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IR35 and umbrella companies

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This is what comes of having legislation that is too complicated to understand: it has side effects that can be quite far-reaching and are not always apparent when it was passed. It matters particularly when it affects an environment in which about a million people work.

The problem this time is in ITEPA 2003 s 61O(1)(b), a part of the public sector off-payroll rules (as IR35 is now to be called), which tells you what kind of intermediary company is caught by them. Currently, it includes only companies in which ‘the worker has a material interest’, i.e. (broadly) a shareholding of 5% or more. In layman’s terms, this means that personal service companies (PSCs) and any other intermediary companies do not, for the moment, need to be bothered with this. However, the Finance Act 2020 is now law, and as from April 2021 it will extend the rules’ ambit to the private sector and add a couple of additional possibilities to s 61O, where:

  • ‘the worker has received a chain payment from the intermediary’; or
  • ‘the worker has rights which entitle, or which in any circumstances would entitle, the worker to receive a chain payment from the intermediary.’

Consider the effect of this on a typical intermediary chain consisting of client > agency > umbrella > worker. A ‘chain payment’ is essentially a payment for work done by the worker for the client, and each party in the chain will pass a chain payment to the next one. The consequence of this change is that (probably under both of these new limbs) the umbrella company becomes an ‘intermediary’, and so the agency becomes a ‘fee-payer’. The worker is deemed to have received employment income – not of the amount that he or she receives from the umbrella, but of the amount that the umbrella receives from the agency – and the agency has to deduct PAYE from the payment. Normally, an umbrella will have an employment contract with the worker, which on the face of it gives rise to a double charge to tax, but s 61W specifies that it is the payment by the agency which takes precedence here.

This is certainly unintentional, and to its credit HMRC seems to have picked up the issue very quickly – at least as far as umbrellas are concerned – and moved to reassure all concerned that there is no intention to change its policy in its Employment Status Manual at ESM10003, which makes it clear that these rules should not apply where there is an employment contract with an umbrella. It will take primary legislation to change this, and this can be expected in next year’s Finance Bill.

Unfortunately, HMRC has not yet explained what it proposes to do with cases where there is no umbrella, such as a chain consisting of client > agency > worker. In this scenario, the agency has to consider the rules in ITEPA 2003 ss 44–47, and deduct tax where there is supervision, direction or control (SDC) over the worker as to ‘the manner in which the worker provides the services’. 

If that does not apply, then under the new rules the client will also have to consider the normal employment status tests and deduct tax on the payment to the agency where the worker is inside IR35. This could cause considerable problems in big construction projects, where it would be quite common for someone to be controlled as to what work is done (so coming inside IR35) but not controlled as to how (‘the manner in which’) it is done (the SDC test).
Furthermore, there are a wide range of exemptions from the SDC test, as detailed in s 47 (in summary, entertainers, models and home workers). It has clearly not been the intention to include these within the scope of IR35 where they are engaged through agencies, but now they can be. It is to be hoped that the government accepts that this should not be done without proper consultation, and if so urgent action is required to assure us that this will be listened to as well. A particular point about models is that employment agencies can charge them fees, for which, if they are self-employed, they can claim a deduction in their self-assessment income tax; this deduction will not be available if they are deemed to be earning employment income. The same might also be true of some entertainers: most would be able to claim a deduction under ITEPA 2003 s 352, but the wording is not quite the same and there might be some gaps. We shall have to see what happens. 
Issue: 1506
Categories: In brief