The contractor tax rules known as IR35 are set to change. In simple terms, agencies and hirers that have historically hired contractors without risk of tax liability will, from 5th April 2020, be liable if they get the IR35 rules wrong. It is therefore relevant to understand when the rules apply.
IR35 is known by HMRC as ‘the intermediaries legislation’. An intermediary for the purposes of the rules is a third party that is responsible for paying the worker or providing a benefit to the worker concerned. For example an agency which supplies a company contractor is not an intermediary because the agency does not pay the worker – instead it normally pays the contractor company which is the ‘intermediary’.
An ‘intermediary’ can be one of several models the most common being the worker’s own company, often referred to as a personal service company (PSC), and a service provider company, generically referred to as an umbrella company. The legislation only applies to intermediaries in which the worker owns at least 5% of the shareholding, so PSCs fall squarely into category whereas umbrella companies, which are owned by entirely different shareholders, do not.
The IR35 rules require assessment of employment status for tax purposes. Under the proposal if status is deemed as employment, namely caught by IR35, the contractor company should be paid net of tax with the payer (usually the hirer or agency) facing an additional ‘employer’ NICs bill. Since IR35 does not apply to payments to umbrella companies, there can be no risk of IR35 tax applying. The use of this model therefore may well become more attractive, making it important to consider both alternative tax ramifications and contractual arrangements.
Tax and regulatory compliance of umbrella companies is critical and should be addressed before any contract is entered into with the service provider. The contract itself should take into account the larger operation and different interests that exist, to ensure that all areas of risk are covered off. For example the umbrella company may offer different models of operation, particularly if it is part of a group. It may employ the worker but equally may hire the worker on a non employment contract. It may engage the worker though other companies, it may offer a Swedish derogation model and so on. Remember that an umbrella company is a commercial organisation that benefits the overall shareholders interests not necessarily just the worker’s interests. Contrast this with a PSC set up simply to benefit the worker in terms of the specific contracted work. There are different risks attaching to each.
To help identify compliant service providers and umbrella companies Lawspeed has launched a new accreditation service, SPA. Our experience in this sector is considerable and we welcome any enquiries concerning contracting models, contracts, IR35 and the new SPA service.
In summary, the proposed extension of the public sector IR35 rules may well result in many contractors switching from PSCs to umbrella service providers. Understanding the different commercial and tax issues is a precursor to setting up the right contracts, and having correctly tailored contracts in place is always a commercial necessity.
Author Theresa Mimnagh, associate director at Lawspeed