New Rules for Contractors working in the Public Sector
By Contractor Weekly
From off-payroll to on payroll
Those pre-Budget newspaper stories about the Government tightening up the rules for ‘off-payroll’ workers in the public sector were actually true as George Osborne announced in the Budget that IR35 for public sector engagements will be reformed...
From April 2017, PSC’s supplying their services in the public sector will be relieved of deciding their IR35 status and this responsibility will become that of the public sector client or agency or another third party. One of those three will have to decide whether or not IR35 applies to a contract and, if so deduct and pay over to HMRC the necessary PAYE tax and NIC.
Where a PSC is engaged via an agency or other third party, then the party closest to the contractor in the supply chain will be the one responsible for enforcing the rules.
In a Budget technical note, HMRC explain that they will introduce clear objective tests for engagers to use to decide at the point of hire whether or not they need to even consider the new rules and then to quickly and decisively identify those engagements that are clearly caught by the rules.
For cases that are less clear cut HMRC will develop a simple and straightforward digital tool to assist engagers in deciding if IR35 is relevant.
HMRC will provide simplified guidance, including the digital tool, to provide up front certainty. By answering the questions in the guidance and using the tools will give the engager HMRC’s view of the correct tax treatment. This would seem to suggest that the tests applied will be more limited than those currently used in deciding employment status together with HMRC’s narrower interpretations.
Businesses and agencies within the private sector will also be able to make use of the new digital tool. Presumably this will be a version of the Revenue’s current Employment Status Indicator (ESI) online tool that HMRC are developing for use within the contracting industry anyhow.
It is important to note that contractors working within the private sector will continue to be subject to normal IR35 rules and will not be affected by these proposed measures.
Where these new rules apply, they take precedence over the current IR35 rules.
Meaning of public sector
Public sector will mean organisations that are public authorities for the purposes of the Freedom of Information (FOI) Act 2000 and Freedom of Information Act (Scotland) 2002.
The FOI Acts define the public sector under broad categories:
- Government departments, legislative bodies, armed forces
- Local government
- Schools and further and higher education institutions
- Other public bodies such as the BBC, Channel 4 and The British Museum
- Publically owned companies (wholly owned by the Crown and/or the wider public sector such as Transport for London)
This is not an exhaustive list.
Where a public sector organisation engages a contractor via an agency then they will have to inform them that the new rules apply and also check that the agency are operating the rules correctly.
For more complex contractual chains, e.g involving a series of agencies or when the liable agency/organisation is offshore, there will be special rules. Where a series of agencies are involved or other third parties in the chain, the party closest to the PSC will be held responsible for complying with the rules.
Deducting PAYE tax and NIC
Where a contract is deemed to fall within the new rules the engager will be required to calculate the deemed employment income. This will be the fee paid to the PSC excluding VAT and minus the 5% fixed deduction that is currently allowed under existing IR35 legislation. The balance will then be subject to tax and NIC and reported under Real Time Information (RTI).
Example 1 - Central Government – rules apply
Grace works through her own PSC and is appointed as a senior analyst at the Ministry when the post holder leaves. She is a locum appointed to a project for 5 months while the job is advertised. Human Resources uses HMRC’s online tool to see that Grace is working in the same way as an employee and the new off-payroll tax rules apply. Payroll are informed and tax and NICs are deducted from payments made to Grace’s PSC. The Ministry pays the secondary NIC and accounts for the tax and NIC liabilities under RTI.
Grace’s PSC invoices the Ministry monthly for £2,400, which includes £400 VAT. The Ministry treats £2,000 as Grace’s earnings and deducts £223 tax and £159 employee NIC, which it pays to HMRC via RTI with £183 employers’ NIC. The Ministry pays Grace’s company £1,618*.
As Grace has paid income tax on income going into the PSC, she receives a credit against employment and dividend income drawn out of her PSC so she does not pay tax twice. The corporation tax liabilities of Grace’s PSC will remain unchanged by the measure.
Example 2 – Local Government using an agency – rules apply to the agency
Charlie is a locum social worker within the Child Protection team at a County Council. The Council contracts with an agency to supply Charlie for 9 months. He is not an office holder under the Local Safeguarding Children Board Regulations (otherwise he would be automatically required to be on the payroll under the current legislation). The agency contracts with Charlie’s PSC. The agency checks HMRC’s new tool to see what the tax position is and finds that the off-payroll rules apply.
The agency must deduct tax and NIC on the payments it makes to Charlie’s company. Charlie’s PSC charges the agency £1,500 per month for his services. Charlie’s company is not registered for VAT. The agency treats £1,500 as Charlie’s earnings and deducts £123 tax and £99 employee NICs. It accounts for this via RTI and pays the tax and employee NICs to HMRC along with £114 employers’ NIC. Charlie’s PSC receives £1,278*.
Charlie receives a credit against employment and dividend income drawn out of his PSC so he does not pay tax twice. The corporation tax liabilities of his PSC will remain unchanged by the measure.
*For simplicity, the examples do not include 5% fixed expenses.
Detailed proposals will be published in a consultation document before the summer when views will be invited on the following points:
- the definition of the public sector for the purposes of these changes and impacts on specific groups;
- the development of the new test and tools for determining whether an engagement should be considered employment for the purposes of employment taxes; and
- how the 5% fixed expense deduction would work with the new rules.
Following consultation, the government will introduce the legislative changes in Finance Bill 2017.
At face value these new proposed measures make grim reading for those contractors affected as they are left out of the decision making process and appear impotent in this respect. However, given the fact that freelancers play an important role in providing much needed services to the public sector and that an organisations’ costs will be driven up by the requirement to pay employers’ NIC, then will these organisations be more keen to ensure that self-employed status is preserved? Particularly in a time where departmental budgets are either being cut or squeezed, then there may be an opportunity to bring all the relevant parties to the table before the start of an engagement to ensure that everyone is singing off the same hymn sheet or is this just sheer fantasy!
Published March 2016