Comment: Contractor tax reform could expose firms to risk

As an employment law specialist my advice to businesses is: act now, don't delay, says Pinsent Masons' Claire Scott. Picture: Contributed
As an employment law specialist my advice to businesses is: act now, don't delay, says Pinsent Masons' Claire Scott. Picture: Contributed
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A fundamental shake up of the tax rules applying to contractors has the potential to cause increased costs and risks to businesses, particularly those in the oil and gas, financial services and infrastructure sectors. Engaging contractors through Personal Service Companies (PSCs) has been an attractive option for a wide range of businesses because it allows them to have greater flexibility in being able to scale manpower up and down according to project requirements.

Previously determining if an individual is taxed as an employee or as self-employed lay with a PSC, but with the introduction of IR35 tax reforms by HMRC that responsibility will now fall to the end-user. Depending on the circumstances, the end-user could be the client at the top of the supply chain or another company within the supply chain. With an eye to IR35 reform, businesses are now grappling with how contractors’ tax should be treated – and if the end-user does not make the correct tax determination they will leave themselves open to financial penalties.

The changes come into effect from April 2020, but as an employment law specialist my advice to businesses is: act now, don’t delay. Companies would be wise to conduct an audit to establish how many contractors are engaged through a PSC and whether they are engaged directly or through an agency or other intermediary.

An analysis of the supply chain and contracts involved will be helpful as liability, and potential costs, can move up through the supply chain. Firms should identify if they are the end-user with responsibility for making a tax determination, or the fee-payer, in which case they will have to make the tax deductions and pay any employer’s national insurance contributions.

Once PSC contractors are identified, I suggest a comprehensive assessment to identify the risk of exposure to IR35 changes, including analysing existing controls such as procurement and HR procedures.

This new legislation may also create commercial risks for businesses. Let’s assume a business has a number of specialist contractors each engaged through a PSC on business-critical projects. If IR35 changes mean they are now taxed in a different way, is there a risk they will seek employment elsewhere and cause disruption or delay to those critical projects? Will they expect increased rates to make up the difference in pay or indeed employment rights going forward? It is crucial that businesses retain a resourcing model that works and early risk assessment and planning is key to success here.

On top of the management time and costs in dealing with the changes, businesses have to factor in the knock-on commercial risk and how they will respond if key staff choose to leave and the financial and reputational cost to the business if that plays out.

Solutions include offering key contractors roles as employees with associated benefits, or increasing the equivalent day rate to compensate for any loss to individual earnings (but that second option may not be popular with all, including current employees).

It is important that businesses communicate openly with their supply chain and agree on how to approach IR35 issues. All parties need to agree who is the end-user and therefore will make the tax determination. They should establish if particular individuals need to remain engaged on key projects and agree the best route for making that happen. Conversations with the contractors themselves are vital – before they decide to seek work elsewhere.

It is clear that addressing IR35 changes will not be a simple fix. It may come down to cost and if companies are prepared to absorb an increase in the cost of day rates to ensure key contractors are not financially impacted or look at changes to their resourcing models. For all firms reliant to some extent on specialised contractor experience this may be a good time to review resourcing models and ensure that risks are minimised going forward.

- Claire Scott, legal director and employment law specialist at Pinsent Masons