IR 35 – a detailed guide for actuarial managers

This article aims to give a comprehensive view of the complex IR35 changes coming into effect in April; it is intentionally long, so for a shorter summary of what we see as the key things actuarial managers need to think about please see here.

Introduction

Up until now, most of us who have had anything to do with the engagement or provision of short term / contract actuarial resource will have had some notion of IR35, but for many this has been an issue for contractors and not anything to expend too much energy worrying about.  All that is set to change as we approach April 2020, when the new legislation becomes effective.[1]

While many in the industry may quite reasonably regard this as an unwelcome development given the work required preparing to be compliant and the inevitable transitional disruption, in fact it is difficult to argue with the underlying purpose of the changes, that those who in effect have a relationship very like that of employment should be taxed in the same way as those who are actually employed.  And although as ever the devil is in the detail, on the whole the legislation feels fairly robust and should avoid too many unforeseen consequences (at least from the government’s perspective!).

Although we hope that this article is of interest generally, it is specifically aimed at managers who hire actuarial contract resource; in it we will try to explain the new requirements and their impact on the market in simple terms, to help to equip managers to prepare for the changes.  The article is necessarily lengthy – this is a complex topic, and there have been some potentially misleading comments in the market which we are keen to address.

Summary of the changes

The first point to note is that the IR35 rules (formally the Off-Payroll Working rules) themselves are not changing.  These rules, introduced in 2000, aim to ensure that anybody who works through an intermediary (in the vast majority of cases this means a Personal Services Company (“PSC”), otherwise known as a Limited Company contractor[2]), but who would be deemed to be an employee for tax purposes if they were not working through the intermediary, should pay similar taxes to other employees.  That’s a bit of a mouthful, but essentially it means that if you look like an employee you should pay tax like an employee, regardless of the mode of engagement.

While the rules themselves are not changing, what will change from April is the responsibility for assessing the tax status and the liability for deducting any payments due.  In summary:

• The responsibility for assessing the employment status for a contractor’s engagement will move from the PSC to the private sector organisation, or end “Hirer”[3], who engages them. This means that the Hirer will have to assess the employment status of all existing workers engaged through a PSC.
• If the assignment is assessed as being akin to employment (often referred to as being “caught by” or “inside” IR35), then the “Fee Payer” (the party contracting with the PSC) is responsible for making all relevant employer’s and employees’ National Insurance and income tax deductions from gross pay and paying these directly to HMRC.
• The Hirer will be liable for unpaid taxes / fines if they do not make a determination, or if they have not used reasonable care in determining the status.
• The Fee Payer will be liable for unpaid taxes / fines if they do not process the payment in line with the Hirer determination.
• The Hirer will be required to implement a “client-led disagreement process” whereby a contractor can request a review of their status if they believe it to be incorrect.

In most contexts the Hirer is the institution using the contract resource (the insurance company for most APR clients) and the Fee Payer is the agency supplying the resource (eg APR).

The government’s primary stated intention in making the changes is to improve fairness in the taxation system, by ensuring that those contracting through a PSC are not able to “sidestep” employment taxes or National Insurance Contributions; that said, current estimates are that removing non-compliance will generate an additional £1.2 billion a year in tax revenues by 2023.   The requirements are similar to changes that have already been implemented in the public sector, but with some minor modifications following a consultation period.

The changes take effect from 6 April 2020, but relate to any payments made to contractors from that date.  Given under most engagements contractors are paid monthly in arrears this means that in most cases ongoing arrangements will ideally need to be in place by the end of February at the latest.

What are the options for clients?

In some senses the engagement options for Hirers have not changed, but the outcomes at an individual contractor level are likely to be very different in most cases.  The options can broadly be broken down into two categories, PSC engagement or on-payroll engagement, depending on whether the contractor continues to operate via a PSC or moves onto a payroll arrangement.  For completeness, we describe both below, but in practice we think it is highly unlikely that PSC engagement will be used in most cases.

