IR35 or CIS? Which regime applies?

The Construction Industry and IR35

April 2021 is fast approaching for those who will be affected by the IR35 reforms (also known as the “Off-Payroll” rules). The changes were originally meant to come into force on 6 April 2020 but were delayed due to Covid-19.

This blog applies specifically to you if you work in the construction industry and if you are unsure whether Off-Payroll will apply to your business activities. If it does, it is essential that you understand the financial, legal and reputational risks involved.

To ensure these potential risks are eliminated you must conduct risk assessments of your temporary workforce to determine the impact of Off- Payroll and start preparing, as soon as possible, so that your internal processes are compliant and robust.

It is expected that these reforms will impact the construction industry massively. At a sector level, anecdotal evidence suggests there is particular confusion in this industry, which has historically relied on contractor workforce, stemming from the interaction between Off-Payroll and the Construction Industry Scheme (CIS) for tax deduction. Many construction businesses and workers have assumed CIS is a way to avoid Off-Payroll, however HMRC has said that Off-Payroll will take precedence over CIS.
 
Here, we briefly examine the difference between the two sets of rules and offer guidance on how construction companies can prepare for Off-Payroll.

When do the Off-Payroll rules apply?

The Off-Payroll rules apply where the end client is a medium or large private sector entity. For the purposes of the legislation the “end client” is the entity which receives the benefit of the services from the worker and/or sub-contractor and, depending on the complexity of the supply chain, the “end client” could be the contractor/construction company engaging sub-contractors.*

For those medium to large companies who are not exempt, Off-Payroll will apply where –

  1. an individual is engaged who
  2. personally performs a service for an end client
  3. through an intermediary which is usually a personal service company (PSC).

The primary effect of Off-Payroll is to shift the responsibility for assessing whether IR35 applies from the worker (usually operating via a PSC) to the end client.

Status assessments

Under Off-Payroll, the end client will be required to assess the worker’s engagement as “inside” or “outside” IR35 by completing a “Status Determination Statement” (“SDS”) – this assessment should be based on the contract that is in place and the actual working practices.To make the SDS determination the “pillars” of IR35 will need to be taken into consideration.

This means assessing whether –

  • Mutuality of Obligation (MOO) exists between the parties;
  • the end client has Supervision, Direction and Control (SDC) over the worker;
  • the worker is able to use a substitute and
  • the contractor takes financial risk

If the engagement is found to be inside IR35 the “feepayer” must make deductions of income tax and NIC. The “feepayer” is the party that is closest in the relevant contractual chain to the PSC. This could be the end client if there is a direct contract with the PSC, however, it is more likely that responsibility will fall to be another intermediary in the chain such as the agency.

Most importantly, if the end client has not complied with the requirements set out in Off-Payroll, or the determination is incorrect, HMRC may pursue them for unpaid taxes owed and possibly also impose fines or other penalties.

Finally, end clients need to ensure that they do not make “blanket assessments” of all roles as “inside IR35” as Off Payroll requires them to use reasonable care in making the assessment. Roles need to be assessed on a case by case basis.

When does CIS apply?

CIS was introduced to limit the amount of tax lost by HMRC as a result of sub-contractors in the construction industry under-declaring or failing to notify that UK taxes were applicable. CIS applies to all contractors and subcontractors, whether sole-traders, partnerships, or limited companies, who are working within the mainstream construction industry. “Contractor” and “Sub-Contractor” have very specific meanings in relation to CIS, different from common usage in the recruitment sector.

“Contractors” can include entities such as property developers, local authorities, and housing associations, that spend annually £1 million or more over a three-year period on construction work.

Under CIS, the contractor is required to deduct payments due to the sub-contractor and pass it to HMRC. Unless the sub-contractor is registered for gross payment, which is more favourable, the contractor will withhold tax at source at a rate of 30% or 20% if the recipient is registered with HMRC.

When to register as a contractor

An individual must register as a contractor if they:

  • pay sub-contractors for work or
  • if the business does not do construction work, but the contractor spends an average of £1 million a year on a 3-year period on construction.

An individual must register as a sub-contractor if they do construction work for a contractor in order to benefit from a lesser tax rate which will be withheld at source. CIS covers most construction work to a permanent or temporary building or structure or civil engineering work like roads and bridges There is a comprehensive list of what constitutes “construction operations” in the guidance document provided by HMRC.

When assessing whether a sub-contractor qualifies under CIS, the Supervision, Direction and Control (“SDC”) rules need to be considered. These rules determine the employment status of sub-contractors by establishing whether they are under the supervision, direction and control of the end client.

The important thing to consider is that Off-Payroll will apply where an individual personally performs a service for an end client through an intermediary (PSC) whereas the SDC legislation applies to individuals directly if they are genuinely self-employed (generally as sole traders).

It should be noted that if the worker is found to be subject to the SDC legislation, then they would not qualify for the CIS scheme. Instead, they would need to be paid PAYE through an umbrella or payroll provider.

It may be possible that the worker in the construction industry may fall foul of Off-Payroll although they have been operating through CIS. As mentiond above, Off-Payroll takes precedence over CIS so this needs to be addressed.

How to prepare for Off-Payroll rules

The chart below sets out the steps you should consider taking to prepare for April 2021.

          *(There is however a small company exemption for engagements where the end clients have a turnover of less than £10.2 million, a balance sheet of less than £5.1 million or the number of employees is not more than 50. For this exemption to apply the end client will only need to satisfy two of those conditions).