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Personal service companies and the public sector

HM Revenue & Customs (“HMRC”) recently published changes to the intermediaries legislation, commonly known as IR35, to be included in the Finance Bill 2017. The object of intermediaries legislation is to make sure that an individual who provides his services through an intermediary, for example a personal services company, who would otherwise have been taxed as an employee, pays employment taxes on his income. The proposed changes take effect from 6 April 2017.

The changes also apply to contracts entered into before that date. If work is completed before 6 April 2017, but payment made on or after 6 April 2017, it will be within the new legislation.

IR35 in the public sector will be amended as follows:

  • responsibility for determining IR35 status will sit with the public sector client;
  • where IR35 applies, the entity paying the intermediary limited company will be required to deduct the appropriate amount of income tax and National Insurance (“NI”) before paying the intermediary limited company;
  • the liability for any unpaid tax and NI contributions will sit with the body that pays the intermediary limited company, unless the client fails to provide a decision within 31 days of a request; and
  • the 5% deduction currently allowed to intermediaries for “notional expenses” will no longer be available for public sector contracts.

How will IR35 status be determined from 6 April 2017?

In summary the new provisions apply when:

  • a worker personally performs services, or is under obligation personally to perform services for the public sector client;
  • the definition of a “public authority” is as set out in the Freedom of Information Act 2000. This includes government departments, universities, local authorities, parish councils and the NHS as well as many companies controlled by such authorities; and
  • the services are provided under circumstances where, if the contract had been directly with the public authority, the worker would be regarded (for Income Tax purposes) as an employee of the public authority (or alternatively the holder of an office with the public authority).

HMRC will look at the reality of the working relationship and what happens in practice, regardless of whether the parties (the public authority and the consultant/consultancy service company) agree they will be engaged as an independent contractor, and not as an employee or worker. To enforce the new rules HMRC has decided that the end user (i.e. the public authority) will determine whether a contract is in, or out of scope of the new guidelines and has developed an online tool to assist with making a decision. The tool covers the following five areas:

  • Supervision.
  • Control.
  • Financial risk.
  • Business details.
  • Part and parcel of the organisation.

Implications for consultants

  • Consultants will have to decide whether to continue invoicing via their limited company, transfer to an umbrella or a managed service company arrangement or move on to a PAYE contract.
  • A recent report concluded that consultants’ earnings would be reduced by up to 33%.
  • The public authority will have to make deductions for PAYE, employees’ NI and will also be liable for employers’ NI.

Long-term implications for public authorities

  • Consultants may reject roles in the public sector in favour of the private sector, leading to a shortage of change/transformation skills to lead on major programmes.
  • The HMRC online tool is very time consuming and requires significant input from the consultant in order to complete it.
  • There will be cost implications for the public authority. A public authority will need to assess whether it is able to maintain the current rate to the consultant to cover the employers’ NI contributions.
  • There are potential additional costs if the consultant transfers to PAYE contracts, including pension and the apprenticeship levy.
  • HMRC has given public authorities thirty one days to give a decision on whether the contract is in or out of scope of the new guidelines. Failure to make a decision will result in the public authority being responsible for the PAYE and NI.