In April 2020 the Government’s IR35 payroll reforms will come into effect in the private sector, putting the responsibility firmly on larger employers for PAYE and NICs in respect of contractors engaged via an intermediary.
The legislative changes will not impact smaller employers or apply to workers that are genuinely self-employed. They will also not affect businesses which engage self-employed contractors through a direct agreement rather than an intermediary (as they are already required to manage the tax risk for those individuals).
This will, however, potentially place a significant tax liability on many oil and gas sector companies engaging contractors through intermediaries.
Initial conversations with larger employers have indicated that the total annual cost increase could run into millions of pounds if working arrangements with limited company contractors are maintained as they are.
With just a year to go until these changes are implemented, there are important steps that businesses need to take to ensure compliance with the new tax regime.
The first step is for companies to carry out an audit of their contracting arrangements. This should cover all contractors engaged through an intermediary. The Government’s CEST (‘Check for Employment Status Test’) can help businesses decide whether a contractor is genuinely self-employed and their tax status. However determining employment status with any certainty does remain legally complex and concerns about the CEST have been raised, including over the number of times it is unable to provide a clear outcome.
The audit enables a business to understand it current approach to contractors and whether, for example, it engages contractors under output-focused, short-term contracts, or tends to integrate them into the organisation to deliver on-going, and supervised, services. This should help determine if this approach is sustainable and whether payments to contractors need to be taxed as if employment income.
Businesses wanting to maintain the status quo with their existing arrangements must bear in mind that HMRC will be guided by the reality of the working relationship, and not simply the terms of the written contract. Both aspects are important but, where the audit identifies that changes are needed to ensure the contractors are truly seen as self-employed, any changes will need to be more than a “paper exercise”.
For example, including a right in the contract for the contractor to send another individual in their place will be ignored by HMRC if it is clear that the client would not accept such a substitution. In reality, amending a contractor’s working practices too significantly might not be commercially or operationally viable, especially in the oil and gas sector, forcing a company to consider alternative options.
If IR35 status does apply, a business will need to deduct income tax and employee NICs from fees paid to the intermediary company and also pay employer’s NICs. Given that many contractors have structured their services with tax savings very much in mind, this may be a move resisted, meaning other compliant options need to be considered. These could include anything from a gross rise in contractor fees for a highly valued or scarce skill, or more generally a move to a managed service or agency provision, including associated costs. Of course there is the option of offering to employ contractors directly, however this will bring extra staffing costs including paid holiday, pension contributions and other benefits.
A one-size solution is unlikely to work for most energy businesses, and most businesses may need to consider a mixture of the above measures, both as they deal with current contractors, and then as a future approach. Building this into budgeting at the right stage will be needed to ensure no nasty surprises.
Once a strategy is determined, discussion should begin with any contractors whose arrangements are intended to change, so as to negotiate required amendments. This may spark a discussion about rate increases and/or employment law rights. The sooner these conversations take place the better, to avoid uncertainty and a potential loss of talent.
The changes driven by this new regime may in turn require changes to organisational procedures around contractor management. Clear responsibilities should be assigned among relevant departments to ensure that engagements are entered into on the right basis in future. Creating an internal code of practice or decision tree could prove invaluable, as might training, to ensure staff understand and can manage risk as well as administering the new arrangements.
While the final legislation is yet to be presented, the direction of travel is clear, and the oil and gas industry will be a clear target for compliance checks given its high use of contractor labour. Preparations should be underway now or businesses may risk the prospect of disputes with HMRC and disruption to their core operations.
Alison Woods, partner and employment law specialist at law firm CMS
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