IR35: Shape of things to come?
by Contractor Weekly
HMRC consults on changes to ‘off-payroll’ in public sector
Following the announcement in this year’s Budget that the rules for ‘off-payroll’ workers in the public sector would be tightened up as from April 2017, HMRC have now released the anticipated consultation document, ‘Off-payroll working in the public sector: reform of the intermediaries legislation.
The consultation is concerned with reforming the IR35 legislation to improve its effectiveness in the public sector and seeks views on HMRC’s proposals, in particular:
- The scope of the reform
- How the new rules will work
- Ways to minimise burdens on engagers who are affected
From April 2017, where a PSC is engaged by a public sector body then it will be the responsibility of either that public sector organisation, agency or other third party paying the PSC to assess and apply the IR35 rules and also to deduct and pay over to HMRC the necessary income tax and NIC. Where there are a number of agencies in the contractual chain then responsibility will rest with the agency that contracts directly with the PSC.
In situations where the agency or third party contracting with the PSC is non-UK resident then the liability will fall on the last party in the chain which is resident here. This will either be another agency or the public sector body itself.
Where the rules have not been applied correctly and foul play has been discovered then the liability can be transferred to the PSC and even the director of the PSC, where the worker fraudulently provides the agency or public sector engager with false information.
In calculating the tax and NIC (employees and employers), the engager or agency will disregard VAT charged on fees by the PSC but there is a question mark as to whether or not the flat 5% deduction that is permitted in calculating the deemed payment should be factored in. The allowance is intended to allow for general expenses of running a business, e.g costs of training and seeking out contracts etc. HMRC clearly don’t think the allowance should be permitted as a deduction from gross pay as it would reduce the tax and NIC take. Furthermore, they argue that it may make the process of accounting for tax more complicated for engagers and for the PSC when it has to account for other taxes such as VAT and Corporation Tax. However, respondents to the consultation document are invited to voice their opinions about this issue.
Simplified process and online tool
To make it easier and more straightforward for an agency or public sector body to decide whether the IR35 rules apply to a contract, HMRC has developed a new simplified process using the current employment status rules and supported by an online tool.
Thankfully, HMRC are not imposing their much favoured supervision, direction or control (SDC) test but it appears that control and personal service will be the deciding factors.
In the first instance the engager will use a new gateway process which will indicate if the rules need to be considered. At this stage, the only factor that will not require the engager to consider the IR35 rules is where 20% or more of the contract is for materials consumed in the service. This is an unlikely scenario for the vast majority of contractors.
Having established that a contract is within the scope of the rules then the engager simply has to answer two questions to decide if IR35 applies:
- Is the worker required to do the work themselves?
- Does the engager decide or have the right to decide how the work should be done?
If the answer to both these questions is ‘yes’ then IR35 applies and the engager will have to account for the tax and NIC on their payments to the PSC. If, however, the engager is unable to answer ‘yes’ to both questions then they will move on and use the digital tool.
The new digital tool appears to be a version of the current Employment Status Indicator (ESI) but tailored to the specific needs of engagers in determining if the off-payroll rules apply. Also, when circumstances change, e.g if the contract is extended or working practices change, then it will be necessary to reuse the tool entering the new facts of the engagement.
When the new tool is in use, HMRC will be bound by the outcome of the test, provided the information entered is accurate and circumstances do not change.
Interestingly, the tool will also be available for those working in the private sector on a voluntary basis and this may well be a signal as to where HMRC are heading with IR35 in the future. If the tool is successful for assessing public sector engagements then do not be surprised if HMRC roll it out universally.
The ESI tool has worked successfully for the construction industry for many years now and there is no reason why it could not work as equally effectively for the freelance sector. This, however, is on the basis that the online tool is developed properly and fairly, with sufficient weight attributed to the relevant status questions. It has the potential to be quick, less complicated and provide a high degree of certainty to contractors from the outset of an engagement.
The government have invited comments regarding the two parts of the test and as to how the online tool can be designed to be simple and straightforward to use.
Respondents to last summer’s IR35 consultation document expressed concerns that engagers would take an overly cautious approach to minimise risk if they were required to take a role in ensuring that the IR35 rules are applied correctly. Far from addressing this concern HMRC are, in proposing two simple questions in the first part of the test, leading the engager to answer ‘yes’ and therefore placing the contract inside of IR35 within the blink of an eye. HMRC must not be permitted to induce agencies, as they will be the one’s predominantly affected, into sleepwalking directly into IR35.
Why the need for change?
The original ‘off-payroll’ rules were introduced only four years ago and then amended in April 2015.
HMRC justify the imposition of these new rules on the grounds that there is evidence of widespread non-compliance with the legislation and that where a contractor provides services to a public sector body and is doing a job in a similar manner to an employee then a similar amount of tax and NIC should be paid. More likely an explanation is that the public sector cannot grasp the existing rules and has made a complete hash of applying them.
Definition of the public sector
A public sector body will be those organisations set out in the Freedom of Information Act 2000 and Freedom of Information (Scotland) Act 2002 and will cover:
- Government departments, executive agencies and non-departmental public bodies
- Police and fire authorities
- Local authorities
- Devolved administrations
- Educational establishments including universities
- BBC, Channel 4
- Bank of England
Private companies who carry out public functions for the state, such as a private healthcare company running an urgent care centre at an NHS hospital or charities working in the public sector, will not fall within the definition.
Thankfully, there will be a statutory right of appeal against a tax and NIC liability. Where a PSC or an engager disagree with a determination that the new rules apply, either party will be able to request a formal review of the decision and to appeal that decision to the Tax Tribunal.
The consultation runs for 12 weeks and closing date for comments is 18th August.