IR35 public sector changes – what contractors need to know

With the Government’s planned reforms to the way IR35 is operated in the public sector set to go ahead as planned from April 2017, we asked a leading IR35 expert to help explain what the changes mean for contractors in reality.

Section 4.11 of the 2016 Autumn Statement confirmed that, from April 2017, the responsibility for operating IR35 in the public sector will rest with recruitment agents (or other engagers), rather than contractors themselves.

Thanks to Seb Maley from Qdos for answering our questions.

1. What motivated the Government to target public sector contractors in the first place?

I would say the primary driver for this change was widespread press coverage and the resultant public pressure. A recurring theme over the last few years has been tax ‘avoidance’ in the public sector, which really gained momentum after the Ed Lester case in 2012. Since then there have been numerous reports of workers in the public sector – many of them high profile – using limited companies to avoid paying tax.

Shortly after the Lester case, the Government brought in a new ‘assurance’ process for public sector engagements. This meant that every worker had to prove they were paying tax correctly, i.e. outside IR35, and the public sector engager was tasked with ensuring the process was carried out adequately. This has been running for the last four years and it seemed to be working relatively well; the Government levied a couple of hefty fines on bodies who had not been implementing the process correctly and contractors have generally got to grips with ensuring – and proving – they are working compliantly.

However, it is HMRC’s view that the process hasn’t worked as they had hoped; they think that only 10% of ‘off-payroll’ workers in the public sector are paying tax correctly. I’m not sure what this figure is based on, but it is in stark contrast to our own experiences.

My making this change, HMRC will be hopeful that the public sector will effectively self-regulate the IR35 rules. Agencies face potentially significant liabilities and, as such, are likely to be risk-averse when it comes to determining a contractor’s IR35 status. HMRC’s already stretched compliance resources have been taken up largely in the public sector in recent years, so it will also give them scope to increase the policing in the private sector.

2. What will the new rules mean in practice?

The responsibility and liability of IR35 passes from the contractor to the agency (or party paying the contractor – including consultancies or direct work). This means the agency will have to assess each engagement and make a decision as to whether it is outside or inside IR35.

If it is outside IR35, the contractor can continue to remunerate themselves as they see fit, although the agency would face the bill if the decision was questioned and overturned by HMRC. If the engagement is inside IR35, the agency will have to deduct PAYE and NI prior to paying the contractor. Confusingly, the contractor will still operate through their PSC but will essentially be taxed as an employee at source. There will then be various tax credits to ensure the contractor does not pay tax twice once the income comes into the PSC.

It is important to note that the actual factors and case law determining IR35 will not change at all; it is just the technicalities around process and liability.

3) How will limited company contractors be affected?

It will largely depend on how agencies and end-users react to the new rules. There is some concern that faced with a new and significant risk, agencies will simply force contractors either inside IR35 or to work through an umbrella company. Ultimately this could mean a lot less take-home pay for contractors and probably a lot less good contractors in the public sector.

I would not be so quick to panic though. All agencies I have spoken to are looking for solutions which are both compliant but also ensure they do not push workers out of their contracts by unfairly penalising them. If the industry takes a sensible and practical approach to the rules, all contractors genuinely trading outside IR35 should be able to continue to do so.

4) What can public sector contractors do to ensure they are not affected?

There isn’t a great deal individual contractors can do beyond engaging with their agency and/or end client to ascertain what their plans are. If contractors are currently on a public sector contract and still expect to be in April 2017, it would be prudent to gather evidence (independent reviews, etc.) in advance in case they are asked by an agency to present their arguments for continuing outside IR35.

5) What is the scope of the new rules? Will they be rolled out to the private sector?

HMRC’s official line is that they have no plans to roll this out into the private sector. However, the general consensus is that they probably will although we don’t know when.

Initially, the scope will target any organisation covered by the Freedom of Information Act. This is a wider net than the current assurance process and will include publicly owned bodies like the BBC and Channel 4.

Read the official guidance

On 3rd February 2017, HMRC published four factsheets on the public sector IR35 reforms – you can read about them here.

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