PSC engagement (for completeness, but unlikely to be used much in practice)

Hirers remain perfectly entitled to engage contractors via a PSC.  However, as a result of the changes Hirers will need to assess whether the arrangement is inside IR35 by making a Status Determination Statement (“SDS”).

• If the worker is deemed to be outside IR35[4] they can continue to be paid on a gross basis. However, note that the Hirer is obliged to review the position on an ongoing basis (although this is not defined).
• If the worker is deemed to be inside IR35 they can continue to be engaged via the PSC but must be paid on a net basis (ie with deductions for PAYE tax and Employee National Insurance Contributions; the Fee Payer will also be liable to pay Employer National Insurance). This is known as a “deemed payment”.

To help Hirers make the assessment the government has developed an online questionnaire-based tool, Check Employment Status for Tax (or “CEST”), available at https://www.gov.uk/guidance/check-employment-status-for-tax.  Hirers are not obliged to use this tool, and can make the SDS via another process.  However, the legislation states that the reasons must be clear and that reasonable care must be taken; Hirers should also ensure that the SDS is given to the worker directly and also to the next party in the contractual chain (for example the agency).  The contractor and others in the contractual chain have a right to challenge the determination if they disagree with the assessment.

While each engagement should be considered on its own merits, the emerging view (and one that we share), is that in most cases clients making the assessment will deem contractors in the actuarial space to be inside IR35, with perhaps a few exceptions at the more experienced, niche end.

There has been much talk in the market about changing contracts to a “Statement of Work”, ie more akin to a consulting arrangement.  This is fine, but care needs to be taken, as it is the actual working practices that are relevant, not the wording in the contract (which itself should just reflect the actual working relationship).  As an example, it’s easy to add a clause to a contract saying that substitution is permitted, but how many clients in reality would be happy to accept an alternative resource on a project without the due diligence that currently goes with engaging a contractor?

On-payroll engagement (likely to be the key approach used by Hirers)

While the government and HMRC probably didn’t have the actuarial contract market at the front of their thinking when coming up with this legislation, it’s clear that the essential premise is that large numbers of contractors who currently consider themselves outside IR35 should, in the government’s view, be treated as inside.  The natural conclusion of this is that such individuals should end up being on some sort of PAYE arrangement.  These fall into three basic categories:

• Engaging through an umbrella company. In most cases individuals engaged in this way will be permanent employees of the umbrella, and so enjoy full employee rights.  The client (either directly or via an agency) will typically pay an “all-in” rate (known as an assignment rate) to the umbrella, and the umbrella will pay a base salary at national minimum wage (or slightly above), with an additional bonus, or commission, payment of the sum remaining after the umbrella has deducted an amount to allow for employer NI, its margin and any other employment benefits.
• Taking on the contractor under a PAYE agency worker arrangement. In this scenario the individual will be added to the payroll of another intermediary (normally an agency).  They will have worker rights but not full employment rights.
• Engaging the contractor on a direct employment (or “Fixed Term Contract”) basis, either as a permanent or temporary employee. This would mean the individual is added to the Hirer’s own payroll and they would be treated as any other employee, enjoying the same benefits and being remunerated under the same pay scales.

In all three scenarios the individual will be paid net of PAYE tax and Employee National Insurance Contributions; they will also have rights under the Agency Worker Regulations, the “Conduct Regulations” and statutory rights.

From the Hirer’s perspective there is no great difference between engaging a contractor on a PAYE agency worker basis as opposed to via an umbrella company, other than another party in the contractual chain.  The main difference as far as the individual is concerned is that under an umbrella arrangement, contractors will (in most cases) be an employee of the umbrella company, which exists purely for the purpose of providing this employment and the services that go with it (chiefly payroll, but also potentially access to additional peripheral benefits); for this they will charge a fee (typically around £100 per month) to cover their costs and margin.  With the exception of some additional employment rights (which, not to trivialise them, are a relatively marginal benefit), there is no real difference between what an umbrella can offer over compared with an agency engaging contractors directly as agency workers and paying through its payroll.

