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Changes to IR35

Changes to IR35

The off-payroll working rules for individuals who provide personal services via an intermediary will change for large and medium-sized businesses in the private sector.

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Director - Employment Taxes

KPMG in the UK


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The off-payroll working rules for individuals who provide personal services via an intermediary will change for large and medium-sized businesses in the private sector from 6 April 2020.

In a significant shift, these reforms will place the Employment Tax compliance burden on the agencies and companies which engage contractors who use Personal Service Companies (‘PSCs’), and are expected by many to increase operating costs and compliance risks, which in turn could have implications from an M&A perspective as well.


The off-payroll working rules, commonly referred to as IR35 after HMRC’s press release that announced their introduction, have a straightforward aim. The rules are intended to prevent individuals from reducing income tax and National Insurance Contribution (‘NIC’) liabilities, through what HMRC considers to be “disguised employment”, where an individual provides their services via a PSC, receiving payment in the form of dividends.

However, in certain circumstances determining whether or not the IR35 rules apply can be challenging.

This article summarises how the IR35 regime currently operates, and the challenges surrounding those rules.  It then discusses the reforms which will take effect in the private sector from April 2020, and the business issues that arise.

To put this in context, we begin with a brief survey of recent developments.

A brief history of IR35

The off-payroll working rules were introduced in April 2000. Under this regime, where IR35 applies, the fees received by the worker’s PSC from the contracting company, are deemed to be employment income. On that basis, the PSC is responsible for operating PAYE/NIC on those fees.

Over the years, a significant practical challenge for HMRC in enforcing the legislation has been the requirement to police the thousands of PSCs responsible for applying the regime.

The Government’s concern that this resulted in widespread non-compliance, and an apparent growth in the use of PSCs, led to HMRC launching a consultation in July 2015 on how to make the regime more effective1.

This was followed by a detailed consultation on public sector reforms in 20162. In summary, this resulted in agencies and bodies which engage contractors in the public sector – rather than the PSCs – becoming responsible for applying IR35 from April 2017.

However, the Government remained concerned that the regime was not working effectively in the private sector, with an estimate that only 10% of PSCs that should be applying the IR35 rules were actually doing so.  HM Treasury also estimated that without further action, the annual cost to the Exchequer would reach £1.3 billion by 2023/243.

Following a further consultation, at the 2018 Budget it was announced that, in essence, the 2017 public sector reforms would be extended to the private sector from April 20204.

The new regime from 6 April 2020

From 6 April 2020, responsibility for determining whether an engagement falls within the IR35 regime will move from the worker’s PSC to large or medium-sized businesses in the private sector. This includes cases where the PSC is engaged via an agency.

Where an employment relationship is deemed to exist for IR35 purposes, the entity paying the PSC will be responsible for operating PAYE and NIC on payments made. This may be the business using the services of the contractor, or otherwise, where the end user instead contracts via an agency, then the agency will be responsible for operating PAYE and NIC based on the end user’s determination as to whether IR35 applies.

Where contractors are engaged by a ‘small’ business, responsibility for IR35 compliance will remain with the PSC. The definitions of “small”, “medium” and “large” businesses for the purpose of these measures has yet to be determined, however the Government has indicated that it intends to use similar criteria to those found in Companies Act 2006. This suggests that a ‘small’ business would be one that satisfies at least two of the following conditions in the relevant year5:

  • Turnover of not more than £10.2 million;
  • Aggregate assets on the balance sheet of not more than £5.1 million; and
  • Not more than 50 employees.

Draft legislation will be published in Summer 2019, following a second consultation to be held in Spring 2019, and so only then will the finer details of the new rules (e.g. the penalty regime) become clear.

Applying IR35 in practice

Notwithstanding the above, the employment status tests which should be used to determine whether or not IR35 applies are not anticipated to change between now and April 2020, and so the basic application of the rules is at least understood. Using current legislation as our guide, IR35 should be applied where:

  • There is an agreement between the end user and the PSC for the worker to provide personal services6;  and
  • Had that agreement been between the worker and the end user, the worker would have been treated as an employee of the client for income tax purposes7 (the NIC rules are broadly similar).

