As if businesses didn’t already have enough on their plate between COVID-19 and Brexit, medium and large companies in the private sector which use limited company contractors need to grapple with the IR35 legislation which is coming into force on 6 April 2021.
Currently, contractors who supply their services via a limited company (known as a “personal service company”) or other relevant intermediary body must take responsibility for considering whether they are, in fact, “disguised employees” and therefore whether they should pay income tax and National Insurance Contributions (“NICs”) on their income.
With effect from 6 April 2021, this responsibility will pass up the chain to the end client, i.e. the business which receives the services of the contractor. The end client will be required to make a determination (a “status determination”) as to whether or not the contractor would be deemed to be an employee of the end-user client, but for the existence of the intermediary. If the contractor is a deemed employee, then the end client must pay the contractor via PAYE (i.e they must make deductions from the contractor’s pay at source for income tax and employee NICs and they must pay employer NICs in addition). Alternatively, if there is an agency (employment business) in the supply chain which actually pays the contractor then they must operate PAYE instead (rather than paying the contractor gross).
Many end clients are concerned about the work and cost involved with this additional administrative burden, as well as being concerned about the possibility that tax liabilities will transfer through the supply chain. However, such businesses may not want to lose the talent and experience that their contractors bring. So, are there any alternatives?
Direct engagement
One option is for the end client to offer to engage the contractor directly, either as a worker (under a contract for services) or as an employee (under a contract of employment). In both cases, the contractor would be paid through PAYE in the same way as any other worker/employee and IR35 wouldn’t need to be considered.
Often, contractors are paid at a higher rate than their employee counterparts, so they maybe unwilling to take the hit on their take home pay which would result from being on payroll, and end clients are likely to be unwilling to increase the individual’s salary to reflect the tax and NICs deductions which they would suffer.
On the other hand, if the alternative is that the contractor would be deemed to be inside IR35 and would be paid via PAYE but wouldn’t have the associated benefits of being an employee/worker (such as holiday pay and sick pay), then direct employment/engagement may be more attractive to them, but the end client would probably wish to ensure the arrangement maintains flexibility and takes into account the extra liabilities that come with direct engagement
Umbrella companies
Another option is for the contractor to become employed by an “umbrella company”. An umbrella company employs individuals under a contract of employment, so the individual benefits from all of the rights of traditional employees, such as holiday pay, sick pay, the right to bring unfair dismissal claims (after 2 years’ employment) and the stability which employment brings.
Typically, the umbrella company will then enter into a contract with an agency (employment business) who will supply the individual’s services to the end client.
Because the individual will be on the umbrella company’s payroll and their pay will be subject to the usual PAYE deductions, IR35 issues fall away. However, umbrella companies typically work on the basis that they pass all of the costs of employment (employer NICs, holiday pay, apprenticeship levy etc) onto the end client together with the umbrella company’s fee (or “margin”), so engaging a contractor via an umbrella company may be more costly for the end client than employing the contractor direct. However, in this scenario, the risks and responsibilities of employing the contractor will rest with the umbrella company, not the end client, and this, together with the preservation of the flexibility of using a contractor, may make this model more appealing.
End clients should be aware that there are some very good, reputable umbrella companies which uphold high standards of compliance, and there are some which don’t. End clients would be well advised only to work with umbrella companies which are a member of a trade body such as the Freelancer and Contractor Services Association (FCSA).
End clients should be alive to umbrella companies with offshore elements or which claim to be able to offer the contractor higher take home pay than other established umbrella companies (by deducting less tax/NICs). It is possible that such companies are not operating legally.
Professional employment model
Professional employment organisations (“PEOs”) are a relatively new type of employment model in the UK, although they have been popular in the USA for several years. PEOs are similar to umbrella companies insofar as contractors become employed by a 3rd party (which takes responsibility for operating PAYE) and are supplied to carry out their services for the end client.
However, PEO models can involve a concept of “co-employment” or “joint employment” whereby the PEO seeks to become the contractor’s employer for tax purposes while the end client intends to become the contractor’s employer in a day-to-day respect. This model is recognised in the USA, but the concept of an employee having two employers is unusual in the UK and raises tricky issues from a legal perspective.
There is no settled definition of a PEO at the moment and different providers operate in different ways. The most common model involves the end client or the agency entering into a joint venture with the PEO provider and the contractors become employees of the joint venture company. In these circumstances the terms of the contracts between the parties are of paramount importance to ensure that the model operates as intended to offer an effective solution.
Statement of works
A “statement of works” is a contracting model being offered by some employment businesses with a view to placing the end-client outside scope of the IR35 legislation. Rather than an employment business supplying a particular limited company contractor to an end client, the employment business provides a whole service or package of works and becomes an outsourced service provider rather than a recruitment business. So, rather than supplying an IT contractor, the employment business will contract to provide an outsourced IT service to the end client; essentially a business to business service provision.
The intention behind this model is to take the end client out of the IR35 picture, leaving the employment business to carry out a status determination and put the contractors’ pay through PAYE if they are deemed to be a disguised employee and to limit the liability for the transfer of debt. However, this model is not suitable for all types of service provision and not all employment businesses are set up to operate in this way, which is fundamentally different to the traditional supply of labour.
Again, the contracts between the parties are of paramount importance in this model and if this model is to work then it needs to be set up correctly. If set up correctly then the outsourced service provider may be a small company and exempt from the IR35 changes, meaning they may be able to continue to pay the contractors gross, or it may just simplify the IR35 compliance requirements of the end client and limit the transfer of debt provisions. It’s important that there’s clarity on the model and how it’s intended to operate if this is going to be a workable solution.
Brabners can work with you to understand your current supply chain, identify the issues and available solutions.
If you already know the model you’ll be using, then we can advise on and draft your supply contracts.
For any help or assistance in navigating the IR35 changes then please contact our team of experts.
