Clarification on tax changes for the public sector ‘off-payroll’ workers
22 February 2017
HM Revenue & Customs has issued guidance on forthcoming changes to the IR35 rules where workers provide their services to a public authority through a personal services company (“PSC”), i.e. a company owned and controlled by the worker.
Currently the PSC is responsible for determining whether IR35 applies. If it does, the PSC must accounting for PAYE and employee and employer national insurance contributions (“NICs”) under Real Time Information (“RTI”) on the fees (excluding VAT) it receives, less a 5% deduction for notional business expenses.
The position will be changing from April 2017, as we have previously reported. HMRC has since clarified that where a worker provides his or her services to a public authority through a PSC, the public authority will be responsible for determining whether IR35 applies. The entity paying the PSC (the fee-payer) will generally be responsible under RTI for deducting income tax and employee NICs from, and accounting for employer NICs on, broadly the fees it pays to the PSC (excluding VAT). A public authority for this purpose is an organisation to which the Freedom of Information Act 2000 or Freedom of Information (Scotland) Act 2002 applies.
HMRC has now issued three guidance notes on how it envisages these rules working in practice: one for designed for public authorities; one for fee-payers; and one for PSCs.
How will the public authority determine whether IR35 applies?
IR35 applies if:
- ignoring the existence of the PSC, the worker would be an employee or office-holder of the public authority; or
- the worker is an office-holder of the public authority and the services he or she provides through the PSC relate to that office.
Whether a worker would be an employee of the public authority if engaged directly by the public authority is determined in accordance with the normal employment status tests.
HMRC will shortly be launching a new “Employment Status Service” tool which public authorities may use to help them determine whether IR35 applies. (This will replace the current “Employment Status Indicator” tool from 6 April 2017.)
What are the fee-payer’s obligations if IR35 applies?
The fee-payer will need to report any “deemed employment income” (see below) it pays to a PSC on or after 6 April 2017 under the RTI system and to operate PAYE and account for employer NICs on that income as if the worker was its employee. PAYE and NICs need to be operated even if the fees are paid to the PSC under a contract signed before 6 April 2017 and/or for work completed prior to 6 April 2017
There are two circumstances where an entity other than the fee-payer will be liable for PAYE and NICs:
- If the fee-payer is based offshore, the last UK resident entity in the chain will be responsible for operating PAYE and NICs.
- The public authority is responsible for informing the fee-payer whether or not IR35 applies. Where the public authority has not done so within 31 days of the fee-payer making a written request, the public authority is liable to account for PAYE and NICs under RTI.
On what amount should PAYE and NICs be operated?
PAYE and NICs should be operated on the “deemed employment income”, which comprises the fees paid to the PSC, excluding VAT, minus:
- any amount which represents the direct cost of materials used or to be used in the performance of the services; and
- any amount in respect of expenses which would have been deductible if the worker had been employed directly by the public authority.
Are there any implications for the Apprenticeship Levy?
Yes. The employer NICs in respect of the fees paid to PSC are taken into account for determining the fee-payer’s liability for the Apprenticeship Levy.
Does this mean the worker becomes an employee of the fee-payer or public authority?
No. The worker remains an employee of his or her PSC. Although the worker will be on the payroll of the fee payer for PAYE and NICs purposes, the changes will not result in the worker having any employment rights against the fee-payer or public authority. Whether the worker has such rights will be determined in accordance with employment law.
Similarly, as a result of this legislation, the public authority and the fee-payer will have no obligation to: pay the worker any statutory payments (e.g. statutory sick pay or statutory maternity pay); enrol the worker in their pension scheme; or make any student loan deductions. These responsibilities will remain with the PSC.
Will the worker or his PSC be taxed twice?
No. There are comprehensive safeguards in place to ensure that there is no double taxation. However, the 5% deduction for notional expenses will not be available where IR35 applies and the worker is providing his or her services to a public authority.
Can the worker challenge a decision that IR35 applies?
A PSC which contracts directly with the public authority has the right to ask it for the reasons why it considers that contract falls within IR35. The public authority must supply its reasons within 31 days of receiving a written request. Where the fee-payer contracts directly with the public authority, it has the right to make such request.
If the worker considers that IR35 does not apply, he or she will be able to submit a tax and NICs repayment claim to HMRC, which will then determine whether IR35 applies.
What is the position if IR35 does not apply?
If the public authority considers that IR35 does not apply, there will be no change and the fee-payer will be able to pay the PSC gross as normal. The public authority will, however, need to keep the position under review.
How should I prepare for the changes?
Guidance on the steps that public authorities, fee payers and workers should consider taking are set out below.
Public authorities should:
- Identify contracts with PSCs.
- Set up a process to help staff determine whether IR35 applies and whether they need any further information from the worker or the PSC before making the decision.
- Determine whether IR35 applies and keep a written record of the reasons for the decision.
- Set up, say, six-monthly reviews of all contracts with PSCs to ascertain whether there has been any change in circumstances.
- Set up a process for informing the fee-payer (if any) whether a contract falls within IR35.
- Set up a process for responding within 31 days to requests for the reasons for a decision.
- Ensure that payroll and other systems will be able to cope with the changes.
- Consider whether any changes to contracts are necessary (e.g. to determine how to deal with the additional NICs costs) and seek to renegotiate contracts where appropriate.
Workers using a PSC to supply their services to a public authority should:
- Ensure they are able to provide any information requested in a timely manner, including their national insurance number, identity details and tax code (including, where appropriate, Form P45).
- If the public authority decides their contract falls within IR35 and they disagree, make a written request to the public authority for the reasons for its decision. If they consider the reasons to be incorrect, submit a reclaim form to HMRC.
- Consider whether they should renegotiate their contract, in particular the rates they are paid, bearing in mind they will lose the 5% business expenses deduction.
What are the implications?
This is a complex change which requires a significant review and overhaul of the procedures and processes of both public authorities and fee-payers in a very short timeframe.
The changes will increase the monetary pressure on public authorities, particularly where the public authority is also the fee-payer. The combined effect of the extra administration in deciding whether PSCs are caught by IR35 and, if so, the additional employer NICs and Apprenticeship Levy costs, are likely to have a significant effect on how public authorities staff projects - unless those costs can be passed onto the worker.
Ultimately, the changes are likely to result in workers being less willing to supply their services to public authorities. While the Government has indicated that it has no current plans to extend these changes to the private sector, it may prove necessary in order to level the playing field between the public and private sectors. (Not to mention the fact this would raise additional funds for HM Treasury!)