UK: Tax Changes Will Take Effect April 2020

 

By Lisa Rix October 17, 2019
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UK: Tax Changes Will Take Effect April 2020

​The United Kingdom's new IR35 tax rules take effect on April 6, 2020, and will shift the burden of tax withholding and payment compliance from independent contractors' personal service companies (PSCs) to the ultimate company needing the services ("end users").

From April, businesses using independent contractors hired through PSCs will need to comply with significant new tax obligations. Noncompliance may result in large back payments of tax and national insurance contributions (NICs) plus any applicable interest and penalties. Many companies have yet to take appropriate action to address the new rules despite the approaching deadline. This article explains the new rules and offers suggestions for what action companies subject to them can take. 

What Are the Current IR35 Rules?

The IR35 tax rules intend to address a form of tax avoidance when an independent contractor contracts through a PSC to provide services to an end user.

IR35 currently applies when, in the above circumstances, the relationship between the end user and the individual providing the services would be one of employment if the PSC was removed from the picture. The courts look at what happens in practice, not just what the contracts say.

If IR35 applies, the PSC is required to:

  • Deduct income tax and NICs from payments it receives from the end user; and
  • Pay employer NICs.

Currently, most PSCs take the view that the IR35 rules do not apply to them and instead take advantage of more-favorable tax arrangements. End users currently have no obligation to determine whether IR35 applies.

How Is IR35 Changing?

As of April 6, 2020, the responsibilities of the PSC under IR35 will shift to end users. End users will be required to make an IR35 status determination on all PSC contractors and to make the payments and deductions set out above which the PSC is currently responsible for. The PSC can ask for the reasons for that status determination, and the company will need to respond in writing within 30 days.

Whether an end user will be exposed to a significant tax risk and compliance burden depends on how likely the individuals providing services to them would be deemed to be in an employment relationship with them. Due to the nature of these arrangements, we anticipate that many independent contractors would be deemed to be employees for tax purposes and subject to IR35. This would be both expensive and unpopular for individuals who are currently carrying out the IR35 determination themselves.

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How to Deal with IR35

There are several options available for end users who believe that their independent contractors are likely to be "deemed employees" under IR35, including:

  • Accept that IR35 applies and make the required payments and deductions. This would mean that end users could continue to engage individuals as they do now, working in the same way, while avoiding the risk of Her Majesty's Revenue and Customs (HMRC) claiming back-dated tax and NICs payments in the future. However, this is likely to be unpopular with independent contractors because it is less favorable than the tax treatment they're used to, and there may be a certain amount of friction with individuals challenging the determinations made. End users will also either have to bear the additional cost of paying employer NICs or seek to recover these costs from independent contractors.
  • Change practical arrangements. Under this approach, an end user would not deduct taxes or NICs, could avoid paying employer NICs, and could retain a flexible contractor workforce. Additionally, individual contractors would prefer to retain their favorable tax treatment and would, therefore, be less resistant to any changes. However, for many organizations, it may be tricky to change existing work arrangements with independent contractors in a way that is both commercially feasible and results in the nonapplication of IR35.
  • Convert independent contractors to employees. This approach would allow independent contractors to continue working in the same way they do now plus if IR35 would apply, employee status might be the best option from the individual's perspective. As employees, the individuals would become entitled to employee benefits and other rights such as sick pay and holiday pay and to any rights protecting them from unfair dismissal.
  • Use an exemption. There is a small-business exemption that applies for companies that meet certain criteria.
  • Appoint an umbrella company to employ the individuals directly. Under this arrangement, the end user would avoid IR35 rules altogether as such a company would deduct the tax and employee NICs from employees, and pay those and employer NICs to HMRC instead of the end user in return for a fee. By not employing independent contractors directly, there would remain a clear distinction between "permanent" employees and the individuals an end user has previously hired as contractors.
  • Accept the risk and continue without making any changes. If an end user has very few independent contractors, or they are very unlikely to be deemed "employees" under IR35, then the risk might be an acceptable burden to bear.

Summary

Our expectation is that most institutions are likely to take a more risk-averse approach than the PSCs have historically done. We expect that many end users, especially those in the financial services sector, will bring contractors in-house to avoid exposure to the IR35 tax risk. Only time will tell what market practices will emerge in this area.

Lisa Rix is an attorney with GQ|Littler in London.

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