On 18 May 2018, HMRC published a consultation seeking the best way to tackle non-compliance with the off-payroll working rules, known as IR35.
IR35 was intended to ensure that an individual, engaged through a personal service company (PSC) but working as if they were an employee, pays the same Income Tax and National Insurance contributions (NICs) as they would if they were employed directly. Although it came to exist 18 years ago, it so far has failed to mature into the revenue-protecting regime that HMRC had once hoped it would.
The number of individuals working through a PSC has grown rapidly in recent years. If an individual is working like a consultant (based on factors such as whether they decide how and when they do the work) then HMRC does not have an issue. However, if the individual is working as if they were an employee but using a PSC to avoid PAYE/National Insurance, then they are getting an unfair advantage.
Additionally, there has been a concern that some ‘end-users’ (i.e. the person who receives the individual’s services) have required workers to provide their services through a PSC, giving the ‘end-user payer’ an immediate saving on employer NICs.
The PSC currently has to decide whether IR35 applies and to operate and pay PAYE and National Insurance if it does. The individual worker, who owns the PSC, may not be fully aware of IR35 or may decide that HMRC is unlikely to focus on a small company (i.e. the PSC). HMRC has estimated IR35 non-compliance to be at around 90% with a cost to the Exchequer projected to reach £1.2 billion a year by 2022/23.
However, IR35 is not without problems. Enquiries and enforcement actions are typically costly and lengthy. Further problems include monitoring the growing number of PSCs, each PSC representing a relatively small tax exposure and, in many cases, PSCs lacking sufficient assets to meet pay any taxes due even where enforcement is successful.
Following a 2016 consultation, IR35 for those in the public sector was reformed with effect from April 2017. The current consultation considers if and how IR35 in the private sector should be changed – in short, it is likely rules the same as (or very similar to) those now applying to the public sector will be extended to the private sector.
The revised public sector rules switched the obligation to comply with IR35 from the PSC in two key respects:
- First, the ‘end-user’ (not the PSC) determines whether an individual working through a PSC should be regarded as employed (in which case IR35 applies)
- Second (where IR35 applies), the person who pays the PSC (e.g. the ‘end-user’ or, sometimes, an employment agency) assumes the responsibility for Income Tax (including operating PAYE) and NICs compliance.
In effect, HMRC has ‘outsourced’ its IR35 administration and compliance function to ‘end-users’. Crucially, ‘end-users’ are at risk of challenge by HMRC if they get it wrong, not the PSC. The ‘end-users’ will generally have bigger pockets and be more concerned about tax compliance than PSCs. The public sector changes were widely interpreted as a trial for extension to the much larger private sector.
Concerns have been expressed about the nature and scope of the public sector changes. These include:
- ‘End-users’ applying the rules too cautiously (i.e. the default position is to conclude, incorrectly, that all cases fall within IR35)
- The new rules could encourage more aggressive non-compliance
- The increased administrative and compliance burden for ’end-users’
- The potentially adverse impact on UK labour market flexibility
- The two regimes result in an ‘uneven playing field’.
HMRC have, unsurprisingly, concluded that the “evidence suggests that public sector reform has been effective in increasing compliance”, has “raised an additional £410 million of income tax and NICs” and the concerns are misplaced. HMRC therefore consider extending the reform into the private sector to be “the lead option which will effectively tackle non-compliance”.
The IR35 changes can be seen as part of a wider initiative to change taxpayer behaviour and deter arrangements resembling avoidance. The problem is that this could limit the activity of genuinely commercial businesses and dissuade small start-up workers entering the market. It could also result in many workers receiving less take-home pay, new contract negotiations and increased costs for businesses or contractors providing services to less cautious (and possibly less-compliant) ‘end-users’, distorting the employment market.
The original public sector concerns are equally applicable to any extension to the private sector. Additional concerns include:
- Further complexity in cases involving intermediary agencies (highlighted by the public sector reforms where agencies have simply ignored the employment status assessment of ‘end-users’).
- The capacity of smaller ‘end-users’ to assume the additional administrative and compliance. Despite HMRC’s assertion to the contrary, assessing employment status for tax purposes is rarely straightforward.
- The time and cost of designing processes and systems for the change – early preparation will be essential (e.g. considering whether existing and new contracts take account of the potential change in responsibility for accounting for PAYE and NIC).
The consultation will close on 10 August 2018. Legislation implementing change may take effect from as soon as April 2019.
IR35 reform has proved controversial and challenging in the public sector. Its impact in the private sector is likely to be wider, more significant and more keenly felt.