Taken at face value, recent guidance published by HMRC on the responsibilities of clients, agencies and intermediaries under the Off-Payroll rules seems to unnecessarily create more confusion for all parties involved.
Often contrary to the practical realities of contracting, and occasionally at odds with the Off-Payroll legislation itself, the published material shows that HMRC has failed to learn from previous warnings about its misleading interpretation of the new rules.
Armed with the Off-Payroll legislation (Chapter 10, Part 2 of ITEPA), ContractorCalculator has reviewed HMRC’s guidance in detail, correcting the most contentious comments, whilst helping all parties make sense of the taxman’s dubious and sometimes contradictory advice.
HMRC client guidance lacks fundamental grasp of IR35
From the offset, the taxman’s Off-Payroll guidance for clients displays a worrying misunderstanding of IR35 fundamentals. Instructions on the client’s responsibilities under the Off-Payroll rules are littered with vague and misleading terminology, which could quite easily result in unwitting non-compliance from clients.
HMRC says: This Off-Payroll guidance is for clients “receiving services from a worker through their intermediary”.
ContractorCalculator says: If the worker is providing “services”, they aren’t a ‘deemed employee’, and hence Off-Payroll and IR35 don’t apply. The rules only apply to arrangements where the worker is engaged in a contract of service. This may seem pernickety, but the ultimate test for IR35 is whether someone is providing services or not.
HMRC says: “You’ll need to decide the employment status of a worker – you must do this for every contract you agree with an agency or worker.”
ContractorCalculator says: Clients are required to assess the employment status of contractors. They cannot simply decide a contractor’s deemed status. Only the courts and HMRC have those powers. For everyone else, it is just an opinion.
HMRC says: “Make sure you keep detailed records of your employment status determinations.”
ContractorCalculator says: This is interesting terminology. When posed with the prospect of aligning status definitions for tax and employment rights, HMRC has been keen to stress that the Off-Payroll rules are only concerned with an individual’s tax status.
HMRC says: “If you’re also the fee-payer and the Off-Payroll working rules apply, you will need to deduct and pay tax and NICs to HMRC.”
ContractorCalculator says: This is misleading phrasing from HMRC. Employment taxes, including employer’s NICs, cannot be deducted from the contractor’s rate, which this guidance fails to clarify.
Taxman’s naïve assumptions threaten private sector chaos
Instructions for clients concerning ‘reasonable care’ and conflicts over tax status expose the taxman’s naivety over the reality of contracting and the commercial impact of the Off-Payroll rules. If clients are to do as HMRC says, and nothing more, chaos will ensue in the private sector.
HMRC says: “You must take reasonable care when you make a determination about the employment status of a worker… Failure to do so will result in the worker’s tax and NICs liability becoming your responsibility.”
ContractorCalculator says: It will be difficult for clients to understand how to ensure ‘reasonable care’ has been taken, given that HMRC has failed to define it in the context of Off-Payroll. Similarly, determining tax and NICs liability isn’t so straightforward where an agency is concerned. Where HMRC challenges an assessment, the agency is likely to contest that the client failed to take reasonable care. Until a clear definition of ‘reasonable care’ is provided to inform parties of their responsibilities and liability risk, this will remain a prominent issue.
HMRC says: “From 6 April 2020, you must tell the worker, agency, or other organisation you contract with of your determination.”
ContractorCalculator says: Parties need to prepare well in advance of April 2020, to identify and potentially renegotiate at-risk engagements. Simply informing contractors that they are a ‘deemed employee’ on 6 April will be too late, especially for agencies who, as ‘fee-payers’ will all of a sudden be liable for a tax bill equating to 14.3% of the contractor’s rate. If agencies aren’t given time to negotiate with clients how to account for these costs, many will go bankrupt.
HMRC says: “You must provide reasons for your determination.”
ContractorCalculator says: Realistically, reasons should be explained with reference to employment case law. However, as it stands, a client could feasibly state “because CEST said so” as its reason for issuing a deemed status. This will inevitably give rise to contract disputes.
HMRC says: Should a worker contest their deemed employment status, “you’ll need to: Consider the reasons for disagreeing; Decide whether to maintain the determination and give reasons why, or withdraw the determination; Keep a record of your determinations and the reasons for them.”
ContractorCalculator says: This is an onerous prospect for clients which will rarely play out in practice, especially given the fact that engagements won’t have begun at this stage, and the risk that contractors will walk. Instead, clients are more likely to advertise contracts as ‘inside IR35’ or ‘PAYE only’, diminishing their access to the key skills provided by thousands of legitimately outside IR35 limited company contractors in the process.
HMRC says: “You must provide a response within 45 days of receiving the disagreement. During this time you should continue to apply the rules in line with your original determination.”
ContractorCalculator says: No contractor will agree to begin work on a contract of which the tax status is still under dispute. Similarly, none will be happy to wait for a month-and-a-half for a response. They will simply find another contract. This guidance demonstrates a complete lack of understanding of the commercial impact of these reforms.
Intermediaries guidance conflates Off-Payroll with IR35
The taxman’s apparent inability to distinguish between two different items of legislation - IR35 (Chapter 8, Part 2 of ITEPA) and Off-Payroll (Chapter 10, Part 2 of ITEPA) - is none more evident than in its guidance for intermediaries.
HMRC says: This guidance is for intermediaries whose “worker provides services to a client”.