There has been much talk of a potential advantage to contractors of engaging via an umbrella, in that they will receive tax relief on allowable business expenses.  While in the past this has been a key benefit of the umbrella model, a change in legislation in 2016 (s.339A Income Tax (Earnings and Pensions) Act 2003) for those that are interested) means that the vast majority of expenses are not tax deductible unless it can be demonstrated that no party exercises, or has the right to exercise, supervision, direction and control over the individual – we have serious doubts as to whether many clients would be prepared to engage contractors without such control, meaning that in practice there is no benefit here.

What is happening in the market?

We have been discussing the upcoming changes with clients, both at an HR and an operational level, for some months, and it’s fair to say that there is quite a wide range in terms of understanding of what’s coming and level of preparedness.  This is hardly surprising given the complexity of the legislation, not least as this is well outside the day-job remit of those directly affected.

But the following summarises the various views we’re seeing from our clients:

• There is a clear common theme that clients are keen to minimise their exposure to the risks associated with non-compliance with the tax regulations. Most are of the view that if assessments are made, the vast majority of contractors will be deemed to be inside IR35.
• Many clients have made the decision that it is more straightforward administratively, and lower risk, simply not to engage contractors via PSCs going forward, and that future engagements will need to be under some sort of payroll arrangement, either umbrella, PAYE or switching contractors to fixed term or permanent contracts.
• Some others are being less rigid and are planning to assess each engagement on its merits, using either CEST or a third party to make the assessment. In most cases it appears this is in the expectation that the arrangement will be deemed to be inside IR35 – if so, they will either insist on engaging under a PAYE arrangement or, in some cases, allow the option of deemed payment in the expectation that contractors will view it as administratively burdensome and costly, and opt to engage via PAYE.
• A small number of clients are exploring ways they can change arrangements with contractors so that they can demonstrate that the engagement is outside IR35, but this is generally only being considered for highly experienced contractors operating in a very niche manner. While there will no doubt be scenarios where this is appropriate, we expect that these will make up a very small minority; we would urge caution, and advise clients that they should make sure a) that the actual working relationship is genuinely one of a service as opposed to employment, rather than just wording in a contract, and b) that they are comfortable with what this means in practice in terms of the service they are receiving.

It’s worth noting that although firms are entitled to make policy decisions not to engage with PSCs, it is not permitted to make blanket SDSs – ie if a firm decides to make an assessment it needs to be done on an individual basis.  The fact that the assessment needs to be made on an ongoing basis, and is open to challenge both from contactors and from others in the contractual chain, is leading many clients to take the view that it is too much hassle to go down this route.  So while there are slightly mixed messages coming from different organisations, the general trend in the market appears to be moving towards one of the PAYE options.

There seems to be much confusion over the distinction between the umbrella company and agency worker PAYE options, with many clients not realizing that the PAYE agency worker approach is a genuine option.  This may be in large part because it is relatively uncommon for agencies to offer this as an engagement basis, but the reality is that there isn’t much difference from the Hirer’s perspective.  Because of our model of using our permanent employed staff as a resource for client projects, APR is already set up for engaging via our own payroll, and in fact we have placed agency workers on a PAYE basis (albeit not in great numbers) for many years.  Our conversations with contractors suggest that many see this as preferable to the umbrella route, as it is more flexible and removes the need for the monthly umbrella payment, for little or no difference in their take-home rate (unless the umbrella company is engaged in non-compliant practices).  We are therefore recommending to clients that they ensure a PAYE agency worker arrangement is allowable under their supplier contracts and made clear as an option to contractors.

A natural consequence of the fact that the changes will lead to an increase in tax revenue for HMRC is that there will clearly be a financial impact on Hirers or contractors (or both).  Most clients have taken the stance that there should be no increase in rates to offset the higher tax burden for contractors, but it isn’t always clear what this means in practice.  For example, is the intention that the rate the client pays to the agency won’t change, and that therefore all employment costs (including Employers’ NI contributions) will come out of the rate before it reaches the contractor?  Or will the client set the rate such that the gross pay to the contractor (ie after Employers’ NI etc but before Employee’s NI and PAYE tax) should be the same as under the PSC arrangement.  Clearly this has a huge impact on the contractors themselves – the extent of this will vary from engagement to engagement, but in many cases will represent a significant reduction in take-home pay; it could also cause pressures on client budgets.