When applying this ‘deemed employment’ test, it is necessary to consider the relevant features of the arrangements between the worker and the end user and determine whether, in substance, the relationship is that of employer and employee, but for the existence of the PSC in between.

These factors include:

  • Mutuality of obligation (is the end user obliged to offer work and, if so, is the worker obliged to do it?);
  • Whether the worker has a right of substitution or is obliged to perform the services themselves;
  • The level of supervision, direction or control the end user is able to exercise over the worker when carrying out their duties; and
  • The level of integration into the end user’s business (i.e. whether the worker is in effect treated as though they were an employee).

The case law from which these tests derive is complex, and the Courts have consistently held that these factors should be considered in the round, rather than being applied as a ‘box ticking’ exercise.

The qualitative and subjective nature of these tests presents difficulties for both taxpayers and HMRC.

Indeed, in the recent Christa Ackroyd Media Ltd case8 the Tribunal Judge stated that reaching a conclusion on these tests ‘is a value judgment… it is in the nature of a value judgement that different people may come to different conclusions’9

Where the compliance risks currently lie

Whilst the compliance risk currently lies with the PSC, from April 2020 it will be the responsibility of the paying entity to operate PAYE/NIC in line with the end user’s status assessment.

Whilst the detail of the new legislation will not be available until Summer 2019, it is expected that if HMRC were to successfully challenge a failure to withhold, it would be the paying entity, and not the PSC, that HMRC would pursue for late payment of the relevant PAYE, NIC, interest and, potentially, penalties. 

What this means for affected businesses

Clearly, all businesses that engage contractors and which will fall within the scope of the new rules will need to take steps to ensure they comply.

Whilst the details of the new regime are not yet known, at this stage affected businesses can still take practical steps to prepare. These include:

  • Engaging with key stakeholders in the business – for example, this may include HR; Tax; Procurement; Finance; the Senior Accounting Officer; and Departmental Heads;
  • Identifying potentially affected contractors from across all parts of the business;
  • Estimating any likely cost increases due to employer’s NIC and Apprenticeship Levy charges arising under IR35, and potential increases in contractors’ rates; and
  • Developing and implementing new systems and processes to ensure compliance.

There are only 15 months until the legislation takes effect, and so early action is recommended to avoid a cliff-edge scenario in April 2020.

What this means for M&A

The prospective changes also give rise to particular commercial considerations and tax risks in the context of M&A transactions.

Commercially, businesses that are planning an exit in the next few years should assess how the new regime might affect their labour supply chain. What impact might an increased liability for employer’s NIC, and contractors potentially adjusting their day rates in response to the new regime, have on profitability and free cash flow?

The same considerations will arise for large and medium-sized businesses that acquire a ‘small’ company which is particularly reliant on contractors. What impact will being brought within the new IR35 regime have on the target’s business when it is acquired by the larger group, and how might this affect what the purchaser would be prepared to pay? 

The due diligence risk is clear. Under the new regime, large and medium sized businesses that engage PSCs will be exposed to a new PAYE and NIC compliance risk where they fail to withhold correctly, or where they have not taken reasonable care when assessing whether the rules apply to engagements through an agency (i.e. where an agency fails to operate PAYE and NIC based on an ‘unreasonable’ assessment by the client, the client and not the agency is at risk).

This risk might be particularly acute for ‘small’ businesses, which will need to monitor when they cease to be ‘small’ and fall within the scope of the new regime.

What happens now?

HMRC is expected to consult on the new regime in early 2019, with a view to publishing draft legislation in the summer.

Businesses that engage with contractors, or which might acquire such businesses, should monitor these developments in order to assess the labour supply chain risks, operational costs, and tax compliance risks that might arise.


HMRC, Intermediaries legislation (IR35): discussion document (17 July 2015).

HMRC, Off-payroll working in the public sector: reform of the intermediaries legislation (26 May 2016).

HMRC & HMT, Off-payroll working in the private sector: summary of responses document (29 October 2018), paragraph 1.2.

HMT, Budget 2018 (HC 1629, October 2018), paragraph 3.8.

CA 2006, section 382.

ITEPA 2003, section 49(1)(b).

ITEPA 2003, section 49(1)(c)(i).

[2018] UKFTT 69 (TC).

[2018] UKFTT 69 (TC) [180].

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