Why have IR35 rules changed for the public sector?

Employment lawyer Simon Whitehead explains the reasons behind the new regulations, and the effects that are already being felt by employers

It’s more than a decade since the Inland Revenue merged with Her Majesty’s Customs and Excise to become HMRC, yet the spirit of the IR’s 35th press release of 1999 not only lives on, it’s been reinvigorated. New rules from April 2017 target those working via intermediaries in the public sector. Those engaging contractors through a personal service company (PSC) in, and recruitment agencies supplying such workers to, the public sector will have already felt the pinch.

Why the change?

‘Off-payroll working rules’, or IR35, is designed to combat ‘disguised employment’.

Employers deduct income tax and national insurance contributions (NICs) on behalf of their employees and account to HMRC for this. They pay employer NICs too. In contrast, self-employed contractors are themselves liable to account to HMRC. Many work through their own PSC, which ‘employs’ them to do the work.

A key driver for deciding to work (or for engaging ‘contractors’) via either a PSC or another intermediary is the perceived tax benefit of doing so. The PSC/intermediary model is particularly popular in certain industries.

The Exchequer isn’t fond of this model. The tax saving (for the former-employee-now-contractor and their former-employer-now-engager) is the Exchequer’s loss. As the PSC bandwagon has gathered momentum, the resultant hole in the Exchequer’s money pot has grown.

And, of course, as the government has been at pains to point out, there’s an inherent unfairness to it all, too. The contractor may be working alongside his former co-employees, doing equal work, but for different pay: where’s the level playing field in that? (Not to mention that those shrewd former co-employees may think the same thing, jumping off ‘HMS employed’ to join the merry ‘self-employed’ crew.)

IR35 is designed to combat this. It looks at the bigger picture and asks: is the contractor who is doing the work (via the intermediary), someone who looks and smells like they should be an employee of the person engaging them (the end-user)?

If they do, IR35 decrees that the PSC/intermediary must account to HMRC for income tax and national insurance by making a deemed employment payment.

New rules

That’s all well and good, but IR35 had an inherent weakness – the enforcement problem. The rules may have shifted responsibility on to the contractor’s own PSCs, but ‘what if’ those PSCs did not account as they should? It’s been a big ‘if’: IR35 non-compliance allegedly cost the Exchequer approximately £440m in 2016-17 alone.

So, from April 2017, new rules have shifted the responsibility in the public sector for accounting to HMRC for income tax and national insurance, taking it away from the PSC and giving it instead to the public sector end-user (or where the worker is engaged via a recruitment agency to work in the public sector, the agency).

And now?

This has created some real headaches for public sector engagers, such as public authorities, the NHS, police forces and schools. They now have the unenviable task of deciding whether a worker, supplied to them via an intermediary, should be treated as a ‘deemed employee’. If it’s a ‘yes’, they must account for them to HMRC.

While HMRC has issued an online ‘tool’ to help, public authorities and recruitment agencies are rarely experts in finely balanced questions of tax status. As the buck now stops with them, they have been adopting a cautious approach.

If this continues, we might start to see a move back towards the employee model (in the public sector at least). But the public sector would have to be desirable enough to attract and retain the employees it needs, and the ripples from other butterflies’ wings’ beats (Brexit, pay freezes and court judgments, to name but three) could each create their own waves in the meantime.

Simon Whitehead is an employment lawyer and managing partner of HRC Law. Article on CIPD