A fundamental shake up of the tax rules applying to contractors has the potential to cause increased costs and risks to the oil and gas industry.
The UK oil and gas sector has a long tradition of engaging contractors through Personal Service Companies (PSCs) and while numbers have reduced during the economic downturn, there remains a significant number engaged within the supply chain. This framework has evolved over time and is attractive to operators and service companies because it allows them to be nimble, offering greater flexibility to scale manpower up and down according to project requirements.
Previously the matter of determining if an individual would be taxed as an employee or as self-employed lay with a PSC, but with the introduction of IR35 tax reforms by HMRC that responsibility will now fall to the end-user. In simple terms, the level of tax to be paid has not changed but the liability for making the assessment has changed and this will have repercussions for businesses throughout the supply chain.
Depending on the circumstances, the end-user could be the client at the top of the supply chain or another company within the supply chain. The oil and gas sector is now grappling with the thorny issue of how contractors’ tax should be treated – and if the end-user does not make the correct tax determination they will leave themselves open to financial penalties.
The changes come into effect from April 2020, but as an employment law specialist working in the energy sector my advice to businesses is to act now, don’t delay. Companies would be wise to conduct an audit to establish how many contractors are engaged through a PSC and whether they are engaged directly or through an agency or some other intermediary.
An analysis of the supply chain and the contracts involved would be helpful because liability, and potential costs, can move up through the supply chain. Businesses should identify if they are the end-user with responsibility for making a tax determination, or the fee-payer, in which case they will have to make the tax deductions and pay any employer’s national insurance contributions. Once PSC contractors are identified, I suggest a comprehensive risk assessment to identify the risk of exposure to the IR35 changes. Businesses should also analyse existing controls including procurement and HR procedures.
Aside from the detail of the compliance project, this new legislation may also create commercial risks for businesses. Let’s assume a business has a number of highly skilled and specialist contractors each engaged through a PSC on business critical projects. If IR35 changes mean they are now taxed in a different way, is there a risk they will seek employment elsewhere and cause disruption or delay to those critical projects? Will they expect increased rates to make up the difference in pay or indeed employment rights going forward? It is crucial that oil and gas businesses retain the flexibility that is so important for the industry with a resourcing model that works and early risk assessment and planning is key to success here.
On top of the management time, effort and costs in dealing with the changes, businesses have to factor in the knock-on commercial risk and how they will respond if key staff choose to leave, and the financial and reputational cost to the business if that plays out.
Solutions might include increasing the day rate of key contracting staff to compensate for any loss to individual earnings or to offer them roles as employees with associated benefits. There are various options open to limiting the impact of the tax changes but businesses need to consider what works best and to plan ahead.
It is important that businesses communicate openly with their supply chain and agree on how to approach IR35 issues. All parties need to agree who is the end-user and therefore will make the tax determination. They will also want to establish if particular individuals need to remain engaged on key projects and agree the best route for making that happen. Conversations also need to take place with the contractors themselves – before they decide to seek work elsewhere or in another oil and gas producing region with more favourable conditions.
IR35 impacts on more than the payroll department and it makes sense to ensure all key stakeholders within a business are included in the process of planning and risk assessment – from HR, operations, supply chain management, legal advisors and communications. It is important that the relevant people are involved at the outset and can add their expertise, as this will help minimise business disruption and commercial risk.
It is clear that addressing IR35 changes will not be a simple fix. It may come down to cost and if companies are prepared to absorb an increase in the cost of day rates to ensure key contractors are not financially impacted. In an industry which is looking to the future challenges of energy transition, this may be a good time to review resourcing models to ensure that risks are minimised going forward.