Off-payroll workers, risks and responsibilities – IR35, umbrella companies and office holders

Many businesses continue to struggle with staff recruitment and staff retention; there just aren’t the workers around to employ. This has meant that businesses have started to consider the alternatives to taking on employees directly and are using workers engaged off payroll, often as self employed or via their Personal Service Company (PSC).

The change in the way that businesses engage with and pay certain workers (contractors), has often resulted in increased costs, for example, increased fees being charged by agencies or, where IR35 applies, a direct increase in employer’s NIC charges. In addition, there is a legal, financial and administrative burden on businesses, at a time when they could do without additional overhead spending.

This all brings with it several risks and HMRC will look very closely at the arrangements for any workers who are not on the payroll. Businesses must fully understand their labour supply chains in order to identify where PSCs and other intermediaries are being used.

IR35

We are now well past the one-year mark since HMRC introduced its expansion of the ‘off payroll changes for the private sector’ via their IR35 reforms.

As HMRC’s initial ‘soft landing’ approach to the IR35 reforms is ending, it is more vital than ever that businesses are compliant with the rules as HMRC start to consider penalties for the future.

The updated IR35 regulations came into effect in April 2021, for medium and large sized businesses in the private sector. This placed additional regulations and burdens on businesses, as the responsibility for assessing the employment status of workers they engaged through a limited company shifted from the worker’s limited company to the engaging entity. From April 2021 these businesses (end-users) have been required to:

• Assess whether the worker would be deemed to be an employee, often using HMRC’s Check Employment for Tax (CEST) tool
• Issue a formal Status Determination Statement (SDS)
• Implement a formal Status Disagreement Process

Many businesses undertook a process to ensure they had robust systems in place to carry out IR35 status assessments, to check they were compliant with the legislation. So why is it that 18-months down the line, IR35 still remains a big issue?

What are the issues?

While a lot of businesses did adequately prepare for the IR35 changes, many did not. They may not have been actively hiring labour through limited companies at the time, considered themselves to be ‘small’, or just had a genuine confusion about how and when the rules apply. There are additional complications regarding overseas contractors, and I’ve seen many examples where businesses aren’t aware of exactly who their contractor population are, or how they are engaged.

End-users who incorrectly classify workers working via an intermediary as being outside IR35 can be held liable for the PAYE, NIC and Apprenticeship Levy due if HMRC successfully challenge the worker’s status and reclassify them as being inside IR35.

What should businesses do?

We expect HMRC to increase the level of compliance activity in this area. Now is a good time to ensure your IR35 procedures and processes are still suitable and facilitate compliance with the rules. You may want to:

• Undertake labour supply chain due diligence to ensure that all engagements falling within IR35 are still being identified
• Ensure internal teams and hiring managers have sufficient ongoing training to raise awareness of IR35 and reduce the risk of non-compliance and demonstrate reasonable care to comply
• Consider revisiting status determination statements previously issued following any potential updates to the working arrangements and the latest updates in case law

Umbrella companies

The use of umbrella companies, especially for contractors, has been on the increase. The changes to off payroll working have led to more workers looking at umbrellas as a way to engage for work with a business and likewise businesses are looking at the umbrella company set up as a way of navigating through or around the new off payroll rules.

An umbrella company is a company that employs a temporary worker (an agency worker or contractor) on behalf of an employment agency. The agency will then provide the services of the worker to their clients. umbrella companies do not find work for the workers they employ.

They can work differently but most umbrella companies employ workers using an employment contract. This means the company must comply with employment law. Being engaged through an umbrella company removes the need to consider the IR35 or agency worker rules.

An umbrella company is no different to any other employer. They must operate PAYE and deduct tax and both employer’s and employee’s NIC from payments to its employees. Sometimes payments will be structured differently, and employees may be paid at the national minimum wage as their hourly rate, with additional bonus payments made on top. All payments must still be subject to tax and NIC irrespective of how they are structured.

So, what’s the problem with using an umbrella company?

If it’s implemented properly and the tax, NIC, and employment rights legislation are adhered to, there is no problem. But umbrella companies have almost constantly been used as vehicles of tax avoidance. HMRC has now even brought out an online “interactive risk checker” to help workers establish if their working arrangements through umbrella companies could be part of an avoidance scheme or not.

There are several things to look out for which could indicate that an umbrella company is part of an avoidance scheme:

• They claim workers can keep more of their wages than a normal employee would
• The arrangements involve third parties to the umbrella company, who could potentially be based overseas
• There are loan arrangements in place which relate to non-taxable elements of pay
• Payments are not made in a structured manner, multiple payments could be made for the same pay period
• Documentation and contracts mention trustees
• There is more than one contract in place
• There are deductions on payslips which don’t make sense
• The employees must pay a fee to the company organising their employment
• Claims that their schemes are “compliant”, “HMRC approved” or backed up by “legal opinion”

When the schemes are eventually taken down by HMRC, often many years after payments were being made to employees, it can still leave workers who were engaged through these schemes with a big tax bill to pay. They will often not be able to reclaim or recover fees or deductions made from their wages, only increasing the financial burden on them.

Mini umbrella companies

HMRC is also acting against the use of umbrella company type structures which facilitate mini umbrella company (MUC) fraud. MUC fraud involves the splitting of a larger umbrella company workforce into many smaller umbrella companies, each typically employing only a few workers. They will then fraudulently benefit from tax reliefs aimed at smaller businesses, such as the employment allowance, and the VAT flat rate scheme.

As in the case of disguised remuneration, umbrella companies may be particularly useful structures for facilitating this type of non-compliance because of the relative ease with which these companies can be established and collapsed.

There is no set structure to MUC fraud, and the creation of several layers of companies and payments can make it harder for HMRC to get to the bottom of arrangements. It also significantly reduces PAYE & VAT payments to HMRC.

If your business is using temporary labour, it is your responsibility to undertake necessary due diligence and check the credibility of your labour supply chains. If it sounds too good to be true, it probably is.

Office holders

And finally…

One of the most regular questions that is currently asked and something that can become a risk on the sale of your business, is the use of consultants and sometimes contractors as directors or non-executive directors (NEDs) who are being paid for their services but are not on the payroll.

A recurring theme related to employment status is the off-payroll engagement of ‘office holders’. This is not an IR35 issue, and so the small company exemption does not apply to these engagements, another potential pitfall for many owner-managed businesses.

Directors, and non-executive directors of a company, are considered by HMRC to be office holders. As a result, remuneration received by an office holder, for performance of their office holder duties, should be subject to tax and NIC through the payroll. Where an office holder invoices for their services, either directly on a self-employed basis or through a limited company, HMRC will deem this to be a failure to operate PAYE by the engaging entity.

It can be possible for an office holder to invoice separately for additional duties alongside their office holder duties. However, there will need to be separate contracts in place, and the duties must be distinct from those of an office holder. For example, a director could be paid through the payroll for their director duties, but also invoice separately for marketing services that they provide.

What are office holder duties?

Typically, HMRC would see duties such as attending board meetings, senior management responsibilities, and having input into the strategy and direction of a business, as being indicative of carrying out officeholder duties. HMRC would not expect an office holder to invoice separately for performing these types of duties under a consultancy agreement.

How can we help?

If you require any further information or advice on any of these matters, please contact the Employer Solution team. We would be happy to have an initial informal discussion to further explore the ways in which we can help your business comply with these complex rules.