Contractor engagement within the UK has been fraught with liability thanks to various changes to tax legislation which has made hirers liable for any tax unpaid by independent contractors. Now, two recent government consultations look set to change the balance of risk.
Under the current IR35 rules, it falls on the end hirer to determine their contractor’s employment status in both the public and private sectors, ensuring the right tax and National Insurance contribution (NIC) is paid to the HMRC.
If either the hirer incorrectly categorizes the contractors’ tax status as outside IR35 (i.e., exempt from employment tax and NI), or a party in the contracting supply chain fails to pay the appropriate taxes, it will be the hirer who is held liable for unpaid tax on the contractor’s income.
Fear of this tax liability has led to some hirers to place blanket bans on contractor roles falling outside IR35, while others have erred on the side of caution in their determinations.
There has been a corresponding rise in the use of umbrella companies to manage PAYE deductions for the increasing numbers of contractors deemed to be working inside IR35. With margins for fulfilling roles remaining slim, this has sparked a race to the bottom on quality, which in some cases has resulted in non-compliance or worker exploitation.
In some industries this has in turn led to talent shortages, hindering efforts to access the specialized skills of contractors wishing to remain outside IR35. Highly skilled contractors tend to prefer PSC engagements due to the autonomy and flexibility they provide. Many are unwilling to take inside IR35 roles without a substantial fee increase to match their outside IR35 earnings.
The Offset Rule
In the existing arrangement, HMRC collects the full tax liability from the hirer, on income paid to the contractor, regardless of whether the independent contractor or intermediary they are working through has already paid some of this themselves.
Currently, HMRC cannot offset previous payments against PAYE liability. In such cases, the worker/intermediary can claim repayment for overpaid amounts, but not the hirer. This leads to the HMRC collecting more tax than is due.
However, the new proposed offset rule may share the tax burden more equally between the employer and contractor, potentially halving the liability for employers engaging with PSCs for roles incorrectly deemed outside IR35.
The Umbrella Problem
At the same time, a second consultation, to tackle non-compliance within umbrella companies, may increase liabilities for companies hiring contractors inside IR35.
The new proposal offers a debt-transfer process as a possible solution to collect tax that was avoided by a non-compliant umbrella company. The tax debt could be transferred to any other entity within the labor supply chain associated with that umbrella company. In most cases, this would be ultimately transferred to the end hirer, but may also include businesses engaged in the supply chain, such as recruiters.
Another possible risk associated with this option is that it may encourage umbrella companies to act non-compliantly, knowing that any tax debt resulting from their non-compliance could be transferred to a recruitment business or end client.
What Comes Next for HR Managers?
With these two anticipated changes to the IR35 landscape, PSCs may once again become an attractive way forward for HR managers and recruiters looking to hire contractors outside IR35.
Meanwhile, those who continue to hire inside IR35 roles would be well advised to put increased due diligence processes in place to manage the risks of umbrella regulation.
This could be a game changer for hirers across industries. We may see a shift in allegiances back towards PSCs as the preferred model for contractor engagement, widening the flexible talent pool for hirers and recruiters with lower tax risk.