The Agency Legislation: an overview for contractors

Incorporated within sections 44 to 47, Chapter 7 of Part 2 of Income Tax (Earnings and Pensions) Act 2003 and the Social Security (Categorisation of Earners) Regulations 1978, the so-called Agency Legislation targets employment intermediaries facilitating false self-employment to avoid employment taxes, writes Chris Mattingly, lead compliance specialist at WTT Consulting.

Fueled by widespread abuse, the agency legislation was significantly amended in April 2014. As well as introducing new anti-avoidance provisions and a new record keeping and returns regime, the legislation introduced changes to the conditions for liability and for determining which party would be responsible for deducting and remitting income tax under PAYE, and who must deduct, pay, and remit Class 1 National Insurance contributions (NICs) as the secondary contributor.

When does the Agency Legislation apply?

The conditions for liability under the agency legislation are that the worker must personally provide services (which are not excluded) to the client, under or in consequence of, the contract between the client (or a person connected and the client), and a third party who is not the worker, the client, or a person connected with the client – the “agency”.

Providing that a worker’s remuneration for providing their services has not already been treated as employment income, the agency legislation applies. And that means the worker will be deemed to be in receipt of employment income -- unless the manner in which the worker provides their services is not subject to (or subject to the right of) Supervision, Direction or Control (SDC), of anyone in the contractual chain.

Who is the deemed employer?

The deemed employer will be the closest agency to the client - or where such agency is offshore, the client -- and they will be responsible for the deduction of income tax and NICs from the worker’s remuneration through PAYE and pay secondary Class 1 NICS.

Should liabilities remain unpaid by the deemed employer, HMRC may hold the company directors (or for LLPs, its members) personally liable.

Supervision, Direction or Control? It’s all about the ‘how’

When it comes to determining whether or not the worker is under supervision, direction or control, the SDC test focuses on whether or not the worker has the freedom to choose ‘how’ they do their work. Does someone have the power or authority over the worker to dictate ‘how’ the work is done, by imposing control over them, subjecting them to supervision or giving them directions?

Where it is determined the worker is not under SDC, the agency does not need to operate PAYE on the worker’s payments and the worker can be paid gross.

It remains that the default position is that SDC exists and therefore the burden of proof is upon the agency to assess and record evidence that can support the basis for any gross payments it makes.

Agency Legislation and IR35

When a worker provides their services through their Personal Service Company (PSC), the agency legislation will not generally apply.

This is primarily because if the SDC rules are applied and the worker is to be taxed as an employee, the remuneration received by the worker by way of salary should already have been treated as employment income.

The PSC would be responsible for making the tax and NIC deductions and paying them over to HMRC.  Any dividends received – providing they are genuine – would be classed as a return on capital distribution, not renumeration in consequence of the worker providing their services.

Where the agency legislation does not apply, the Managed Service Company (MSC) legislation, the Off-Payroll Working rules and IR35 would prevail; in that order.

Agency legislation case law – K5K Limited

Recently, the First-tier Tribunal (FTT) released the first ruling in some time on the application of section 44 ITEPA 2003 with K5K Limited v HMRC [2022] UKFTT 217 (TC08450).

Many expected the agency legislation only to be applied in situations where a worker had received gross payments while under the supervision direction or control of a party in the contractual chain. But, in this case, HMRC successfully argued that a number of engagements involving the supply of workers through their own PSCs were caught by section 44 – and that K5K Limited, the agency that supplied the workers, should have deducted income tax and NICS from the payments it made to its workers.

It is normally the case that a decision in a tribunal acts as a pointer toward those actions a taxpayer should take to avoid being in the same boat. In this case however,  there was a fundamental hole in the processes operated by K5K Limited -- there was no contract between the individual worker and the end-client.

The tribunal therefore reached a conclusion that essentially said, ‘We all agree there is a worker and all we need to decide is who the employer is.’ In the absence of any recorded terms and conditions between the end-client and worker, there was only ever one answer -- K5K Limited were squarely caught by the agency legislation.

These rules were designed entirely for this purpose and to nobody’s surprise, worked as advertised. The only lesson here is that lack of attention to the basics has only one outcome.

Unknowns of the K5K Ltd case, and an alert...

We don’t yet know if HMRC sees this situation as a common one in agencies in the health sector, or just common in agencies generally. It is common for HMRC to kick off a campaign in a particular business sector with a ‘slam dunk’ case in tribunal to act as a benchmark. This may be that case for those small agencies working in the health sector.

There is no mention in the K5K Limited case as to the fate of the workers. Yes, their remuneration was held to be taxable and that tax/NIC was due from K5K, but what happens if it’s not paid? Many agencies work on fine margins and may not have the resource to pay that bill which is likely to run back many years.

Be aware, it is a trend in contracts between intermediaries and workers to see tax indemnity causes. Basically if the party liable to tax eventually pays something due to a fault or flaw in the process, that party can seek recovery from the individual worker. Such contracts are clearly signed on a voluntary basis (most of the time), but care should be exercised to read and understand very carefully any clauses that mean the tax burden, brought about by poor compliance or misunderstanding of the rules, might throw up in the future.

Either way, the judgment underlines that HMRC can -- and will -- use the agency legislation to tackle disguised employment, even when a PSC is present.