One of the intentions behind the intermediaries legislation – commonly known as IR35 – is to ensure that individuals who provide their services through a personal services intermediary (generally a personal service company) cannot avoid paying the income tax and national insurance contributions (NICs) which would have been payable had they been engaged, as an employee, directly by their client. For ease, in this note we refer to relevant personal services intermediaries as PSCs.
Until now responsibility for determining whether IR35 applied, and for accounting for income tax and NICs, lay with the PSC, which benefitted from a 5% allowance to reflect the cost of administering the rules. However, the government has long been concerned that there is widespread non-compliance with IR35 and that HMRC does not have the resources to effectively enforce it. As a result, under new rules applicable to public sector bodies, responsibility for determining whether IR35 applies and consequently whether any relevant tax deductions should be made, will shift to the public authority from April 2017.
Who is affected?
The new rules apply to public authorities, as defined in the Freedom of Information Act 2000. This includes government departments and their executive agencies, educational establishments including universities, local authorities, parish councils and the NHS. It also includes many companies owned or controlled by the public sector.
The PSCs themselves will lose the 5% allowance but will still be able to claim business expenses for the costs of their administration.
Third parties, such as employment agencies, outsourcing companies and consultancy firms which supply workers via their PSCs to public sector engagers will also be caught by the new rules. Where it is the third party that makes the payment to the worker's PSC, it is that third party and not the public authority which is responsible for making any relevant tax deductions.
What about employers in the private sector?
Employers in the private sector should also take heed of these changes. The government estimates that the new rules will raise an additional £555 million in revenue by the end of 2020-21. If successful, therefore, despite their comment that there are "no current plans to extend the reform beyond the public sector", it seems likely that the government will target non-compliance with IR35 in the private sector next. In the shorter term we may see a move of contractors from the public to private sector.
When does it apply?
The reform applies to contracts entered into any and payments made on or after 6 April 2017. Where work is completed before 6 April 2017 but payment is made on or after 6 April 2017, the new rules will still apply.
What does the public authority have to do?
The public authority is obliged to determine whether the off-payroll working rules should apply (see below), and if so:
- notify the PSC whether the off-payroll working rules apply
- deduct income tax and employee NICs from the payment and account for them to HMRC
- account for employers' NICs.
Note that where the public authority is using a third party (e.g. an employment agency) to provide labour, the public authority must notify the third party whether the off-payroll working rules apply. If so, the third party generally becomes liable for the taxation and NICs rather than the public authority.
If the intermediary is a compliant managed service company or the workers in question are subject to PAYE and NIC as employees of an agency or umbrella company, the arrangement will be outside the new rules.
Why is this significant?
As well as creating an administrative and compliance burden for public authorities and their labour suppliers, the new rules will result in additional costs in the form of employers' NICs. In addition, payments made as a result of the new rules will count towards calculating liability for the Apprenticeship Levy.
In order to process payroll for individuals caught by the new rules, certain information will be required which the public authority (or relevant third party) may not currently have, such as the ownership structure of the PSC and the legal form of the entity in question, as well as the individual's national insurance number, P45, date of birth and address.
Stakeholder pensions, statutory payments and other employment rights are not affected by the new rules, however.
Without the benefits of the tax advantages a PSC can provide, many workers may consider that they would prefer to benefit from the protections that employment law provides to employees rather than simply bearing the additional cost with no upside. This could result in additional costs over and above the administration of the new rules.
How do we determine whether the off-payroll working rules apply?
The new rules apply when:
- an intermediary exists which satisfies one of 3 conditions designed to identify "personal services" – these conditions broadly relate to the ownership structure of the entity
- a worker personally performs services, or is under an obligation to personally perform services, for a public authority
- the services are provided under circumstances where, if the contract had been directly with the public authority (as opposed to via the PSC), the worker would be regarded for income tax purposes as an employee of the public authority or the holder of an office with the public authority, or the worker is actually an office holder with the public authority.
What should public authorities do now?
Public authorities should:
- identify individuals who are currently engaged via a PSC
- ask third parties which supply labour to identify individuals provided via a PSC
- review any such existing contracts and consider whether they are likely to be caught by the new rules. Where it is unclear whether the worker would, if contracting directly with the public authority, be regarded as an employee of the public authority, they should consider seeking advice
- calculate the additional cost of employers' NICs (and the Apprenticeship Levy if applicable)
- consider whether existing contracts can be renegotiated to factor in these additional costs (and, if appropriate, authorise the PAYE & NIC deductions from payments) or, if appropriate, terminated and new arrangements entered into
- draft communications to be issued to individuals engaged via a PSC or to third party providers
- review the engagement of individuals via PSCs and determine an appropriate strategy moving forwards
- consider the additional costs when entering into new engagements in the future.
Given the lost cost benefit of using PSCs, public authorities may consider engaging workers directly instead. However, workers engaged directly would benefit from additional employment benefits for workers, such as national minimum wage, paid annual leave and protection from unlawful deductions from wages. If the individual was to be viewed as an employee this would bring with it significant additional rights and protections.
Detailed guidance on the application of the new rules, together with worked examples, has been published by HMRC. In particular, a crucial question is whether the worker would, if contracting directly with the public authority, be regarded as an employee of the public authority for tax purposes. To help with this assessment, HMRC has produced a digital tool, the Employment Status Service, to provide the HMRC view of the worker's employment status. However, there may be particular circumstances where a more detailed analysis of an individual's status would be advisable.