Contractors, will the client owe you a backdated pension now you’re their employee?

As businesses hurry to adopt April 6th’s IR35 reform, one area which has been partly overlooked in the rush is pensions – and the risk that engagers may be liable for backdated pension contributions for contractors newly classified as employees, writes Jeremy Harris, pensions lawyer at law firm Fieldfisher.

The important backdrop is that chancellor Sajid Javid’s review of IR35 reform was announced on January 7th, to the suggestion that the changes to the off-payroll working rules will proceed on April 6th without major revisions to the draft IR35 legislation.

Engager? Worker? Or contractor?

For engagers, the pension implications of the new rules are gradually being recognised as a significant risk, particularly at those private sector end-users with large off-payroll resources.

For workers, those who were previously classed as contractors but which are now being decided as employees for IR35 purposes by engagers racing to get ready for April 6th, it is important that their status is determined by engagers to ascertain what, if any, backdated payments are owed to those individuals. A complicating factor is that an individual's status is not automatically the same for IR35 purposes as it is for employment and pension purposes.

However, the same test applies for pensions purposes as for employment purposes as to whether an individual is an employee or worker on the one hand or a contractor on the other hand. It’s a question of employment law. 

Pensions would dwarf holiday pay and sick pay as a backdated liability

If workers are assessed as employees under IR35 for tax purposes, their employers need to quickly ascertain their liabilities and prepare themselves -- financially, if it transpires they owe sizeable back-payments.

While backdated holiday and sick pay can amount to significant sums, pension contributions potentially represent a much bigger financial risk to employers.

Under UK law, all employers are obliged automatically to enrol in a workplace pension scheme employees working mostly or entirely in the UK, aged between 22 and state pension age and earning more than £10,000 per year .

Assuming that an individual's working practices have not changed over the course of their engagement by the end-user, these individuals could be owed significant sums in pension contributions.

The employer's automatic enrolment obligations are subject to the worker's right to opt-out of membership of a workplace pension scheme. Employers are statutorily prohibited from inducing a worker so to opt out.

Put another way, employers cannot force employees not to have auto enrolment pensions. The Pensions Regulator has statutory power under Part 1 of the Pensions Act 2008 to fine employers for such action.

Would you accept less pay as a permie in return for benefits, including a fat pension?

Some individuals who choose to work through PSCs for tax reasons may resist changing their relationship with an end-user, regardless of how they are assessed for tax under IR35.

However, there will be others for whom employment rights are more important, and who might be willing to accept a reduction in pay, in exchange for the security offered by benefits such as sick pay and pension contributions.

Some former contractors-now-employees may be happy to accept the change in status, move onto the payroll, and settle privately with their employer regarding any financial contributions owed under their previously unrecognised employment law rights.

For pension contributions, such private settlements are unlikely to be effective, as statute prohibits employers from encouraging or forcing workers to opt out of their workplace pensions.

Aside from potential administrative costs, pension auto-enrolment could potentially be administered in a way which causes no overall loss to either contractors or clients. For example, if the worker is prepared to accept a reduced salary in return for pension contributions, this is one way in which the workers can continue to enjoy some tax benefits, without increasing the cost to the employer.

And the benefits are not just purely tax-related. Pensions really are a valuable benefit of employment. As a contractor who becomes an employee, you could have to pay contributions of three per cent of earnings between £6,136 and £50,000 per year; but your new employer would be obliged to pay contributions of at least five per cent of earnings between those levels. 

Achieving a pension position that is acceptable to the worker, client/intermediary and HMRC relies on careful negotiation and full presentation of the facts and available options – a process that can be made much smoother by taking appropriate legal advice.

Engagers are insuring themselves to defuse the ticking pensions-claims timebomb

While the remit of IR35 is in theory relatively clear, many end-users are concerned that any contractors they retain off-payroll will eventually be reclassified as employees by HMRC, creating a ticking time-bomb of employment and pensions claims.  

To light the fuse however, the employee would have to complain to the Pensions Regulator. The Pensions Regulator has power under Part 1 of the Pensions Act 2008 to fine employers, including escalating fines, for breaching their auto-enrolment duty. 

Accordingly, some businesses have concluded that the only viable way of addressing this risk of former contractors being reclassified as employees and pursuing employment and pensions claims is to seek insurance.

Initially, insurers were sceptical about insuring against backdated claims for employer contributions to pensions and other workplace benefits as a result of this April’s changes to the IR35 legislation.

Some have since indicated they are willing to offer insurance if the right legal opinions are provided to back up the end-user's assessment and the chances of successfully justifying it are sufficient. Businesses will need to weigh up whether it is worth taking out insurance based on their circumstances.

Final thoughts

In advance of April 2020, end user businesses will need carefully to assess whether contractors who use personal service companies are in fact workers and employees for IR35 and also for pensions and employment law purposes. If they are workers, such businesses may be faced with an obligation to pay backdated pension contributions to workplace pension schemes for them. Specifically, Part 1 of the Pensions Act 2008 requires employers automatically to enrol their UK employees in a pension scheme with minimum contribution rates. If individuals are found to have been employees from a previous date, then this pensions auto-enrolment obligation will also be backdated.

Businesses may be able to mitigate that obligation by agreeing with the individuals to reduce their pay or by insurance. In some circumstances, the business may be able to justify, on advice and by careful analysis, the continued treatment of such individuals as contractors.