A new consultation document heralds a reform to the taxation of contractors working through personal service companies, writes Elizabeth Middleton of law firm Cripps.
After a period in abeyance, the Government has re-focussed its sights on the perceived tax advantages of ‘off-payroll’ working through personal service companies (PSCs).
In May, a consultation document focusing on off-payroll workers in the private sector was published by HMRC. This indicates the start of a new regime whereby, irrespective of the PSC, the client (or an intermediary such as a staffing agency) will be liable for PAYE taxes as if the individual was directly employed.
Typically, off-payroll workers are contractors providing their services to clients through the PSC in which they (or they together with family members) hold all the shares. By taking this approach, the client saves on National Insurance contributions and income tax through gross payment of the fee to the PSC and extraction of profits through dividends.
The current legislation, known as IR35, tackles this by treating the PSC as the employer in circumstances where, had the contract been directly between the client and the worker, it would have had the characteristics of an employment contract. PAYE taxes are then imposed on the PSC (and not the client) as if the contractor was an employee. The government believes, however, that the IR35 rules are not being properly applied and they estimate the loss to the Exchequer at £75m per year and rising. They believe that one third of individuals working through PSCs should be taxed under IR35 but only a tenth are actually reporting their taxes correctly.
Taxpayers and their advisers would argue the rules are unclear, inconsistent and difficult to apply, with an individual’s status being determined by a balance of factors developed in case law, favouring either employment or self-employment. But there is also a general view that HMRC has had a somewhat tolerant attitude to enforcement, which is now coming to an end.
In a recent case before the Tax Tribunal involving Christa Ackroyd of the BBC’s Look North programme, Ms Ackroyd’s contract with the BBC via a PSC was determined to have been in the nature of employment, despite several strong indicators in favour of self-employment, and despite professional advice having been taken and the contract being one typically used by the BBC. HMRC now hopes to claim tax of more than £400k in historic PAYE taxes from Ms Ackroyd’s company.
The case is a salutary tale of the difficulties of applying the ‘tests’ of employment and self-employment to individual contracts, which will remain in the new regime, as well as the severe tax penalties of ‘getting it wrong’.
Last year, HMRC introduced new rules for public sector contractors which shifted the burden of determining employment status – and the responsibility for PAYE taxes – from the PSC to the client, thus changing the landscape for PSC workers in the public sector. The current consultation document proposes an extension of the new regime to private sector contractors.
Under the proposed new rules, the tax risks of employing individuals through PSCs will be considerably increased, particularly in any case which is borderline, or where the ‘tests’ of employment are not easily reconciled with the facts of the engagement contemplated (as in the Ackroyd case). It is likely that clients will be unwilling to take tax risk with the result that those happy with their independent status may have to accept being treated as quasi-employees for tax purposes and a reduction in post-tax receipts. The consultation document asks for comments on a wide range of questions including compliance, the level of obligation to be placed on the client, and the level of record keeping required and we can expect a fair bit of lobbying on the rules from contractor bodies in various industries. However, while the document is a ‘consultation’, it is realistic to plan for implementation, in largely the form proposed, next year.
Clients engaging contractors via PSCs need to keep a close eye on developments. Those using a lot of contractors may need to plan for new checking, compliance and record-keeping obligations and possibly increases in PAYE costs. Those using PSCs may find clients less willing to accept their status and standard-form documentation. In either case, existing contracts may need to be substantially amended to ensure there is no tax risk for either party.