Dean: What is changing in relation to the tax treatment of off-payroll workers in the UK?
Hannah: From April 6 2021, new rules will apply to the engagement of off-payroll workers through intermediaries by private sector clients in the UK.
In summary, the rules provide that clients who engage these workers via an intermediary – such as a personal service company – must determine whether, if the intermediary was ignored, the worker would be regarded as their direct employee or office holder for income tax purposes.
If they would, then the client, or the agency paying the intermediary if different, must deduct income tax and national insurance contributions from the fees paid to the intermediary and account for employers' national insurance – and apprenticeship levy if relevant – as if the fees were payments of salary.
Dean: Why is this change significant?
Hannah: The engagement of workers through personal service companies and other intermediaries is central to the economic model of many different businesses. Until now, if the status of a worker engaged in this way was challenged by HMRC, the liability to account for income tax and national insurance on payments made to the worker would fall on their personal service company.
Under the new rules, the liability to account for tax and national insurance will rest with the end client – or in certain circumstances, a third party such as an agency through which the worker engages. This shifting of liability will create additional risk for many businesses engaging workers off-payroll, and in the context of mergers and acquisitions (M&A) transactions, is likely to be an issue identified by buyers in due diligence.
Dean: It sounds like the new rules could create a significant compliance burden for businesses in certain sectors that rely heavily on consultants, such as IT for example. What should acquirers of businesses in particularly affected sectors be aware of?
Hannah: There are two potential areas of risk for buyers in an M&A context. The first is that as the new rules come into effect, companies may fail to operate them correctly, creating a significant historic tax exposure. This risk already exists in relation to off-payroll workers who are engaged directly, but in some circumstances the level of risk and amounts in issue may increase significantly as a result of the change to the rules.
The second area of risk is that a challenge to the status of workers in the future may lead to the company having to account for income tax and national insurance without being able to adjust the amounts payable to the workers to reflect this.
Whilst many businesses will no doubt do what they can to mitigate these risks through compliance procedures and appropriate contractual terms, for buyers of businesses who engage large numbers of off-payroll workers, or who have key individuals operating on these terms, it may be unattractive to have to rely on making a claim against their workers under contractual indemnities.
Dean: What can buyers do to manage the allocation of this risk inherent in a wide range of businesses?
Hannah: Where this is an issue for a target business, a buyer may be able to obtain contractual protection from the seller in respect of the risk. However, in practice, the seller may resist this if it has a different view on the level or quantum of the risk or considers that the buyer can recover the tax from the workers themselves under existing contractual indemnities.
If a seller resists giving an indemnity for the risk, insurance may provide a solution, although this is likely to turn on the facts and may be more challenging in some situations than others. The question of whether a worker would be an employee if they were engaged directly by the client company is a factual question, which turns not only on the contract between the client and the worker, but also how they deal with one another in practice. It is therefore necessary to have a detailed understanding of both elements in order to form a view as to the risk of challenge.
Where there are large numbers of such workers and variations in the terms on which they are engaged or the basis on which they perform their role in practice , it may be difficult to look at each worker's position in sufficient detail as part of a standard due diligence exercise to enable an insurer to form a view of the likely risk. This may make insurance difficult or impossible to obtain without significant further due diligence.
Dean: IR35 – or similar rules – are something that have been insured across Europe. Do these changes make this risk more challenging to insure against?
Hannah: Risks around employment status have existed for a long time in relation to individuals who are engaged directly. The new rules expand this risk to include workers who operate via intermediary companies, so they are broadening the range of workers to which the risk can apply rather than creating a completely new area of tax risk.
As is the case for workers who are directly engaged by businesses, insurance may provide protection in certain situations. For example, where a company has a small number of high value contracts with off-payroll workers which can be reviewed in detail, or where it is clear that a very conservative approach to the risk has been taken, closely following HMRC practice – but it is unlikely to provide a universal solution to historic risks in this area. It is also worth noting that it will not provide a solution to any future business risk that might be created by a challenge to the status of workers.
Dean: Thanks, Hannah. Where businesses face a material exposure from a wholesale challenge of a significant number of their off-payroll workers, insurance may be able to provide a ‘worst case scenario’ cover so it’s worth having a conversation with the global BMS tax liability insurance team, no matter what the fact pattern or where the risk is.
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