Payments to personal service companies: operation of PAYE
If you either supply your services through a personal service company (“PSC”) or are an engager of a PSC, you need to be ready for important changes coming into effect from 6 April 2020. From that date, some engagers of PSCs will be obliged to operate PAYE on payments they make to them.
Most people are aware of the “IR35” rules: they’ve been around for nearly 20 years but have attracted a good deal of publicity recently from a couple of cases involving TV presenters – you can find more from us on those cases here. If nothing else, they show that it’s sometimes difficult to know whether the IR35 rules apply in any particular case.
IR35 was HMRC’s response to perceived avoidance of tax (and more especially of National Insurance Contributions) by workers providing their services via a limited company (a so-called personal service company) rather than being employed directly by the end user client. Essentially, IR35 asks the question:
“If the contract with the end-user had been made directly with the worker, would the worker have been treated as the end user’s employee?”
If the answer is yes, the PSC is, broadly, treated as if it had distributed all its income as remuneration to the worker and is required to operate PAYE accordingly.
HMRC originally wanted it to be the end user (not the PSC) that would be responsible for deciding if the assignment fell inside or outside the IR35 rules and for operating PAYE. But following representations from big users of PSCs (particularly banks and other financial institutions), the onus was placed on the PSC itself. HMRC have always seen that as a flaw and have never been happy with the way that IR35 operates.
In April 2017 HMRC got their way – at least in part – when the law was changed in regard to public sector contracts. From that date, if someone works for a “public authority” (including central and local government, the BBC and the NHS as well as scores of other bodies) via a PSC, it is up to that public authority (and not the PSC) to decide if IR35 applies or not.
If the conclusion is that it does, then if the public authority pays the PSC direct, it must operate PAYE. If the payment to the PSC is made by someone lower down the chain, such as an agency, the public authority must notify its conclusion to the payer and the payer must operate PAYE.
HMRC provide an online status checker tool: but even that doesn’t always give a clear answer. And anecdotal evidence suggests that where a public authority is in doubt it will tend to err on the side of caution and protect itself by operating (or mandating the operation of) PAYE.
One major criticism of the legislation is that there is no statutory machinery for the PSC to challenge the end-user’s decision. The consultation paper dealing with the extension to the private sector recognises this difficulty, but the solution proposed in the paper (essentially that each end user should set up its own dispute resolution framework) seems naïve and unsatisfactory, especially when one considers the relative negotiating strengths of the parties.
The 2020 change
From April 2020, the public sector rules will be extended to all end users. The only exception will be where the end user is a “small business”. Where that is the case, the existing IR35 treatment will apply – that is, it will remain the responsibility of the PSC to self-assess the application of the IR35 rules.
For companies, the definition of “small” will be taken from the Companies Act. That means that at least two of the following criteria will need to be met, namely
- Annual turnover no more than £10.2m
- Balance sheet total no more than £5.1m
- Not more than 50 employees
For businesses other than companies, the criteria are yet to be finalised but will be similar to the above.
When the “public sector” rules were introduced in 2017, they applied to all payments made on or after the implementation date of 6 April 2017, even if they related to services supplied before that date. It is to be assumed that the same will apply to the extension to the private sector from 6 April 2020; it will apply to all payments made on or after that date, with no “grandfathering” of existing contracts.
Whether it is the end user or the PSC that is assessing the position, the principles that have been determined by case law to be relevant remain the same. The question of whether a relationship amounts to employment is notoriously fact-dependent and multi-factorial, but in a recent case the main principles have been summarised as
- Mutuality of obligation to perform personally work offered and to pay remuneration is the “irreducible minimum … necessary to create a contract of service”
- Whether the worker is subject to “a sufficient degree” of control in terms of what is to be done, and where, when and how it is to be done as a contractual right
- The existence of a right to substitute, irrespective of whether or not that right was exercised in practice
- Whether the worker was in business on his own account, including consideration of factors such as:
- Whether the worker had to provide at his own expense the necessary equipment and hire his own helpers
- Whether the worker bears a financial risk
- Whether the worker has the opportunity to profit
- Whether the worker engaged himself to perform services in the course of an already established business of his own
- The duration of the contract, degree of continuity and whether the worker was “part and parcel” of the organisation
Of these, “control” is increasingly coming to be seen as key.
Preparation for the change
The full text of the consultation document is available here. In it, the government suggests that organisations affected by the reform may wish to take the following actions now to prepare for the reform:
- Identify and review their current engagements with intermediaries, including PSCs and agencies that supply labour to them
- Review current arrangements for the use of contingent labour, particularly within the organisation functions that are more likely to engage off-payroll workers
- Put in place comprehensive, joined-up processes (assess roles from a procurement, HR, tax and line management perspective) to get consistent decisions about the employment status of the people they engage
- Review internal systems, such as payroll software, process maps, HR and on-boarding policies to see if they need to make any changes
For PSCs, the implications are perhaps even starker. Unless the end user is “small”, the decision whether a particular contract is within IR35 will be taken out of the PSC’s hands. We envisage that some end users will make unwelcome decisions that may call into question the viability of operating through a PSC at all. PSCs may need to start questioning end users and making their plans now.
For more information, please get in touch with your usual BKL contact or use our enquiry form.
You may also like to read our recent article for Taxation magazine on IR35 and contracts of employment.