Impact of IR35 reforms on construction businesses
What is IR35?
IR35 is tax legislation which is designed to combat tax avoidance by individuals who supply their services via an intermediary (such as a Personal Service Company ‘PSC’, partnership or other individual) but who otherwise would be a direct employee of the company if the intermediary was not used.
What is the background to IR35?
In the public sector, public authorities have been responsible for deciding if off-payroll working rules apply to contractors since April 2017. However for the private sector, currently the person who is providing the services is responsible for making that decision.
Private construction businesses using contractors were therefore not affected by IR35 legislation.
What will change?
In April 2020 the Government’s IR35 payroll reforms will come into effect in the private sector too, putting the responsibility firmly on employers for the appropriate treatment of PAYE and NICs in respect of contractors engaged via an intermediary.
The responsibility for determining whether IR35 applies to an individual working through an intermediary will fall on the organisation receiving the individual’s services rather than the individual themselves and as a result of the huge number of contractors used within the sector it is anticipated that a high number of construction companies will be affected.
In short, it will become the construction firm’s responsibility for determining the employment status of their contractors and also for deducting any tax and NICs if they are due.
What is the potential impact?
Whilst the changes will not impact smaller employers, workers who are genuinely self-employed or affect businesses which engage self-employed contractors through direct agreements, they will potentially place a significant tax liability on many construction businesses who use contractors through intermediaries. At the very least it will increase compliance costs.
What action do construction companies need to take?
Businesses need to review their contracting arrangements covering all contractors engaged through an intermediary. Whether contractors are engaged under short-term contracts, or integrated into the organisation to deliver ongoing services will affect their status.
Construction bosses will then need to decide if existing arrangements with contractors are sustainable or whether payments should be taxed as if they were employment income.
HMRC will be influenced by the actual nature of the working relationship, and not simply the terms of a written contract.
So for example, if the contract states that the contractor may send another person in their place but it is obvious that the construction company would not accept the substitution, HMRC would reject this and find that IR35 status applies. If IR35 status does apply, the business will need to deduct income tax and employee NICs from fees paid to the intermediary company and also pay employer’s NICs.
Many contractors have structured their services with tax savings in mind and they may be resistant to the new arrangements and construction businesses may need to consider alternative compliant options.
These may include a gross rise in contractor fees where skills are highly valued; a move to a managed service or agency provision; or offering to employ contractors directly although this would result in paid holiday leave, pension contributions etc.
Conversations with contractors need to begin as soon as possible and company budgets reviewed to take account of the changes.
Will HMRC help?
In addition to HMRC’s published guidance on the application of the rules of IR35, they also provide an online tool called CEST ‘Check for Employment Status Test’ which can be used to check whether IR35 applies to individual contractors.
HMRC also has a confidential IR35 helpline and offers a contract review service, in which they will review a written contract. If HMRC decide that IR35 does not apply to the contract, they will provide a confirmation letter that will be valid for three years.
It is essential that businesses take steps now to ensure they will be compliant with the new tax regime. Failure to make preparations now may mean that businesses risk the prospect of disputes with contractors as well as with HMRC and disruption to their core operations.
It’s anticipated that given its significant use of contractors, the construction industry will be a likely target for compliance checks by HMRC.
The information was correct at time of publishing but may now be out of date.