Contractors and those paying them will be subject to a whole host of costly processing if the proposed public sector IR35 reforms go ahead, due to the unworkable demand that agencies collect contractor’s taxes and report amounts via the real time information (RTI) process.
Both contractors and their agencies will be hampered by this heavy process burden, which is set to cause chaos for flexible workers within the public sector. The greater concern is that a private sector rollout will swiftly follow if these proposals go ahead.
Whilst HMRC is adamant that the reforms will be included in the next Autumn Statement for implementation in April 2017, they are still under consultation until 18 August meaning there is still time for contractors to fight them by raising awareness and lobbying MPs.
This warning comes from Duncan Strike, director of contractor accountancy firm Intouch, who claims that numerous oversights by HMRC are set to result in a public sector nightmare:
Why the RTI proposals are too complex to work
“Fundamentally, the flaw in the idea is the oversimplification by HMRC regarding the detailed calculations necessary under current IR35 legislation for agencies to determine tax and employment status,” warns Strike. “This and the underestimation of the resources required of the taxman itself to deal with the repayment claims and disputes that will arise as a result.”
According to the proposals, it will be the contractor agencies in most cases who will be faced with the arduous task of calculating and deducting tax for contractors deemed to be inside IR35. However, Strike stresses that agencies simply won’t have sufficient information to make the correct calculation:
“In addition to accounting for income tax and National Insurance Contributions (NICs), agencies are also expected to identify all of the relevant pension contributions, expenses and other allowable deductions including capital allowances.
“This information won’t be available to the agency when making the payment, so the contractor’s tax calculation will be flawed from the very start. How HMRC can possibly believe that correct deductions will be made is unfathomable.”
Whilst Strike notes that repayment of any taxes reported through RTI that are corrected during the year should in theory flow through, the inadequate exchange of information means it will be impossible to ensure that the right amount of tax has been paid. This not only compromises the intended outcome, but also poses significant problems for contractors further down the line.
Contractors will be overtaxed and will need to apply for rebates
Strike explains that the onerous nature of identifying, authorising and approving each individual deduction means agencies would need to invest substantially in their own resources to carry out the job properly. This won’t be an option for many agencies whose costs will outweigh any benefit gained from dealing with public sector contractors.
“The smaller agencies in particular are going to find it extremely difficult because, proportionately, the amount of time spent on sourcing all of the necessary information is going to be much more than it will for the larger agencies,” he adds.
The likely fallout from this will see agencies submit tax calculations based on inadequate information. As a result, public sector contractors could find themselves forced to claim back expenses and allowable deductions at the end of the tax year, leaving them out of pocket in the meantime.
Agencies can only fund the extra processing by reducing contract rates
An alternative option for agencies – which wouldn’t leave contractors chasing their own expenses – would be to outsource their tax reporting process. Strike notes that many agencies already outsource their payroll process and could include tax reporting as an extension of their outsourcing.
However, realistically this is only an option for larger agencies with the financial resources. The proposals spell disaster for smaller agencies who neither have the resources to carry out sufficient calculations in-house nor the funding to outsource tax reporting.
The reality is that many agencies will need to recoup funds one way or another, either in order to compensate for the additional processing or to fund outsourcing. The seemingly inevitable outcome is increased agency margins across the board.
This could mean reduced rates for contractors, who may risk pricing themselves out of a contract if they attempt to up their own rates to compensate. Alternatively, public sector clients will have to bear the brunt of rising contractor fees.
HMRC will also incur huge extra costs
Perhaps the most startling oversight by HMRC concerns the repercussions it will face as a result of its own legislation, both in terms of costs and resources. According to the taxman’s own estimates, 26,000 public sector contractors will require testing - most of whom will have tax payments to contend due to incorrect agency calculations.
“My own experience would suggest that dealing with a repayment claim would cost a contractor roughly £375,” says Strike. “You can only assume that HMRC will be incurring a similar cost. So if you have 26,000 contractors making repayment claims at the end of the year, HMRC will have to dish out an equivalent cost reconciling each situation.”
In addition to this, it is estimated that HMRC will also have to fork out similar costs to contractors who challenge their employment status and who take them to tribunal, £4,000 and £20,000 respectively.
Strike concludes: “So, at the end of the day, everybody loses out and HMRC doesn’t stand a cat in hell’s chance of bringing in the £400m it claims it will.”
Act now to avoid IR35 nightmare
The proposed IR35 reforms will create a merry-go-round of additional costs and burdens. For contractors, it means reduced opportunities, potentially reduced pay, hurdles to claiming expenses and the potential end of personal service companies in the public sector. For all other parties it means unnecessary added costs and severely stretched resources.
HMRC is already at the stage of implementing the regime, with a view to it being introduced by next April, but it isn’t too late to put a stop to it. If you’re a contractor, help combat the proposals by raising awareness of the magnitude of the damage they will cause and by contacting your local MP now.