Following, the introduction of the off-payroll rules (IR35) in 2021 Lawspeed advisers have seen an increase in queries relating to the engagement of contractors as self-employed sole traders, as an alternative to personal service company (PSC) engagements. The question is whether a sole trader model is a viable option or is it simply swapping one problem for another?
It is true to say that individuals engaged by a recruitment business as sole traders will normally not fall within the scope of the IR35 rules. However, IR35 is not the only tax rule to be concerned about, and whilst the model solves the problem of IR35 for recruiters and hirers, for recruiters in particular, it opens up other key areas of risk.
Firstly, under the agency tax rules (ss.44-47 ITEPA) recruitment businesses that supply individuals, whether sole traders or PAYE workers, are responsible for paying PAYE levels of tax and national insurance on the payment the individual receives for the work performed. Unpaid levels of tax, with interest and penalties for non compliance, can be recovered by HMRC retrospectively direct from the agency. This is a default responsibility unless either (a) ‘the manner in which’ the individual performs these services is not subject to, and no one has the right to exert, supervision, direction or control (SDC), in which case the individual can be paid as a sole trader, or (b) the individual is otherwise paid for the work under the PAYE scheme, for example by an umbrella company.
This rule applies to all types of supply including arrangements under the construction industry scheme (CIS). In practice and only in some very obvious cases, where the work is clearly a project with no SDC, will the ‘pay by PAYE’ rule not apply. Putting it another way, if there is no SDC it is unlikely that the IR35 tax rules will require deemed employment anyway, so you may as well supply a PSC!
The position under (a) above is often complex, there being no cut and dried interpretation of the meaning of the legislative words ‘the manner in which’ or when SDC applies. The fact is, even if told otherwise by a party in the supply chain, recruiters will have little actual knowledge of, or influence over, the level of SDC exerted by hirers or anyone else, leaving them taking a step into the dark. This makes the sole trader model a potentially unattractive option. The risk of a retrospective claim by HMRC remains high even if an umbrella company, which hires the worker as a sole trader, is involved and determines that there is no SDC. Here, given the risk, prudent steps to take would be to review the umbrella’s process for determining SDC and ensure that the contract terms provide for an indemnity by the umbrella company.
Secondly, engagement of sole traders, again whether direct or via an umbrella company, may raise issues regarding the employment status of the individual. In recent years there have been several high profile cases (including Uber drivers and Pimlico plumbers) where self-employed individuals have argued that they should be afforded worker rights. As the tests for actual worker status and self-employment for tax purposes are different, it is possible for an individual to be both self-employed and a worker with worker rights. In general terms, self-employed individuals who are not genuinely independent may be regarded as workers.
Getting this wrong can be expensive. In a recent Court of Appeal case, a self-employed worker who had been engaged by Pimlico Plumbers successfully argued that he was entitled to accumulated holiday pay of some £70k, back pay for the entire period of his engagement.
Thirdly, as there is no automatic exclusion of the self-employed (for tax purposes or otherwise) from entitlement to rights under the Agency Worker Regulations (AWR), both recruiters and hirers should still consider whether the AWR will apply and take all appropriate steps.
As always, the golden rule is to understand what the hirer wants and tailor the contractual arrangements accordingly. No single model will ever provide a complete solution. So, before hailing sole traders as the answer to the IR35 problem, recruiters thinking of this model should carefully consider the risks involved, as well as any steps necessary to mitigate those risks.
For more advice or suitable model templates call Lawspeed on 01273 236236.
Theresa Mimnagh is Associate Director at the recruitment and employment law specialists Lawspeed.
Lawspeed group corporate clients benefit from immediate up to date advice on staff engagement and related regulation; employment status; client, IR35, PAYE, and umbrella contract templates; contract review/negotiation; self-employment and CIS contract templates; trade membership and government representation; accreditation services and a state of the art digital contract management platform.