For many years the options available to businesses for hiring in staff have included the use of contractors, and the number of people willing to work as contractors has grown exponentially over the last decade. Engaging talent therefore has been a relatively straightforward exercise given the few obstacles that have existed when hiring in contractors; all that is needed is to identify the person with the right skillset and availability, agree a rate, make sure the person has a company and not a personal service company (PSC), enter into a contract for the work requirement with that company and pay gross on invoice delivered. No tax risk, no employment rights. And the contractor gets higher net receipts. This method has been particularly suitable for businesses that have a policy to hire temporarily and have no need to hire employees.
However PSCs have, since 2000, under the tax rules known as IR35, been obliged to report in their annual returns to HMRC indicating whether the hire arrangement would have been employment were it not for the existence of the company in the contractual chain (‘status’). Since the level of tax paid increases if there would be employment, most companies have insisted on their contracts pointing away from an employment relationship, these contracts widely referred to as ‘IR35 friendly’. Relying on those contracts, many contractors have simply not reported that status would be employment and so have continued to take advantage of the company tax breaks.
Unsurprisingly HMRC has noted the consequent tax and (NIC) losses, concluding the problem arises as the contractor, the party who makes the ‘status’ decision, has a considerable incentive to avoid reporting that the IR35 rules apply. At the same time a significant accountancy related industry has emerged to advise contractors how best to maximise tax breaks, justifying ‘no employment’ status decisions made by the contractor.
HMRC believes the loss to the Exchequer will be £1.4 billion a year by 2024 and so it has decided to make a dramatic change to the law. From April 2020 the status decision will be made by the hirer, not the contractor. Further if status is one of ‘employment’, the hirer will be liable to account to HMRC for pay as you earn (PAYE) and both employee and employer NICs on the invoice charge for work done.
This radically changes the dynamic and means that HR will, wherever the decision is to hire PSC contractors, have to assess the employment status of the arrangements. Avoiding making a decision leads to liability, and regardless of the outcome, HMRC is entitled to the PAYE and NICs if the arrangement in fact is one of employment, meaning that an incorrect status decision will leave the hirer liable for these taxes. Only where a ‘no employment’ status decision is correct will a hirer safely be able to pay the contractor gross on its invoice. As liability for taxes and NICs last for 6 years this requires careful thought – how confident can a hirer be that the arrangements are not caught under these rules and do not expose it to tax risk?
Using an agency does not alleviate risk or the IR35 rules in these circumstances. Although the agency makes the payments the hirer remains responsible for the status decision and can still be liable if the tax and NICs are not correctly accounted for down the chain. Further there are obligations to pass on information as well as review requirements that add to effort. There is temptation and critically hirers should be wary of solutions offered by other third parties that involve insurance and status reviews, given that none can remove risk but simply change perception of it.
Alternatives to hiring contractors using their own companies include hiring through an agency, using an umbrella company, negotiating the rate and absorb the cost, and hiring as self employed. This last option offers no panacea. Direct hire in any form is risky if the individual is not to be employed, with rights entitlement, or treated for tax purposes as employed with PAYE and NICs following.
The three remaining options offer a safer approach. The first, using agencies regulated under the Conduct of Employment Agencies and Employment Business Regulations 2003 (Agency Regs) to find and supply suitable workers has an arguably clearer solution to finding the right people than using online sites and social media. Whilst agencies charge a margin, that cost should be balanced against cost savings and time spent in recruiting direct. Policy here may of course affect HR personnel engaged in undertaking contractor recruitment themselves.
The second option, umbrella, has mixed advantages. Umbrellas take on the employment obligations but cannot provide a work finding service, so cannot legally search for and propose workers for hire. As they pay workers net after taking their employment charge, the proposition has few obvious benefits particularly for the worker who receives a lower pay packet, no work finding service or agency Regs protection.
The third, negotiating new rates, is a mathematical exercise, but many would question why a contractor would want to retain use of the company when being paid a lower sum net of taxes. Some may, of course.
Inevitably the new IR35 rules will affect the approach taken by HR to hiring policy. Whilst it has always been easier to hire a company rather than an individual, the downside of doing so may now seem daunting. That is not to say that some arrangements may clearly be ‘no employment’, but just getting to that conclusion and being ‘tax risk’ free will no longer be straightforward. Many will therefore want to avoid the application of these rules, by ruling out use of PSC contractors, except where the arrangements are for key individuals required temporarily for a project under which the employment status is definitively ‘not employed’ and the right contracts are in place. Even then the process for making and relaying a status decision under the rules will still apply.
Adrian Marlowe is a lawyer and the founder of the recruitment and employment law specialist Lawspeed. This niche consultancy has operated since 1997 and advises businesses on engagement contracts and commercial and tax elements of all types of hiring arrangements. IR35 has been an area of speciality since its inception in 2000.