How will IR35 changes affect the “dispersed”, “umbrella” or “virtual” legal service providers?
What is a “dispersed” or “umbrella” or a “virtual” legal service provider?
These firms are essentially a legal hub with a minimal bricks and mortar presence supporting a central admin and IT staff and they operate using a bank of consultant lawyers operating through their own individual personal service companies (“PSC”) tied in various ways to the central firm. Fees earned are effectively shared between the individual PSC of the solicitor giving the advice to/acting for the client and the central firm. A good description of these types of firms written by LexisNexisPSL can be read here. They operate in various ways and some of these use elements of the traditional arrangements that have been used by the Bar for hundreds of years with clients contracting directly with the individual lawyer’s PSC through the central hub with fees paid direct to the lawyer who pays a commission to the hub provider to reflect its central costs. Essentially, it’s an “eat what you kill” approach to profits combined with an element of costs and profit sharing to reward what is in effect the franchisor and the shareholders in it. Although the PR blurb often refers to innovative ways of working and better ways to “deliver” legal services one of the main drivers behind these structures is our old friend tax and NIC savings in terms of PAYE and employer’s NIC compared with the more traditional firm that employs solicitors directly below an elite layer of owners or “partners” and who pay full employers NIC. The risk that these firms face from a tax and NIC perspective is that they offer what is really disguised employment of lawyers through the medium of PSCs especially where the clients contract with the firm. The risk of these arrangements being challenged by HMRC will increase with the extension of the IR35 rules from the public to the private sector in April, 2020.
What will these rules require?
From April 2020 when the IR35 rules apply, the central firm or legal hub paying fees to the lawyer’s individual PSC may be treated by HMRC as the employer for income tax and NIC purposes. The fees paid to the PSC will be treated as if they were in fact a payment of the lawyer’s employment income when they are paid. The amount treated as the lawyer’s employment income will be the VAT exclusive amount paid to the PSC. For income tax and NIC purposes, the lawyer will be treated as having an employment with the central firm rather than the lay client. This will require the central firm fee-payer to operate the rules for tax and NICs in the same way as for a normal employee. The off-payroll lawyer will be legally required to provide their National Insurance Number, tax code and identity details to enable the correct tax to be deducted. On or before the central fee-payer makes a payment to the lawyer’s PSC, the fee-payer will have to complete the normal Real Time Information (RTI) process and notify HMRC of the amount of the taxable earnings and the tax and NICs deducted.
Will there be exceptions from IR35 working for small firms?
Yes. Firms that are classed as “small” organisations will not be affected by the reform and will not need to decide the status of the off-payroll lawyers they hire or to operate IR35. They will need to use the existing statutory definition within the Companies Act to determine whether or not a corporate client is small. This definition is in section 382 of the Companies Act 2006 and provides the Companies Act definition of “qualifying as small”. The qualifying conditions are met by a company in a year in which it satisfies two or more of the following requirements —
- Annual Turnover not more than £10.2 million
- Balance sheet total not more than £5.1 million
- Number of employees not more than 50
The reform will apply to all firms who do not qualify as small under the test set out in section 382 (including those small companies which are excluded from qualifying as small despite meeting the requirements). Companies in small groups as defined by section 383 of the Companies Act will also qualify as small for the purposes of the April 2020 changes.
How can I tell if I will be affected?
HMRC offer an on-line tool called Check for Employment Status for Tax or CEST to help Clients decide if PAYE should be applied to the fees paid to the lawyer’s PSC.
Are the problems with HMRC’s online CEST?
It seems that CEST fails to reflect many previous tax tribunal decisions on whether a worker is genuinely self-employed or a disguised employee and as such subject to PAYE. Worse still when the information regarding the TV presenter Lorraine Kelly was put into CEST it said that she was really an employee, contrary to the clear decision of the tax tribunal. Therefore, please be careful when using HMRC’s CEST tool and seek professional legal advice if you are unsure about IR35 off-payroll working and how it will apply to “dispersed’ or “virtual” law firms in the private sector or could use help drafting the contractual documents.
Some tips to avoid IR35 in the Legal Sector
There are various things that central legal hub type firms can do if they wish to preserve their current tax and NIC advantages and avoid the application of IR35 from April 2020. First, one of the crucial tests for genuine self-employment status is whether or not the PSC has the right to substitute another worker to fulfil the obligations under the contract between the PSC and the firm. As a drafting matter this is fairly easily achieved however careful consideration needs to be given in the context of legal services regulated by professional bodies such as the Solicitors Regulation Authority as to whether the lay client has given genuine and informed consent to the possibility that the particular lawyer he has retained could be replaced during the course of the matter given the duty to act in the best interests of the lay client. In reality is there a bank of solicitor colleagues available to take over the matter at short notice should the need arise as there would normally be in a traditional law firm? Second, in many cases the individual lawyers have, through their own PSC, historically contracted mainly or only with one “dispersed” firm. Many such lawyers are now seeking to widen the scope of their “dispersed law firm” “clients” with whom their PSC does business in order to be able to demonstrate to HMRC that they are operating more like self-employed consultants with a range of clients rather than mainly with just one “employer”. Again, if the lawyers are genuinely acting for a range of different organisations this might give rise to a tension between the desire of a particular ‘dispersed law firm” to present itself to lay clients as having the resource of a dedicated group of lawyers with all the coherence and continuity of a traditional law firm (“our dedicated lawyers” for example) when in reality the firm is an “umbrella” which hires in consultants lawyers when a client approaches it for advice and those lawyers have commitments elsewhere. Clients must not be misled about this from a professional viewpoint but HMRC will be concerned to check that the other consultancies that the lawyer holds are genuine and produce remunerative work.
This article was provided by Patrick Cannon, leading SDLT Barrister and Tax Barrister. Patrick advises on and appears in civil and criminal tax disputes with HMRC, challenges to tax avoidance schemes and action against professional and other advisers who mis-sold aggressive tax avoidance schemes now subject to APNs and Follower Notices.