The Government have recently issued a consultation document, seeking views on how best to deal with non-compliance with the IR35 rules in the private sector. Rebecca Cave, contributor to several Bloomsbury Professional titles, looks at what this consultation might mean.
Consultation on changing the IR35 rules
The operation of the IR35 changed for public sector contracts with effect from 6 April 2017. HMRC believes this change has made the whole contracting sector more compliant in the public sector and has brought in more tax for the Exchequer. HMRC is now consulting on three possible changes to the operation of IR35 in the private sector, with a view to making contracting in the private sector also more tax-compliant (as HMRC see it).
There are two ways in which the IR35 rules (aka ‘off-payroll working’) are applied to contractors who work through their own personal service companies (PSC):
Private sector contracts
The individual worker (the contractor) decides which of his contracts, operated through his PSC, fall within IR35. This decision must be based on the operation of a hypothetical contract between the contractor and the end client (body which uses the services of the contractor), ignoring the other organisations in the chain: the PSC and any other agencies. If under that hypothetical contract, the contractor would be treated as an employee of the client, it is said to fall within IR35. If in that hypothetical contract the contractor would be self-employed, the contract does not fall within IR35.
If a contract does fall within IR35, the PSC should treat the net income from that contract – after deducting allowable expenses, as employment income of the contractor. It should be paid out of the PSC to the contractor as a salary, taxed under PAYE. If this income is not paid to the contractor as salary, the PSC must make a deemed salary calculation at the end of the tax year and pay over PAYE and NIC as if the net income from the IR35 contract had been paid as a salary.
Public sector contracts
The end client (public body which uses the services of the contractor), decides whether the IR35 rules should apply to that particular contract. This judgement is based on the same factors, and should be made in the same manner, as for contracts in the private sector. However, the contractor can’t appeal against the client’s decision.
If the client judges that IR35 should apply, the fee-payer in the chain (normally the employment agency which recruited the contractor), must deduct tax and employee’s class 1 NIC under PAYE from the amount invoiced by the contractor’s PSC. No other deductions for expenses are permitted from the invoiced amount. Any VAT charged by the PSC is dealt with separately.
What won’t change
The consultation is very clear that the underlying rules for determining whether a contract falls under IR35 will not be changed. Although the Taylor Review has made some suggestions in this area, those are not taken account of in this consultation.
The three options suggested in the consultation are not necessarily mutually exclusive, as HMRC may decide to implement two or more of the proposals.
Extending public sector rules
This appears to be the favoured option for HMRC.
The responsibility for assessing whether a contract falls under IR35 would move from the contractor to the end client for all private sector contracts. It is not clear whether the other factors of the public sector regime would also apply in the private sector - such as no appeal against the client’s decision, and no deduction of expenses. The consultation is asking for suggestions on how the public sector IR35 rules should be adjusted to work in the private sector.
In practice engagers (the end client) would need to rely on HMRC’s online ‘check employment status tool’ (CEST) and HMRC’s other guidance to determine whether IR35 applied to each contract and each contractor. Unfortunately there is a low level of confidence in the CEST as it does not reflect the employment status tests as established by case law.
Secure labour supply chains
The second suggestion is to require businesses to audit their labour supply chains, to ensure that all contractors and agencies are complying with the IR35 rules correctly. There is already HMRC guidance on how to undertake due diligence checking on labour supply chains, and HMRC believe that some of these checks could be adapted to the IR35 rules, for example:
- checking the agency rules have been applied, if appropriate; and
- ensuring the agency has made the required quarterly reports under the employment intermediary reporting
Additional record keeping
The third option is to require engagers to keep more records about the contractors they engage, such as copies of contracts, shift rotas, and line management reporting relating to the engagement. If this information was retained HMRC would be able to quickly gather what it needs directly from the engager should it later open a tax enquiry into one or more contractors or PSCs.
This level of record keeping would be an extra burden for businesses, with no obvious benefit, other than perhaps the avoidance of non-compliance penalties.
This is a stage 1 consultation, and as such it focuses on policy design rather than practical aspects of regulation. The ‘how to’ stage will be fleshed out with draft legislation, which is likely to be released this Autumn, with a view to passing the law in time for implementation from 6 April 2019. However, if enough people and organisations respond to the consultation and ask for longer lead-time in order for businesses to properly prepare, and for systems to be changed and tested, the implementation could be pushed back to 2020.