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Over the last decade full-time employment has been declining in favour of freelancers and contractors. Around 15% of the UK workforce is self-employed and this is an even higher percentage in the construction industry which is estimated to be in the order of 30 to 40%.
Compared to European contractors the UK construction sector has a much higher reliance on a self-employed workforce. The trend is showing some signs of reversal with large contractors like Laing O’Rourke committing to a permanent workforce and mega projects like Hinkley Point C having union agreements that demand permanent resourcing strategies for the supply chain partners.
A common approach for freelancers is to set up a limited company which is categorised as a personal service company (PSC) by the tax authorities. PSCs are generally ‘one man band’ operations who own most or all of the shares as a director of the limited company. There are estimated to be more than 250,000 PSC’s in the UK and this type of arrangement is common in the construction sector.
PSCs can be a tax-efficient way for individuals to work, because they are able to invoice the client for the services performed and take some or all of their earnings from the PSC as dividends subject to a lower rate of corporation tax rather than salary which would be subject to higher levels of income tax. This also means they do not pay employer or employee national insurance contributions (NICs) on a large part of their overall income. PSC’s can also save tax by splitting ownership of the company with family members or employing them in order to place income in lower tax bands.
Employers benefit from not having an employee or worker on their books providing them with increased flexibility in their workforce planning along with reduced liabilities associated with workers’ rights.
IR35, named after the HMRC press release in which the rules were announced, was introduced in the 1999 budget as anti-avoidance tax legislation designed to tax "disguised employment". Before IR35 was introduced, individuals who owned their own companies were allowed to receive payments from clients direct to the company and to use the company revenue as would any small company. The IR35 legislation imposed a series of tests to verify whether the relationship should actually be classified as being self-employed or if it is in affect an employee relationship.
The original legislation required the Ltd Company contractor to assess whether they are inside or outside of IR35, and unsurprisingly as it is in their interest to seek the tax benefits, many PSC’s have deemed themselves to be outside of IR35. Possibly because of the complexity of the rules, the fact that the HMRC has to start an investigation in order to challenge a PSC’s IR35 assertion and the sheer number of PSCs, the HMRC has exhibited a light touch approach to implementing the rules.
Under the previous IR35 rules the tax risk relating to the arrangement has been with the PSC, however, new rules came into force in April 2017 which now put the liability with Public sector employers to determine IR35 status. Where the end client is not defined as a public authority then the rules continue to operate as before.
To decide if IR35 applies to a contract it’s important to establish what the underlying employment status is between the worker and the employer for each contract or engagement. Employment status is expressed as one of three types, namely employees, workers and self-employed, which define both how taxation is applied and an individual’s rights in employment law. An individual's employment status can ultimately be determined only by a court or tribunal on the basis of what really happens in the work relationship rather than what a contract states or the parties claim they are doing. Recent cases reiterate the need to make these assessments on a case by case basis.
The new regulations will force public sector employers, rather than the PSC’s, to define working relationships as being inside or outside the IR35 rules at the outset of an engagement. Having made the determination, if the assignment is inside of IR35, the hirer must communicate this to the intermediary who will be responsible for making PAYE and NIC deductions at source.
HMRC has published an online tool to help determine the status of the PSC. The assessment involves answering questions about the limited company contractor and the assignment. Typical indicators of being inside of IR35 are that the Ltd Company contractor either works under direction, supervision or control, is required to perform the work personally, or does not take any commercial risk when performing the assignment.
Some intermediaries structure their contractual arrangements by including a substitution clause in the relevant contract, in theory removing the obligation to provide personal service. However, where the right to substitution is conditional on the substitute being approved by the employer, and the right is never in practice exercised, tribunals may conclude that there is not a right of substitution and that personal service exists.
If a client or other third party produces what HMRC calls a “fraudulent document” to confirm that no control exists, the legislation allows the PAYE and National Insurance liability to be passed to whoever produced the document. If that third party is a company, the PAYE and National Insurance liability can also, in some circumstances, become a personal liability of the directors.
Businesses should assess their self-employed workforce and evaluate the risks they face if a court or tribunal finds them to be workers or employees. While some employers may make assessments on a case-by-case basis, the cautious approach in the public sector may see them taking a blanket approach bringing everyone under IR35.
Employers will need to consider the impact on the cost of their workforce including the employers NICs, the Apprenticeship Levy and any employment rights to holiday and pensions that would need to be included in negotiating a revised rate with their Ltd company contractors. To retain contract workers employers may also need to increase the agreed charge rates to offset the effect of the new legislation which could impact up to a third of a contractors take-home pay. As hirers assess the additional costs of contracting Ltd companies under the IR35 rules they may choose not to engage people who operate through PSC’s.
Recruitment firms will need to assess their risks associated with the classification of workers being inside or outside of IR35. Agencies where they act as the intermediary will be responsible for deducting income tax and NIC’s and need to ensure that the additional costs and workers rights are included in payments. They will continue to be responsible for reporting any self-employed workers that are not taxed as employees to HMRC in accordance with the employment intermediaries reporting requirements. The Ltd Company contractors will need to ensure that they do not double-tax themselves when drawing monies from their limited company.
Similar changes are likely to be imposed in the private sector, which will create a period of uncertainty. Many public sector organisations will not have the budget to increase rates or recruit permanently, while many contractors will need to review the benefits of continuing to work in a self-employed capacity leaving some doubt as to the final impact the new legislation will bring.
A2O People are a specialist Training, HR Consultancy and Recruitment Agency in the Nuclear and Construction sectors.
If you would like to learn more about job opportunities in the nuclear sector or on the Hinkley Point C project you can contact one of our team on 01278 732073 or submit your CV.
A2O People are a member of the Hinkley Point C Professional Services Group. You can find out more about the project and the nuclear sector in our Guide for Job Seekers in the Nuclear Sector.