Will reform of the intermediaries legislation (IR35) reduce your income come April 2017?

Back in 2013 The House of Lords set up a select committee to investigate the use of Personal Service Companies (known as PSCs) for tax collection. The investigation report published in April 2014 concluded that, if IR35 is to be maintained, the guidance which is currently made available to those affected must be improved. A discussion document was published on 17 July 2015 to cover the rationale for change, options to improve the effectiveness of the rules and the next steps. On 16 March 2016 the government announced at Budget that it will in fact reform IR35, but only for public sector engagements. It was made clear that at this point that they were only specifically looking at the public sector engagers and not the private sector.

IR35 was introduced in 2000 to ensure that people doing the same job in the same manner pay broadly the same amount of tax and national insurance, regardless of whether they are employed directly or work through an intermediary, such as a PSC. As is widely known, operating through a PSC can have significant tax savings over being employed and taxed under PAYE. Under the existing IR35 legislation, if a person determines that their contract is caught by the rules and should be taxed as if it were employment income, the responsibility lies with that person to calculate a “deemed employment payment” and report and pay the tax and national insurance to HMRC before the end of the tax year.

However, ever since the introduction of IR35, many people have struggled to clarify their status from contract to contract with any great certainty. HMRC estimate that widespread non compliance with the legislation means that only one in ten PSCs who should be operating the rules on at least part of their income are doing so, at an estimated cost to the Exchequer of £440m in 2016/17. Whilst recent changes to dividend taxation may have made the PSC model less desirable to workers, as people are paying more income tax on dividends, the model is still popular and the Exchequer still loses out on employer national insurance contributions too.

The changes

A consultation document titled “Off-payroll working in the public sector: reform of the intermediaries legislation” was published on 26 May 2016 to commence a 12 week consultation, which ended 18 August 2016. HMRC are now in the process of analysing the feedback. Whilst the changes have been open to consultation its pretty clear the changes will come into effect next April.

At the moment the onus is on the individual working through their own PSC in the public sector to determine whether IR35 applies to their contract and make sure they are paying the relevant tax and national insurance. From April 2017, the responsibility will instead move to the public sector employer, agency or third party that pays the worker’s intermediary (the PSC). Where the public sector body engages a PSC through an agency or third party, the party closest to the worker’s PSC in the supply chain will be required to comply with the rules.

The detail
  • Government will use the definition of public sector set out in the Freedom of Information Act and includes government departments, non-departmental public bodies, NHS, police, local authorities, BBC, Channel 4 and the bank of England. It doesn’t include private companies carrying 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.
  • Employment agencies, consultancy firms and outsourcing firms who supply workers to a public sector client will be required to take responsibility for determining if an engagement is in scope of the rules and paying the tax.
  • If there is more than one agency, legislation will apply to the agency that contracts directly with the PSC.
  • If the agency is resident outside the UK the liability will fall on the last party in the chain which is resident in the UK. If there is no other UK resident party it will fall on the public sector engager.
  • To minimise the burden on engagers HMRC will provide a simplified process and new online digital tool to help make it easier to make a decision on an engagement.
  • Where HMRC identifies the rules have not been applied properly there are options for deciding where the liability should fall – jointly and severally on engager and PSC, engager alone if they make the wrong decision or the PSC if it purposefully provides wrong information to the engager.
  • The government wants to explore how accounting for the existing 5% expense allowance (if caught by IR35) would work in practice.
  • Government estimates around 26,000 PSCs will be affected by the change.
Impact

Reform of IR35 was clearly needed and it’s been a long time coming, but some would have preferred a different approach. Some concerns raised by stakeholders include the possibility that it creates a less flexible labour market by impeding the PSC model, there may be a significant reduction in post-tax income for some contractors, forcing some out of the UK, and that it will create “false employment” where engagers take a prudent view and assume contracts fall under IR35 when they don’t. These are clearly valid concerns and it will be interesting to see what other comment or changes come about from HMRCs recent consultation.

Getting a simple online tool which gives certainty on whether or not someone is in the scope of the rules will be challenging, but HMRC will have a test outcome to be bound by and it will be something those working in the private sector can make use of too. What isn’t clear is how long it will take until the reform extends to the private sector. Clearly if the government gets its own compliance in order with a system that works it should be able to transfer it to private sector companies. However, it’s likely that private sector reform will be harder to implement due to the varied industries and practices and it is probably some way off yet. For now, Its business as usual for those PSCs who are properly following the existing steps to determine their status in the private sector.

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