ContractorCalculator says: If the worker is providing “services”, they aren’t a ‘deemed employee’, meaning Off-Payroll and IR35 don’t apply. This demonstrates a concerning grasp of the fundamental principles of deemed employment.
HMRC says: “From 6 April 2020, all public sector clients and medium or large-sized private sector clients will be responsible for deciding your worker’s employment status.”
ContractorCalculator says: Clients become responsible for assessing the tax status of contractors. If employment status were being determined, ‘deemed employees’ would rightfully receive the employment rights that their status warrants.
HMRC says: “If the Off-Payroll working rules apply, your worker’s fees will be subject to tax and NICs.”
ContractorCalculator says: Unlike under the original IR35 legislation, employer’s NICs is not to be borne out of the worker’s fees. HMRC has once again failed to clarify this. This, along with the taxman’s continued conflation of IR35 and the Off-Payroll legislation, risks mass unlawful deductions from contracting income and subsequent civil claims.
Guidance on status determinations leaves questions unanswered
Aside from continually conflating IR35 with Off-Payroll, the taxman’s guidance for intermediaries also raises a number of questions about how the Off-Payroll rules will work in practice.
HMRC says: “If you do not receive a status determination from the client you, as the intermediary, should determine whether the Off-Payroll working rules apply.”
ContractorCalculator says: If the intermediary hears nothing from the client, are they expected to work out for themselves whether the small company’s exemption applies? Or, are they expected to simply assume that the original IR35 rules apply, and act accordingly? The intermediary has no means of determining the former, and so if a client fails to provide an SDS to the contractor, the intermediary could end up inappropriately determining their own status under the original IR35 legislation.
HMRC says: “If you make the status determination then you are responsible for deducting tax and NICs from your worker’s fees and paying it to HMRC… As the intermediary, you are responsible for deducting employer NICs from fees for your worker’s services.”
ContractorCalculator says: You are only liable for NICs if you make the status determination and are deemed caught by IR35. In this scenario, the original IR35 legislation applies instead of the Off-Payroll rules, which HMRC has failed to acknowledge. Intermediaries can’t simply deduct employer’s NICs from contract fees. They are required to calculate the ‘deemed payment’.
HMRC says: “If the client makes the status determination, and the Off-Payroll working rules apply, then the fee-payer is responsible for deducting tax and NICs and paying it to HMRC.”
ContractorCalculator says: Immediately after describing an intermediary’s responsibilities under the original IR35 legislation, HMRC reverts back to Off-Payroll - the new legislation - without acknowledging this nor the fact that this arrangement involves an entirely different tax calculation. This whole section is incredibly confusing and will inevitably lead to unlawful tax deductions.
HMRC says: Where the Off-Payroll rules apply, tax and NICs deductions will be made at source. When the intermediary pays the contractor, they can pay them as either a non-taxed salary through a payroll or via tax-free dividends.
ContractorCalculator says: This is incredibly impractical. If the entirety of a limited company’s income is being taxed at source, how are they supposed to account for expenses? Does HMRC expect affected limited companies to pay ongoing costs, such as bills and accountants fees, out of post-taxed money?
Agency guidance threatens to incite rife non-compliance
HMRC’s guidance for fee-payers – usually agencies – contains misleading terminology, scapegoating contractors while failing to clearly convey the fee-payer’s employment tax liability. In some cases it even appears to encourage agencies into unlawful behaviour by deducting their employment costs from the contract rate, which is in breach of the Social Security Contributions and Benefits Act, Schedule 1, Section 3(2)(a).
HMRC says: “The Off-Payroll working rules make sure that workers providing services through an intermediary pay broadly the same tax and NICs as an employee.”
ContractorCalculator says: This is a classic example of HMRC scapegoating the contractor. As shown in the taxman’s own sample calculations, the bulk of the perceived tax lost from an off-payroll engagement – secondary class 1 NICs – is avoided by the hirer.
HMRC says: “The client will need to pass the worker’s employment status determination to the agency or other organisation they contract with.”
ContractorCalculator says: HMRC is placing firms at risk with all this misleading talk of “employment status”. If firms begin issuing ‘employment status determinations’, the workers in question could have the basis of a strong claim for rights at the employment tribunal.
HMRC says: “If the rules apply, the fee-payer is then responsible for deducting the tax and NICs and paying these to HMRC.”
ContractorCalculator says: There is no mention here of the requirement for the fee-payer to pay employment taxes on top of the sums paid to the contractor. Surely HMRC isn’t implying that these costs also be deducted from the contract rate, contrary to existing legislation?
HMRC says: “When you receive the worker’s employment status determination and the Off-Payroll working rules apply, you must calculate the deemed direct payment to account for employment taxes and NICs associated with the contract.”
ContractorCalculator says: You can’t deduct the employment taxes from the direct deemed payment. This is the contract rate that the contractor has agreed to do the work for. HMRC has once again conflated the Off-Payroll and IR35 legislation by encouraging fee-payers to carry out a tax calculation akin to that applied to contracts under IR35. By following guidance, fee-payers will find themselves in breach of the SSCBA.
HMRC says: “You need to deduct tax and employee NICs as appropriate from the deemed direct payment. You also need to pay employer NICs.”
ContractorCalculator says: This contradicts what was said previously. If not entirely clear, it is at least correct – the fee-payer must pay employer’s NICs on top of the contract rate.