means that companies do not need to worry about employment status if the individual has their own company (for now anyway).

In April 2017 the government amended legislation to stipulate that if the work was in the public sector, it would be the public sector body or agency paying the individual that would actually be liable for employment status. This was a significant change and has caused much upset and widely reported problems in the public sector.  At the time the government said they had no immediate plans to roll out such a change in the private sector however most remained sceptical of this and the government have recouped a substantial amount of tax from the change in the public sector and so it is really just a case of when it will be implemented in the private sector.

Only six months later and it has been reported in the papers that the Chancellor will announce in the Autumn Budget on 22 November 2017 that the measure will be applied in the private sector. Whether this is correct remains to be seen but we would expect this change to be forthcoming even if it isn’t highlighted as soon as the 22 November. Some experts have predicted that any change would be subject to a consultation period and not implemented until 2019, we don’t believe a consultation will happen because the public sector has effectively been a guinea pig for this and so we believe it will simply be adopted, probably from April 2018.

What is the problem?

Non compliance essentially. The government introduced IR35 in 2000 and Robert Walker LJ summarised why it was introduced in the case of R (Professional Contractors Group) v IRC 2001 – Court of Appeal:

“to ensure that individuals who ought to pay tax and NIC as employees cannot by the assumption of a corporate structure, reduce and defer the liabilities imposed on employees.”

There was a growing problem at the time of people leaving their full time employment so that they could return to the same job but work through their own limited company as it was more tax efficient. IR35 was then introduced to effectively ignore the existence of the limited company and establish whether the individual would have been an employee of the client, if so they would be liable for additional tax and national insurance. When the legislation was first proposed in 1999 the liability was originally going to rest with the client but due to its unpopularity, the lobbying and resentment across industry the liability was shifted to the limited company contractor.

Since its inception, IR35 has generated very little revenue for the government and only a very small minority of people declare they are caught by IR35. HMRC have also been poor at tackling the issue both in respect of the number of enquiries they have the resources to open and how they then actually argue those cases. Dave Smith, one of the owners of Marble, represented the taxpayer in the first IR35 case at the tax tribunals where the taxpayer was successful (Lime IT v Justin) and the HMRC officer in that case had to start the court proceedings with a 10 minute apology to the tax payer about how he had conducted the enquiry and behaved, not exactly the best start to a tribunal hearing for HMRC. HMRC have had some success since Lime IT at the tax tribunals but it is a fairly mixed bag and over the last 6 years they have won few very cases, it also takes a considerable amount of time and resource to conduct an IR35 challenge and it only addresses IR35 one taxpayer at a time. If the client is the entity liable not only will they have more financial resources to meet such a liability but they may also have lots of contractors working for them at any one time meaning HMRC can challenge lots of contractors all in one enquiry.

The 2017 Changes 

In 2016 the government announced plans to change IR35 in the public sector (the logic being that the government has a duty to ensure the public sector operates correctly) and move the liability for IR35 from the limited company to the public sector body or company paying the limited company. This change was implement in April 2017 and led to a vast number of people operating via personal services companies being subject to tax and national insurance as though they were employees. Some bodies took a zero risk approach and had blanket policies that everyone would be subject to PAYE in full. The law was only a change to the tax legislation and so unfortunately not only did it mean the individuals in question had significantly reduced pay (the cost of employer’s national insurance would often be passed onto the individual) but they were not granted “employment” status within employment law meaning they suffered the downside of being under PAYE without any of the benefits.

The change was in fact so effective in converting people to PAYE (irrespective of whether they were genuinely operating their own business) that the natural conclusion for the government is to roll it out in the private sector to try and claw back some of the money it so desperately needs.

Changes to IR35 in the private sector, what can we expect?

We believe that the tax the government will receive from any such change in the private sector will be significantly less than the public sector because the private sector will be more commercial about this area and willing to consider the position and act accordingly rather than simply putting everyone on PAYE by default.

If the government do announce in the Autumn Budget that the client will now be the liable party under IR35 it will be imperative for all companies that engage personal service companies to act quickly to assess the impact and what they need to do. Any change will likely come into effect from April 2018 and so there will not be a huge amount of time to get everything in order.

It is also worth noting that the individuals that usually work through their own limited companies also command a higher rate of pay which in turn means the liabilities due to HMRC are significant. A good example of this is the well publicised case of Dragonfly v HMRC in which the liability for the one contractor was £99,000 plus interest and penalties.

Any company would have to be very confident that any individuals working through their own limited companies would not be deemed employees. This could be even more prevalent given the Matthew Taylor Review into modern working practices recommended to the government that if an individual is deemed an employee for tax purposes, they will automatically be entitled to employment rights and protections as though they were an employee. This doubles the incentive to get this crucial area correct because not only could a company be hit with a substantial tax liability but they could also end up coughing up for employment rights such as unpaid holiday pay.

How is IR35 determined?

It is not possible to cover employment status in one blog as it is a large topic and one in which a whole book would be needed to adequately cover it but hopefully the below will provide an overview of the main points that should be considered.

There is no helpful definition as to what make an individual an employee or self-employed. The relevant legislation simply refers to an employee working under a contract of service but does not clarify when a contract is one of service. The courts have then been left to interpret this and so an in depth knowledge of case law and the key legal principles is essential in order to determine IR35.

There has been talk for many years about whether this area of law can be given more clarity by introducing legislation that specifically states when someone will be employed or self employed but each time it is considered the conclusion is that it is a complex area without a simple solution.

So what are the factors that must be considered? If you talk to the bloke in the pub he may inform you that if the individual only works for one client and works regularly he is an employee. This is a common perception but it not accurate and there is much more to consider.

The courts generally accept, following the case of Ready Mixed Concrete 1968, that there are three important factors that must be considered before anything else as they are fundamental features of an employment relationship. Those three factors are whether the individual is required to carry out the services personally, whether they are subject to a sufficient degree of control and whether there is an obligation to offer and accept work (referred to as mutuality of obligation). If one of these aspects is not present in the relationship, it cannot be one of employment. Once those areas have been explored the courts will then turn to any other factors which are inconsistent with an employer/employee relationship and this is where things like working for others will be taking into account (but will not be determinative on their own). If there are a sufficient number of factors that demonstrate the individual operates as a business is its own right it will again not be caught by IR35 and be deemed an employee.

What to do now?

The IR35 legislation has not changed in the private sector yet but it is highly likely that it will, whether it be within the next year or the year after. Any company engaging contractors that operate through their own limited company should start paying more attention to the way in which those people work and be prepared for any such changes so they are aware of not only the impact but the potential exposure/risk or cost if individuals will need to move over to PAYE.

The owners of Marble have considerable experience in this field and operate a specialist tax practice (RIFT Legal Services) so can assist clients in relation to employment status.  The team have defended IR35 enquiries in all sorts of industries and for clients big and small including representing them at the tribunals, writing books and articles on the topic, providing specialist training and seminars for people affected by IR35 and other professionals. Please get in touch if you have any concerns about IR35 or employment status for a no obligation chat about where you stand and if we can help.