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Self-employed face effective double taxation under Off-Payroll Tax

Thousands of the UK’s contractors are being subject to an effective double taxation as clients and agencies either misinterpreted or misrepresented the Off-Payroll Tax, consequently deducting employment costs from the contract rate. This practice is contrary to the legislation, which requires that these costs be borne by the ‘fee-payer’.

Measures applied by clients and agencies, including the insertion of contractual clauses agreeing to the deduction of employment costs and the renegotiation of rates for ‘inside IR35’ contracts, are also in breach of the Social Security Contributions and Benefits Act (SSCBA).

“Possibly the only positive change introduced by the Off-Payroll legislation is that the contractor is relieved of the employer’s NICs liability,” says tax barrister Alexander Wilson of Invicta Chambers. “Unfortunately, companies are either failing to grasp this change in law or are intentionally misrepresenting it, subjecting contractors to excessive taxation.”

Firms struggling to grasp correct Off-Payroll tax treatment

The Off-Payroll legislation – Chapter 10, Part 2 of the Income Tax (Earnings and Pensions) Act 2003 - requires that employer’s National Insurance Contributions (NICs) (13.8%) and the Apprenticeship Levy (0.5%) be paid on top of the contract rate by the ‘fee-payer’.

The sum to be treated as employment income is referred to as the ‘deemed direct payment’, the calculation of which is crucially separate from the consideration of employment costs.

This differs to the original IR35 legislation – Chapter 8, Part 2 of the ITEPA - which confusingly involves a calculation to determine the ‘deemed payment’ for contractors considered ‘inside IR35’.

This calculation effectively means treating the affected contract income as the total cost of employment, deducting the proportionate cost of employer’s NICs from the sum before applying income tax and employee’s NICs deductions. This subjects the contractor to an unjust double tax charge that the Off-Payroll Tax sought to rectify.

Contractors face double taxation through non-compliance

As clients and agencies adapt to the Off-Payroll Tax, a concerning number appear to have introduced arrangements that apply the IR35 ‘deemed payment’ calculation to the ‘inside IR35’ contract income.

A recent ContractorCalculator survey of more than 12,000 contractors found that, of contractors deemed ‘inside IR35’, 79% claimed to have had employer’s NICs unlawfully deducted from their contract rate. Meanwhile, 45% of all contractors had been told by clients or agencies that this deduction was required under the Off-Payroll legislation.

“There are two common measures taken by companies to offset their employer’s NICs liabilities,” notes Wilson. “The first is the ‘assignment rate’ route, whereby clients and agencies introduce contractual clauses confirming that the rate agreed with the contractor is to be subject to employment cost deductions.”

“The second is the renegotiation of rates. Here, a contractor will agree to a rate which is later renegotiated down if it is determined that the contract is ‘inside IR35’. The end goal for the client and agency is to ensure that the total cost of employment amounts to a comparable sum to that originally agreed with the contractor.”

Employment cost deductions prohibited by law

Both are already established practices, and the latter has even been endorsed by HMRC in published guidance, advising that fee-payers: ‘could, depending on the contractual terms, negotiate a lower fee’.

However, Wilson highlights that employing either tactic would leave parties in breach of the SSCBA, Schedule 1, Section 3(2)(a) of which states: ‘No secondary contributor shall be entitled to make, from earnings paid by him, any deduction in respect of his own or any other person’s secondary Class 1 contributions.’

In addition to this, Schedule 1, Paragraph 3A(1) sets out firm restrictions on indirect means of recovery of employer’s NICs, stating:

‘A person who is or has been liable to pay any secondary Class 1 contributions shall not –

  1. make, from earnings paid by him, any deduction in respect of any such contributions for which he or any other person is or has been liable;
  2. otherwise recover any such contributions (directly or indirectly) from any person who is or has been a relevant earner; or
  3. enter into any agreement with any person for the making of any such deduction or otherwise for the purpose of so recovering any such contributions.’

“It’s very clear. Companies can’t recover employer’s NICs after the event, they can’t come to an agreement to recover it, and they cannot deduct it,” comments Wilson. “The legislation basically shuts off every possible measure that a hirer might apply to source this cost from the worker.”

Wilson notes that, while contractual clauses concerning the deduction of employer’s NICs are explicitly forbidden by the SSCBA, the renegotiation of rates would likely be considered an indirect means of recovering contributions, and therefore also unlawful.

County Court provides remedy for affected contractors

In either case, the recommended means of recourse for affected contractors is the same. Contractors are advised to make a County Court claim for breach of contract as Wilson explains:

“This is the most likely remedy as the County Court has the jurisdiction under contract law to strike out an unlawful clause. Thereafter, the contractor would be entitled to a reimbursement of monies held back from them and the offending party may well have to pay the contractor’s legal costs. It’s considered a breach of contract because, once the invalid clause has been struck out, the deduction applied is therefore in breach.”

Awarding damages is an unlikely prospect, because the provision doesn’t make it a criminal offence. That is except for the unlikely event that the offending party is found to have violated the Fraud Act 2006:

“As a general principle, under the Fraud Act 2006, if a party makes a statement that they know is false and they do so dishonestly with the intent of depriving someone of money, or of making a gain themselves, then it could be a criminal offence. However, this is a very high test, because it must be proven that the party in question didn’t misinterpret the law. It has to be deliberate and dishonest.”

Wilson observes that a client or agency would realistically expect to succeed in defending against criminal charges by arguing that they simply misinterpreted the legislation:

“HMRC’s guidance regarding the Off-Payroll legislation, which it also confusingly refers to as ‘reform of IR35’, isn’t crystal clear. A company that has renegotiated contract rates to accommodate employment costs would be particularly safe, given this is a route that HMRC has actively encouraged. Nonetheless, this doesn’t prevent it being an unlawful deduction.”

Wilson adds: “An alternative route may be to claim unlawful deductions through the Employment Tribunal (ET). However, strict time limits apply and unless the individual is an employee on paper as well as in practice, the ET may need to be persuaded that it has jurisdiction to hear the complaint.”

Factors to consider before taking action

Although Wilson advises any contractors considering taking action to seek legal advice, this comes with a caveat: “The difficulty is most contractors will be looking to claim sums in the thousands of pounds rather than tens of thousands of pounds, and so securing legal advice that’s proportionate to that can be difficult.

“However, in many cases contractors who win can expect to recover their costs from the client. In any case, I would encourage anyone to seek advice and not to assume that it can’t be afforded. No-win-no-fee arrangements are available, and an initial consultation could be enormously helpful.”

Contractors who act are also reminded that they risk the almost inevitable termination of their contract, while Wilson issues advice for contractors propositioned with an unlawful arrangement:

“Suing a client is always a difficult proposition. Unfortunately, this is the horrible position that the Off-Payroll rules have placed many contractors into. Those negotiating contracts to find clients and agencies attempting to facilitate unlawful deductions need only to flag up the illegality. If client and agent still insist on applying such measures, the contractor will have to consider whether they want to accept a contract with a party that’s willing to disregard the law.”

Published: 20 March 2020

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IR35 and Off-Payroll Explained