16th June 2016IR35 – The government ups the ante for contractors working in the public sector

IR35 is the name of the tax regime governing contractors who don’t meet HMRC’s definition of self-employment, and who instead work for their clients through an intermediary such as a limited company.

Under changes announced in this year’s Budget, the system is to be reformed to force public sector organisations to tax contractors as employees, rather than paying them without deducting tax.

What’s behind the proposals?

The government has had its eye on IR35 for a while as it believes there to be widespread non-compliance under the current system.

There are, of course, many advantages for public sector organisations that use individuals for contract work. For example, they avoid employer obligations such as sick pay, pensions, etc. For this reason, they often ask individuals to provide services through a limited company.

This also has benefits for the individual – as they can take out money as dividends, and so potentially pay less income tax and National Insurance.

However, HMRC say this type of arrangement is still leading to tax avoidance, with contractors taking the benefit of any doubt when self-assessing whether the rules apply.

Who will be affected?

It’s not just classic IT contractors who will be hit. The new rules will apply to any contractors operating via a limited company and working for a public sector body. This includes the NHS, schools, universities, government departments, local government and the police. Many front line service providers will be affected, such as NHS locums.

It’s worth bearing in mind that some contractors work for both the public and private sectors. For example, they may do contract work for the BBC but also have their own production company.

How will it be assessed?

It will no longer be up to the individual contractor to decide if they meet the IR35 conditions or not.

The public sector body will be responsible for operating the new rules, including assessing who should be classed as an employee for tax purposes. They will get access to an IR35 digital test to help with the decision-making process, although there are concerns that this might not always be the most reliable or objective tool.

At present contractors can submit their own argument to HMRC and are arguably less exposed to political pressures to accept HMRC’s stance than public sector bodies reliant on Treasury funds.

If a contractor is deemed ‘employed’, they will be liable for the full amount of income tax and NI, with the public body paying these taxes to the government.

The only saving for any contractor already within IR35 is that the new rules pass the burden of the Employers’ NIC from the contractor’s company to the public sector body but it cannot be long before that transfer is reflected in the rate paid to the contractor.

The rules will be applied on a contract-by-contract basis – so each time a contractor starts a new contract with a public sector client, they will need to be assessed.

Wherever possible, we advise getting an expert to look over a contract, for example a lawyer or accountant, or through the professional contractors’ trade association, IPSE.

Of course, the new rules will put contractors in a detrimental tax position as they will pay higher rates of tax and pay the tax earlier- but without many of the employee rights and benefits.

You may feel that this latest development won’t affect you directly. But all contractors should take note of these changes, whatever sector they work in.

While the government is currently only clamping down on public sector bodies, it doesn’t mean its plans will stop there.

With HMRC determined to improve Treasury cashflows, in future the new rules- meaning more PAYE- could easily be extended into the private sector too.

For more information, please contact:

Tim Walford-Fitzgerald, Private Client Principal
T 020 7380 4927

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