IR35: Umbrella companies won’t keep out the rain
David Kirk explains why the standard umbrella company model will not work under the off-payroll rules from 6 April 2021, due to a last minute change in the law.
Do you remember the game scissors, paper, stone, which has no winner because of its circular nature? The world of IR35 seems to have descended to something like this, thanks to the discovery of a late addition to Finance Bill 2020 as it was going through Parliament.
Like all unannounced changes, it has not been thought through and has unintended consequences which merit a closer look. HMRC described the new addition as one of a number of “incidental changes and corrections to ensure the legislation applies as intended”.
Unfortunately, it goes quite a lot further, with consequences that umbrella companies are going to need to think carefully about because, on the face of it, the standard umbrella model will no longer work from 6 April 2021.
Links in the chain
The problem revolves around an obscure clause in ITEPA 2003 chapter 10 that deals with public sector IR35 cases (also called off-payroll) – that tells you what sort of arrangements it applies to.
IR35 deals with chains of contracts and payments between the client and the contractor, and requires PAYE to be operated on them. Two typical examples of chains might be:
- Client > agency > PSC (personal service company) > worker
- Client > agency > umbrella > worker.
Current law to 5 April 2021
The IR35 rules come into play if the worker has (broadly) a 5% shareholding in the intermediary, which will cover a PSC, but not an umbrella company. It is difficult to see why HMRC is not satisfied with this. Although it does not catch umbrellas, they will generally be able to get hold of umbrella arrangements by other means, either because the umbrella has a contract of employment with the worker, or if it doesn’t because of the agency rules in ITEPA 2003, chapter 7, which make the agency responsible for operating PAYE.
There are also anti-avoidance rules for dealing with situations that do not quite fit the conventional models.
For some reason HMRC isn’t satisfied, as FA 2020 added two further possibilities to the list of qualifying intermediaries in s61O as from 6 April 2020, when the rules extend to the private sector. These are:
- where the worker has received a “chain payment” from the intermediary; and
- where the worker has rights which entitle him to do so (for example from from a contract).
This extends the rules to umbrella arrangements by making umbrellas “intermediaries”.
Well, I think it does. This clause is really badly drafted and some bright spark is bound to point out that the definition of “chain” in ITEAP 2003 stops with the intermediary – that is, it doesn’t include the worker, and so a payment from the intermediary to the worker is not a “chain payment”.
Unfortunately, that doesn’t work, because the definition of chain payment does not refer back to the definition of chain (I’m not making this up), but I have no doubt that some unscrupulous operators will try it on.
From 6 April 2021
From April 2021 chapter 10 will include the client > agency > umbrella > worker arrangement. Does it matter? Surely the umbrella company will have a contract of employment with the worker and so PAYE will have to be operated that way?
Won’t HMRC be happy as long as it’s getting PAYE from the umbrella?
Well actually, no, because the deemed direct payment (the one that PAYE has to be operated on) is now the payment from the agency to the umbrella, which will be quite considerably bigger than the one from the umbrella to the worker, and so will be the corresponding amount of tax.
Let’s look at the provision to prevent double taxation: surely that says that this doesn’t apply when the normal employment income charge applies (ie on the payment from the umbrella to the worker). Unfortunately in this case it works the other way round – it makes it clear that it is the payment from the umbrella to the worker that is not charged to tax and the payment from the agency to the umbrella that is.
Agency rules, or not
The chapter 7 agency rules take precedence over chapter 10. However, this doesn’t work as unlike chapter 10, those rules are specifically disapplied when there is an actual employment contract, which the one between the umbrella and the worker is.
That’s the scissors, stone and paper problem: employment contracts take precedence over chapter 7, chapter 7 over chapter 10, and chapter 10 over employment contracts. So you’re left chasing your tail for ever and ever.
Umbrella companies are an inventive lot and I have no doubt that they will find some solution to this.
One possibility might be for them to operate two companies: one to receive the money from the agency and the other pay the worker. That ought to work, but the trouble with it is that it would also work for practitioners of whatever-it-is that HMRC is objecting to, so it probably won’t be allowed to work for long.
Maybe the umbrellas will go for the simplest solution. One of their main purposes, and one thing that they are really good at, is to run payrolls. So why not make a virtue of this and reinvent themselves as payroll operators to take themselves out of the chain?
Afraid not, as this will then push the chain one stage further back, with the agency being the intermediary and the client operating PAYE on its payments to the agency. Unless, of course, the agency rules apply. But then the agency rules have a different test – the supervision, direction and control test as opposed to the employment status test, and IR35 territory is just the sort of place where the former will not apply and the latter will. So that’s no good either.
Maybe if we were to look at the legislation a bit more closely. It’s the payment chain, not the contractual chain, that matters here.
Now we have two chains:
- Client > agency > worker (contractual chain)
- Client > agency > payroll provider > worker (payment chain).
Are we OK now?
Yes, until HMRC’s barrister points out that the payroll company is an agent for the agency. There are two sorts of agency here: an employment agency (which is known in employment law as an employment business, just to cause confusion – to them an employment agency is something slightly different), and an agent under the general laws of agency.
This means that the payroll provider isn’t in in the payment chain either, even where it receives a payment from one party and makes a payment out of the same receipt to another.
If your head’s now spinning and you think you’ve walked into a Marx Brothers film script, you’re probably not far wrong.
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David Kirk is a tax consultant specialising in employment status, employment taxes, intermediary work (including IR35), and Revenue inquiry work. He represents the ICAEW on the IR35 Forum, and is the author of Employment Status – the Tax Rules published by Claritax...