We get the sense that while many clients are starting to adopt set positions on how they will deal with contractors, as the date of the change approaches, and probably beyond, there may well be some loosening of policy or flexibility around the rules, as clients seek to avoid the risk of losing key expertise on critical projects.  Whether this simply leads to an acceptance that rates may need to increase, or that clients may be willing to undertake the SDS assessment in limited cases remains to be seen.  Where the latter is true, there is of course still a high chance that the outcome will be that the contractor is inside IR35.

A contractor’s view-point

As you’d expect, there is a range of opinion among the contractor community (although the one constant is that the changes aren’t welcome!).

Some take the view that they’ve had it good under the current regime and that it’s now time to take the rough after a long period of smooth; others are adamant that they are clearly outside IR35 and that contracts and working practices will just need to be tinkered with to ensure that’s reflected.  As you’d expect, the majority sit somewhere between these two extremes – not being hugely happy about the changes but accepting that they will need to adapt and comply.

There is also a fairly wide spectrum in terms of the level of understanding of the changes.  Although most have been aware that change is coming, many Limited Company contractors, until recently at least, haven’t had a detailed grasp of the specifics of IR35; others have been following with interest and have already taken advice from professionals (usually tax accountants) on the implications for them.

Naturally the greatest concerns are around level of take-home pay.  As mentioned above, those who were paying themselves very little by way of salary could see their net pay decrease significantly, particularly where their client adopts an entirely cost-neutral approach.

This effect is further exacerbated by those who incur significant travel and subsistence expenses, as in almost all cases these costs will need to come out of net pay under any PAYE arrangement (or deemed payment), whereas currently they are deductible as business expenses.  (This may make it more difficult for some clients to attract contractors without paying a premium on rates.)

Unsurprisingly many feel that they shouldn’t bear the full brunt of the change, and that rates should increase to offset at least some of the additional tax burden they will face.  Equally unsurprisingly most clients are reluctant to commit to this, and we have seen many clients communicate to contractors that rates won’t be changing – however, as noted above, it often isn’t clear what this means in practice.  We have also seen examples of where clients are prepared to make exceptions on a case by case basis to mitigate the risk of losing key expertise, and we expect to see more of this as April approaches.

In terms of existing engagements, it’s less clear that this will extend to widespread rate inflation, but it’s also difficult to imagine that there won’t be a general upward movement in costs over the mid-to-longer term, as contractors try to recoup some of the cost of tax and NI in negotiating rates on future contracts.

Aside from purely financial considerations, a number of contractors are concerned about changes in arrangements now prejudicing them in any future HMRC investigation.  While HMRC have said that the change won’t automatically trigger an investigation, there is some logic to the idea that if a contractor considers an arrangement outside IR35 and the Hirer then assesses exactly the same arrangement as being inside, it may be difficult for HMRC to resist taking a look.  For this reason many see a move to a PAYE arrangement without going through the assessment process as a lesser evil (particularly if the outcome of an assessment is likely to be that they are deemed inside IR35).  Others take a more extreme view that they would prefer a clean break altogether, and are intending either not to extend their current contracts past April or will exercise notice at the last possible moment.  This could post a significant risk to some projects and we strongly advise clients to discuss intentions with any contractors they see as critical to their business.

Those that still feel strongly that their arrangements should be considered outside IR35 put a lot of faith in the idea of substitution, which generally features in their contracts with agencies (although is unlikely to be reciprocated in the agency’s contract with the Hirer).  We are sceptical that in practice many clients would countenance allowing a contractor to provide a substitute, so this feels like a weak argument unless the fundamental nature of the contracting market were to change, something which noises coming from clients suggest is unlikely, at least in the short term.  However, it does mean that there is a small but non-trivial group of contractors whose current position is that they won’t work for clients who refuse to treat them as being outside IR35.

