Perhaps surprisingly in a Conservative government, the IR35 rules have been tightened, in order to ensure that the taxman gets its fair share of revenues, when creators and their clients enter into entertainment, film, media and professional sports contractual arrangements. What is at stake for the creative industries in the UK? How to make the most of loan-out companies and loan-out agreements, while ensuring compliance with the revised IR35 rules?
1. What are loan-out companies?
In the entertainment industry, accountants often advise their clients, who work as key talent and crew in the film, TV, sports and media sectors, to set up a personal service company (‟PSC”) with Companies House, the United Kingdom (‟UK”) registrar of limited companies.
Such personal service companies are also called ‟loan-out” corporations because this is the jargon term they are referred by, which comes from the USA. Indeed, the US, as a global leader in the entertainment industry, was the first country where creators used this form of US business entities to loan-out their services, via the corporate body, to their end-clients.
The creator is usually the sole shareholder and director of the loan-out company.
The loan-out entity is engaged by external third parties (i.e. the end-clients) to fulfil entertainment, media or professional sports services, which are going to be performed and executed solely by the creator. Consequently, it is the talent’s loan-out company that is referred to, and liable, in contracts to perform the services required.
Since the creator’s services are typically performed on individual contract bases, in exchange of large, irregular sums of income throughout the year, the loan-out business model is especially prominent in the entertainment, media and professional sports industries.
Article 17 of the OECD Model Income Tax treaty of 1930 appears to be the foundation by which loan-out corporation structures may be used, as it provides that athletes, celebrities, artists who operate across several countries, and who therefore earn income under several national taxation systems, may only be taxed in their home jurisdiction’s source of income (even without an established corporate body).
By the 1970s-1980s, loan-out companies, or PSCs as they are more commonly referred to by the UK taxman, HMRC, and UK lawmakers, were widely used by entertainers, top talent and crew, as well as professional sportspeople, in the UK.
2. How to use PSCs and loan-out agreements?
Loan-out companies are used as a means to reduce the personal liability of the talent, as well as protect their personal assets.
Indeed, since the SPC is the sole party to any services agreement entered into with the end-customer, then, such end-client cannot go after the personal assets and liability of the creator, in case things go south during the execution phase of such services. The end-client – who is the counterparty to that loan-out agreement – will only be able to sue the SPC and trigger the limited liability of such loan-out company.
Moreover, in the UK, private companies limited by shares (which represent over 95 per cent of all companies in existence in that country), limit the liability of their shareholders to creditors of the company, to the capital originally invested, i.e. the nominal value of the shares and any premium paid in return for the issue of the shares by the company. Therefore, a shareholder’s personal assets are protected in the event of the company’s insolvency or increased liability to a third party.
Also, in the UK, the corporate veil is thick and not often, or easily, pierced: UK company directors incur no personal liability because all their acts are undertaken as agents of the SCP. While there are certain circumstances where personal liability may be imposed by the UK courts, particularly in respect of wrongful or fraudulent trading, it is rare that the corporate veil is pierced, and that the owners are held accountable, on their own assets, to pay off the limited company’s debts.
In a loan-out agreement, the party which is the loan-out company is typically responsible for dealing with the tax and/or any applicable national insurance contributions (‟NICs”) on any payments made under this agreement, by the counterparty.
This loan-out structure is therefore beneficial to, and flexible for, the end-client, who is unencumbered by HMRC’s rules on income tax and employer NICs payable on employees’ salaries, as well as protective employment law regulations applying to employees and self-employed people/freelancers relating, in particular, to a right to holiday, the national minimum wage, workplace pension and the maximum amount of 48 work hours per week.
There are also some tax advantages to this loan-out arrangement for the creator: first, the range of expenses which the PSC may set against its taxable profits will be much wider than that allowed to an employee to set against their taxable income. Second, there will be a cash-flow benefit in avoiding income tax being deducted at source each month. Third, the individual, as shareholder, may be in a position to be paid dividends by their loan-out company, which is a more tax-efficient alternative to only being paid earnings as the PSC’s employee, since this dividend form of income is not subject to NICs.
Therefore, loan-out agreements often lead to win-win situations, for the talent and their end-clients, provided that such services agreements are drafted correctly. In particular, the producing entity needs to ensure that all intellectual property created by the talent is assigned to the production.
