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Contractors in the public sector – reform of the intermediaries legislation (aka IR35) – key points you need to know

The use of contractors is widespread in the public sector from programmers and IT consultants through to NHS locums and peripatetic musical instrument teachers. Contractors often contract through an intermediary – their own personal service companies (PSCs) – in order to benefit from the more favourable tax rules and rates which apply to companies. Under IR35 (the intermediaries tax legislation) it used to be the responsibility of PSCs to decide whether or not to deduct tax and NICs from income earned by the contractor. Following a public consultation, the Government has announced its plans for reforming IR35 as it applies to contractors in the public sector as follows:

  • From 6 April 2017, responsibility for deciding whether to deduct income tax and national insurance at source from fees paid to contractors engaged through their own PSCs will move from the PSC to the public sector body, agency or third party engaging them.
  • Public sector bodies include all bodies which are required to respond to Freedom of Information Act requests – so this includes the BBC, local government and NHS trusts as well as government ministries.
  • The public sector body will be guided by the employment status service tool on the HMRC website – however this tool has not been published. With one month to go, this is cutting things fine!
  • Contractors caught by this measure will then pay tax and NICs which is deducted at source by the public sector body engaging them as if they were employees. However, the fact that a contractor may be regarded as an employee or worker for tax purposes does not mean they will qualify for employment rights or benefits, such as rights to claim unfair dismissal, statutory redundancy pay and family friendly rights, because the tests are different.
  • As a quick fix some public sector bodies have been seeking to move staff onto payroll through third parties. However where the contractor is genuinely self-employed, this can lead to a substantial cut in take-home pay compared to the previous rules. Hasty action could lead to unnecessary loss of key personnel on critical projects.
  • Putting contractors on short term staff payroll cuts the available pool of talent – separate new tax rules on travel and subsistence expenses mean a week’s work in London for a Manchester based contractor could barely break even after costs and tax, on a £250 daily rate. Many roles will offer less, and so can’t be taken up by the best talent nationwide (unless the public sector reforms quickly to allow telecommuting).
  • Where an agency sources staff for the public sector body and pays the PSC, the agency will be responsible for applying the decision made by the public sector and deducting tax. Thankfully the Government has listened to representations that agencies cannot make the decision where they don’t know what the client asks the contractor to do on a day-to-day basis – but agencies are still going to bear additional compliance costs.
  • What about outsourcing? The Government’s initial consultation indicated that some outsourced contracts could be caught by the new rules – but it is far from clear that this is carried through into the legislation. If all that happens is small businesses are replaced by the big 4 accountants, this will certainly not save money overall.
  • This all arises because the underlying rules on the difference between employment and self-employment for tax purposes are hopelessly complex and outdated and are different from the tests applied to determine employment status. A straightforward safe harbour could be allowed for short term contractors performing defined tasks but employers will not welcome any extension of employment rights to long term contractors. Six years on from the founding of the Office of Tax Simplification, and despite their many useful suggestions, there is little sign of a simpler world happening in practice.

For further information please contact:

Jon Keeble, Employment, jon.keeble@dwf.law

Jon Stevens, Corporate Tax, jon.stevens@dwf.law

Caroline Colliston, Corporate Tax, caroline.colliston@dwf.law

 

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Legal news, views, trends and tools for HR Professionals. Stay ahead. Go further