Where it’s clear that the ongoing basis of engagement will need to be under some sort of PAYE arrangement, messaging from clients seems to be very much that umbrella is the route to take.  However, most of the contractors we’ve spoken to are unimpressed by the idea of incurring an additional fee to engage via an umbrella and see it as simpler just to go onto the agency’s payroll where this is an option.

Finally, while the Fixed Term Contract / Permanent options might be attractive in theory to many clients, it’s fair to say that contractors are luke-warm to the idea, given this is likely to represent an even greater reduction to take-home pay, as most clients will be unable or unwilling to go outside existing pay structures.  (The FTC option also has the potential to cause problems where clients are going through any sort of redundancy programme.)  Of course many contractors also value the flexibility of their current arrangements and will be reluctant to lose this even despite the financial aspects.

To conclude

This is a highly complex area and one in which many in the industry have only a limited level of understanding (or at least did until the last few months).  We hope that the above has been useful in filling in any gaps in your knowledge.

The next few months will be challenging, and even as many clients are firming up their plans for how to meet these challenges, there will inevitably still be some difficult decisions to make for all involved, whether on a policy or individual level.

We leave you with a few final thoughts on how all this might affect the way you work with APR:

• Most importantly, to be absolutely clear, where clients are engaging APR staff on projects, none of these changes will have any impact. Our staff are permanent employees of APR, paid in full via PAYE, so IR35 is not relevant to these arrangements.
• Most (but not all) of the contractors who have so far expressed a view to us, prefer the PAYE agency worker route to engaging via an umbrella company, so we would strongly recommend clients include this as one of the options they will allow.
• Most clients are, rightly, focusing on discussing arrangements with the contractors involved, but please do remember to keep your agencies informed of your current thinking, not least so that we can make sure we communicate consistently to the contractor population. This includes being clear what your stance will be on PAYE rates.
• Similarly, remember that where you are conducting SDS assessments you need to ensure that the outcome is communicated to all those in the contractual chain, not just the contractor.

If you would like to discuss any of the points raised further please do get in touch with me or another APR partner.

Tim Nash

December 2019

[1] It’s worth noting that the final legislation has not yet been passed, and with the forthcoming general election there is of course a chance that it will be cancelled, or at least put back. The Liberal Democrats and the SNP have made manifesto commitments to reviewing the plans; although not in their manifesto both the Conservatives and Labour have also suggested they will review. That said, given the changes are predicted to generate significant additional tax revenues, it seems hard to envisage that an incoming government will choose not to move ahead with the changes. There is a chance that the new requirements will be set back until the following year, which may be welcome to some, but could just add a further period of disruption and uncertainty. Perhaps more likely is that the legislation will be passed, but rushed through without the level of scrutiny needed to remove some of the wrinkles that still exist – to some extent this was the case when the changes were introduced in the public sector in 2017.

[2] In this article we have used the term “contractor” fairly generally as an individual providing interim services to end-clients, regardless of the basis of engagement. Where the context requires we revert to the more formal terms (PSC / PAYE agency worker etc).

[3] The new requirements will only apply to Hirers that are large or medium-sized businesses; in practice this is likely to encompass all institutions that engage actuarial contractors, but for completeness a company is deemed small if it satisfies two of the following conditions:

• It has a turnover of not more than £10.2 million.
• It has a balance sheet total of not more than £5.1 million.
• It has no more than 50 employees.

See http://www.legislation.gov.uk/ukpga/2006/…small-companies-regime for more detail.

[4] The primary factors that might suggest the arrangement is outside IR35 are that the work relates to a genuine project which is specific, clearly scoped and not ongoing in nature; that there is no ability for the Hirer to change the project requirements other than within agreed parameters; that the contractor has significant freedom over how the work is carried out – this includes, but is not limited to, the ability to provide a substitute worker; that the work is undertaken under a genuine business to business commercial contract without mutuality of obligation.