Such loan-out agreements are typically called ‟producer agreement” or certificate of engagement (‟COE”). Indeed, a COE transfers to a studio or production company all rights in the results and proceeds of the services of an independent contractor (talent like an actor, producer, model, director or professional sportsperson) on an entertainment production, such as a television movie, theatrical motion picture film, TV or online series, social media content, or commercial. The COE includes work made for hire and assignment provisions. The parties negotiate and execute the COE promptly after agreeing to all deal terms before entering into a long-form agreement, such as a producer agreement, at a later stage.
As there can be some risks with the loan-out approach, in case the COE and/or long-form agreement are drafted incorrectly, it is best practice to seek expert legal advice when drafting, and reviewing as well as negotiating, a loan-out agreement.
3. What is the future of loan-out companies and agreements within the new IR35 landscape?
While I highlighted that loan-out agreements may be a win-win arrangement for the creator and their end-clients, there is one entity which has a lot to lose out of them: the taxman.
By the late 1990s, there were concerns that PSCs were being widely used, in the UK, to disguise the fact that, in many situations, individuals were working effectively as their client’s employee, while garnering the loan-out structure’s tax benefits.
To counter this type of tax avoidance in the March 1999 Budget, the Labour government announced it would introduce provisions to allow the tax authorities to look through a contractual relationship, where services were provided through an intermediary such as a PSC, but the underlying relationship between the worker and the client had the characteristics of employment. In those circumstances, the Labour proposals went, the engagement would be treated as employment for tax purposes.
Provision to this effect was included in the Finance act 2000, with effect from the 2000/01 tax year. The legislation is commonly called ‟IR35”, after the number of the Budget press notice which first announced this measure.
For the last 20 years, IR35 remained controversial, but were retained, even by the Conservative governments which succeeded the Labour one.
However, concerns escalated when it was discovered that the use of PSCs was common by senior staff in the public sector and by contractors working for the state-owned broadcaster BBC.
Since 2014, the various Tory governments went about cleaning the slate, by reforming the way the IR35 rules worked in the public sector. Following these reforms to the application of IR35 in the public sector, the government introduced legislation to make similar changes for the private sector to take effect from April 2021.
How do these changes affect creators in the entertainment, media and professional sports industries, since April 2021?
From 6 April 2021, IR35 rules applying to PSCs shift the responsibility from the PSC to the organisation receiving the talent’s services.
Before 6 April 2021, it was the loan-out company that was responsible for assessing and making payment of income tax and/or NICs for the services being provided by the creator/talent.
The government’s reforms for private sector companies are intended to improve compliance with the IR35 rules by moving the responsibility for tax assessment and payment from the contractor to the end-client. What this means, in the film, media and sports context, is that a producer engaging the services of a talent is now responsible for assessing whether that individual should be legally treated as an employee if they were being engaged directly by the producer, rather than through the loan-out company, and, if so, for accurately deducing income tax and NICs from the individual’s pay.
However, this change only affects large and medium size businesses, meaning that producers which fall into the category of a ‟small business” are not affected by the new IR35 provisions. It is not yet known how a ‟small business” will be defined by HMRC, and what criteria will be applied by HMRC to any assessment as to business size.
For example, our law firm Crefovi recently advised a client, whose producer services were retained by a production company working on behalf of the BBC, the commissioning broadcaster of an upcoming TV series, via his loan-out company. When I asked this client how much the budget of these TV series was, since such information was not disclosed in the draft producer agreement he had asked us to review and analyse on his behalf, he replied ‟GBP10 million”. I would argue that this budget size definitely places the BBC- commissioned production company into the category of ‟medium to large business”. Yet, the production company’s solicitor had drafted the loan-out agreement in such a way that the onus of paying any income tax and NICs liabilities, on the producer’s payments, layed solely with our client’s loan-out company, not with the production company.
Even if HMRC has confirmed, in its guidance on the new IR35 rules, that ‟customers will not have to pay penalties for inaccuracies in the first 12 months relating to the off-payroll working rules, regardless of when the inaccuracies are identified, unless there’s evidence of deliberate non-compliance”, and that HRMC ‟will not use information acquired as a result of the changes to the off-payroll working rules to open a new compliance enquiry into returns for tax years before 2021 to 2022, unless there is reason to suspect fraud or criminal behaviour”, it seems that UK production companies and their accountants and lawyers still turn a blind eye on their new responsibilities, post April 2021. This will trigger quite a few compliance enquiries with HMRC and, no doubt, tax litigation in the coming years.
Watch that space and, if you are a responsible creator, or production company owner, do reach out to us, at Crefovi, so that we may advise you on how to still reap the benefits of loan-out companies and structures, while minimising heightened legal and tax risks caused by this more stringent IR35 framework.