Contractors, did you know the viability of umbrella companies hinges on the word ‘or’?

Since we illuminated the quietly tweaked new IR35 term ‘intermediary,’ there’s been quite a bit of hype regarding how potential interpretation of this amend to the off-payroll legislation could class umbrella companies as such an intermediary, before which deduction of employment taxes would be due -- meaning umbrellas simply wouldn’t be needed anymore, writes Lucy Smith, managing director of Clarity Umbrella.

'Absurd'

This interpretation, called “absurd” by the chairman of a leading contractor trade body, indicates that recruitment firms will be given the responsibility of ensuring the correct employment tax deductions are made from April 2021, before parting with any money for their contractors’ assignments. Others who’ve followed through this interpretation even think that it would mean that the new IR35 rules are going to apply to agencies who engage contractors on PAYE contracts!

Much of this increasingly discredited but understandable interpretation stems from the definition of 'intermediary; within the incoming off-payroll legislation and who in turn becomes the ‘fee-payer’ responsible for income tax and PAYE deductions. The issue has arisen on the basis that the legislation and guidance provided by HMRC appears to contradict each other. It is not the first time that legislative holes in the IR35 framework, which HMRC will likely go onto deem ‘unintended consequences’ have been spotted at the 11th hour.

Umbrella contracting's viability? It all hinges on 'or'

Our reading is that it still appears at present that the position remains that umbrella companies, in which the worker has no material interest, can continue exactly as before subject to employment payment rules. But this is all down to the interpretation of the word “or”, which is included in the legislation (italicised below) but omitted in the corresponding guidance.

In section 61O(1) (conditions where intermediary is a company) for paragraph (b) substitute—

“(b)it is the case that—

(i)the worker has a material interest in the intermediary,

(ii)the worker has received a chain payment from the intermediary, or

(iii)the worker has rights which entitle, or which in any circumstances would entitle, the worker to receive a chain payment from the intermediary.”

The requirement in the legislation that ‘the worker has a material interest in the intermediary’ is still in place, so if the first condition applies, the conditions listed below it then apply too. So umbrella companies become exempt, whereas organisations in which workers do have a material interest e.g. a PSC that either make a payment or defer a payment (to which the worker is entitled) must comply with the new IR35 rules.

However, the guidance indicates something to the contrary; this time it adds in the word “or” at the end of point (i), by claiming that the legislation reads as follows: (i) the worker has a material interest in the intermediary, or.

If the guidance is correct and the published legislation is to be subsequently amended, the knock-on effect would indeed apply the IR35 rules to agencies who engage contractors on PAYE contracts, because 'material interest' would be irrelevant and the agency would be the intermediary, thus removing the option of using an umbrella company.

Over to a legal eagle to unpick this further...

Here, I’d like to defer to Victoria Goode, consultant partner at Lewis Silkin who I approached for this ContractorUK article.

“Strictly under the legislation in a labour supply chain of client-agency-umbrella-employee, the agency would be required to operate PAYE/NICs as the feepayer,” she explains.

“There is nothing to prevent the umbrella still operating PAYE/NICs as agent for the agency. But strictly-speaking under the new IR35 rules, if there was a default the agency would be ‘on the hook’ and would be left seeking to recover the amount from the umbrella under any contractual identities.” 

So like many others in the contractor industry, Goode believes that, “HMRCs need to clarify the position as a matter of urgency.

“And perhaps they should introduce an exemption for employment income  -- where the 5 per cent-shareholding-test does not apply. If the rules are left as currently drafted, it does create a huge amount of uncertainty for all parties in the labour supply chain.”

The backdrop isn't in agreement either

With much seeming to hinge on the word ‘or,’ are we all getting hung up on an unintentional typo on the part of HMRC? I would assume so.

Since the publishing of the Taylor Review, we know that it is HMRC’s intention to provide some kind of regulation within the umbrella industry while supporting those umbrella players who are operating compliantly.

One could therefore ask, why would officialdom be spending time on implementing ‘Taylor’ if their intention was to effectively remove the requirement of the brolly altogether? If the change was amended to bring the legislation in line with the guidance, it would undoubtedly cause huge issues within the industry not only for umbrella companies who would be brought under the remit of IR35 and excluded from working with those ‘deemed employees,’ but it would also put pressure on the agencies who would now have less than six months to provide a fully functioning payroll division in order to make the required deductions!

To the fretters...

I, for one, am not going to sit and fret. For those who are, bear in mind HMRC has already confirmed that this interpretation is going to be looked into. But more than just that actually – the Revenue has already said that the rendering of umbrellas as redundant in this way isn’t their objective and so they are going to move to ensure the interpretation is headed off. Storm in a teacup, anyone? Or the very real dangers of an HMRC typo we might never receive an apology about? Contractors will make their own minds up, in time. And similarly, I will now be waiting patiently for the HMRC amend to be tabled – apparently as soon as tomorrow (Wednesday), which rather underlines just how keen the Revenue is to put a lid on this can of worms.