Contractor changes in the private sector (IR35) – spotlight on Engineering and Construction
30 November 2018
The Government has announced that the current public sector rules for contractors will be extended to the private sector. However, having announced an April 2020 implementation date, the Government seems to have listened to the flood of representations calling for a sensible lead time for the changes.
Even so, the impact of these reforms should not be underestimated, and arguably represent the most significant changes to the operation of employment taxes for many years. For the Engineering and Construction sector this has the added complexity of dealing with the interaction with the Construction Industry Scheme (CIS).
These changes will potentially introduce additional direct costs into the supply chain, largely driven by employer NIC and Apprenticeship Levy totaling 14.3%. These amounts will become chargeable on fees from any contractor deemed to be within the rules, where previously a view may have been taken that they were not caught.
So how do businesses make best use of the lead time to implementation to ensure they are fully prepared for what will be significant operational and commercial changes? We’ve highlighted below the key steps businesses should take, as well as some of the nuances found in the detail of the 2018 Budget announcement.
What has been announced?
The changes relate to the taxation of off-payroll workers (i.e. contractors) who fall under the IR35 rules. These rules apply to any contractor who works for an end user business via an intermediary such as their own personal service company (PSC). The IR35 rules currently operate differently depending on whether the engaging business is a public or private sector organisation, but in their decision, the Government has opted to largely align the rules with those currently in place for the public sector, except in the case of “small companies”.
Under the reforms, any business which is not a small company will be required to undertake an employment status assessment in respect of any of their contractors operating through a PSC, whether they work directly with the business or via an agency. Where the result of that assessment shows that the arrangement is one of employment, payroll tax and NIC withholding will need to be operated on the contractor’s fees by whichever entity is paying the PSC, be that the business itself or an agency. These rules take precedent over CIS and will need to be factored into the current process when dealing with contractors in this sector.
Small companies using contractors will not be caught by the reforms. As such, the current IR35 rules will continue to apply to them. The Government has indicated that they intend to use a similar definition of small companies as used in the Companies Act, so a test based on number of employees (50 or less), turnover, and balance sheet values seems likely.
When will the changes take effect?
The Government has announced the changes will come in from April 2020. At first glance, this provides plenty of time to prepare for the new rules, and for businesses with small numbers of contractors this may be the case. However any organisations with a significant contractor population should not underestimate the amount of work required. A common feature of the Engineering and Construction sector is that there is wide use of off-payroll workers, including those through agencies and PSCs, and therefore are likely to fall into the latter category.
The preparation will include understanding and assessing the status of the current contractor population and those roles/skills which are critical, renegotiating commercial arrangements and communicating with those who are affected (which for this sector may also include information about the changes compared to CIS). It should also include establishing the processes and systems necessary to maintain compliance going forward beyond April 2020.
The extent of this change means that some businesses may use this as an opportunity to consider whether the underlying strategy currently adopted for engaging with off-payroll workers is fit for the future. For example, this may lead to a shift towards offering contractors normal employment roles or perhaps operating a ‘contractor in house’ population via short term contracts. Many contractors enjoy the flexibility of their current working arrangements and businesses will be keen to be able to tap in to a flexible workforce.
So how can businesses start preparing for the changes?
We recommend that businesses put together their project team (which might include legal, tax, finance, operations) and project plan now, which incorporates the following four key phases:
- Identify their current contractor population, specifically those using PSCs, whether directly or through an agency.
- Assess those contractors to determine which would be deemed to be employees under the status tests.
- Design and build new systems and processes for dealing with those contractors impacted by the changes, which might include interaction with payroll, CIS and accounts payable. It should also incorporate communication with the contractors and/or renegotiation of commercial arrangements where required.
- Implement the new arrangements to ensure compliance going forward from April 2020.
The operational challenges associated with the changes could be substantial. For example, organisations may have difficulty just identifying those contractors impacted by the changes, and then collating the information required to allow an informed determination of employment status to be made. There will also be the need to communicate the impact of the changes to the affected population (both the contractors themselves and business stakeholders), which for those within CIS could be a scenario where deductions are to be made from the invoice value, where previously they had been gross payment status under CIS. Changes will likely be needed to the accounting and payroll systems to deal with both the payments of VAT, PAYE and NIC.
With proper planning, all of these challenges are manageable. We have used our experience of the changes already implemented in the public sector to develop a suite of technology tools which can help with each of the four stages above, allowing businesses to understand the potential cost impact of the reforms and manage their compliance going forward. If you would like to discuss the impact of these changes to your business, please contact Paula Letorey or Paul Dixon.