IR35 in the public sector: proposed government changes
Earlier than expected, HMRC has announced worrying plans to radically change the way IR35 works for public sector engagements. IPSE will robustly fight the plans announced in the consultation yesterday, which the government intends to come into force from April 2017.
What exactly is government proposing?
The consultation document puts forward a set of proposals that will change the way IR35 works for public sector engagements. In essence the government wants public sector organisations or the agency to determine the IR35 status of engagements and then, if caught, apply taxes as they would for their employees, through the RTI system. This paragraph from page six sums it up:
‘This means that where an individual provides services to a public sector engager through a PSC and is doing a similar job in a similar manner to an employee, both they and their engager will be required to pay broadly the same tax and National Insurance as if they were an employee. This will be the case whether the individual is engaged directly or through a third party such as a recruitment agency. Taxes will be reported through the Real Time Information system, and paid using HMRC’s accounting procedures which public sector organisations and agencies will already be using for any individuals they employ directly’.
How will these changes affect independent professionals?
IPSE believes that by transferring liability to pay the correct employment taxes from the worker’s own company to the public sector body or agency a number of problems will be created. Independent professionals will be deterred from working in the public sector, while organisations will be less likely to “risk” engaging contractors, damaging their ability to deliver vital projects.
Further, these proposals blur the boundary between employment rights and tax status – the government want to tax independent professionals as if they were employees, but not give them employment rights.
Is this just for the public sector?
Yes – for now. The consultation document makes clear the rules in the private sector will remain unchanged. However there are inevitably concerns that if this measure can be “successfully” brought in to the public sector, further down the line the government will seek to apply it to the private sector too. It is therefore even more essential that IPSE challenges the proposal effectively.
How are public sector bodies and agencies going to determine the IR35 status of engagements?
HMRC is going to develop an online tool to determine status. The IR35 Forum is already being consulted on the development of this tool. IPSE has serious concerns about the tool providing results that are accurate and unbiased.
Are the underlying factors which determine IR35 status changing?
No. IR35 status will still be determined using the same tests e.g. substitution, SDC (supervision, direction and control), MOO (Mutuality of Obligation) etc. Many had thought HMRC would seek to streamline the test to make it just about SDC – but the document makes clear this isn’t happening:
‘The basis on which the rules are applied to determine whether a worker would have been an employee if engaged directly is not changing. This is the case for engagements with both private and public sector clients’. (page 11)
The only thing that’s changing is, that in the public sector only, the responsibility (and liability) for determining whether IR35 applies is moving from the contractor/PSC to the public sector body or agency.
Can the decision be appealed?
Yes. Page 29 states:
‘There will be a statutory right to appeal against the tax and National Insurance liability. Where a PSC or an engager disagree with a determination that the new rules apply, the PSC and/or engager will be able to request a formal review of the decision and to appeal that decision to the tribunal in the same way as other Pay As You Earn and National Insurance decisions and determinations’.
This has big implications. If the new rules are brought in and used to unfairly determine status, it can be challenged at tribunal. If successful it would undermine the tool and the rules, so there is some pressure on the government to make the tool robust in the face of appeals, which will be challenging.
When is the public sector body responsible and when is the agency?
If there is no agency in the chain and the PSC contracts directly with the public sector body, then the public sector body is responsible for determining status.
If there is one agency in the chain, responsibility passes to the agency.
If there is more than one agency in the chain, responsibility passes directly to the agency that contracts directly with the PSC.
What constitutes a public sector body?
Any organisation that is legally required to respond to Freedom of Information (FOI) requests. Examples given are on page 12:
- 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
An extensive list of organisations covered by the FOI legislation is included in the Annex (p.47).
When does the government want these new rules to come into practice?
April 2017. Draft legislation is expected after the Autumn Statement later this year. This short deadline poses a technical problem for engagers. They often have entirely different computer systems for paying employees through RTI and paying invoices.
To apply these rules these systems will need to be joined up. Government acknowledges this problem (page 19) but believes the April 2017 deadline gives plenty of time to put the necessary systems in place. It is likely some engagers will disagree.
How will VAT be affected?
PSCs will still have to charge and pay VAT, even if they are caught by the new rules. This means the exchequer will be getting significantly more tax than if the worker were engaged as an employee.
What about the 5% allowance?
At the moment, PSCs in an IR35 caught engagement get a 5% tax free allowance on income from that engagement. Government is minded to keep the 5%. This will reduce the client’s national insurance payment and the contractor’s contribution, but it could make accounting for other taxes more difficult.
What about employment rights?
This is one of the big questions with the proposal, and one which IPSE raised strongly when responding to last year’s discussion document on IR35. The government address this point in two sentences:
‘For workers in the public sector this reform changes which party is liable to decide if a payment should be taxed as employment income. No changes will be made to existing employment law’.
This is insufficient. IPSE will continue to press this point strongly. If the government want to apply employment taxes, it should employ people and give them the appropriate rights.
Which engagements will be in scope?
The document sets out a number of “gateways” designed to easily distinguish between engagements that need to consider the new rules and those that don’t, before the online tool is considered. These can be simplified to the following:
Gateway 1: Is 20% or more of the contract for materials consumed in the service (i.e. as it might be for a builder)? If the answer is ‘yes’ – the engager doesn’t need to consider the new rules.
Gateway 2: Consist of two questions:
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 questions is yes, then the new rules automatically apply. In these cases the online tool will not be referred to.
Gateway 3: the online tool
Has HMRC published an impact assessment?
Yes (page 31), but it is insufficient.
- The government estimates that around 26,000 personal service companies will be affected
- The measure is not expected to have any significant macroeconomic impacts – IPSE will seek to challenge this
- The government predict the measure will not discriminate against women - its analysis suggests that men below pension age predominate the impacted population.
- Government acknowledges some agencies will incur costs as a result of the requirement to operate payroll and gather information needed to assess whether IR35 applies.
- Government calculates the measure will bring in £265m in the first year and significantly less in subsequent years.
- HMRC calculates the cost of implementing this change is not expected to exceed £500,000.
- The cost to government departments that engage PSCs is not considered. IPSE raise this point
- The cost to government of dealing with appeals is not specifically considered. Again IPSE will raise this point.
IPSE has already been working with organisations to build a strong case against the proposals, and these efforts will of course need to be stepped up in the weeks ahead.
We will consult widely with the membership and will engage directly with HMRC. We need to leave the government in no doubt of how damaging the reform will be.
We would encourage individual members, especially those with public sector experience, to respond to the consultation personally. Let the government know how this will affect your business and your public sector clients.
Please keep checking our website for more information and developments.