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Public sector IR35 reforms: Agency/client cooperation key to overcoming hurdles

One week until the implementation of the public sector IR35 reforms, clear communication between public sector bodies (PSBs), agencies and contractors is essential to ensure compliance requirements are met whilst mitigating tax risk.

But with the public sector unprepared for these changes, and with question marks hanging over aspects of the legislation, Freelancer & Contractor Services Association CEO Julia Kermode warns it won’t be a smooth transition.

  • Clear communication is needed to maintain harmony in the supply chain
  • The legislation’s ‘reasonable care’ requirement may not work in practice
  • The ESS tool isn’t definitive – clients need to consider third party solutions
  • Contractors should move to established umbrellas over questionable schemes

“This is a major problem. Each party will want to ensure contractors are taxed correctly without assuming tax risk themselves. It requires discussion between parties but processing high volumes of contractors at such short notice will be a challenge”

Public sector IR35 reforms – ‘reasonable care’ offers no quick fix

Recent tweaks to the legislation introduced the provision that clients must take ‘reasonable care’ when deciding whether IR35 applies. But Kermode warns it may struggle to have the desired effect for two reasons:

  • It has been introduced at the last minute
  • There’s a lack of clarity over what ‘reasonable care’ means

“On paper, the ‘reasonable care’ clause appears to take away the autonomy of a client to assess the tax status of a contractor. But with this change coming so late on, realistically there isn’t enough time for clients to take reasonable care for contractors who require evaluating immediately.

“Even once clients become aware of their responsibilities there are issues. The agency or contractor must prove it if a client hasn’t taken reasonable care. But with no clear definition this may prove difficult, and could give rise to disputes. So whilst in writing the law makes provisions for contractors, I’m struggling to see how it’s going to pan out in practice.”

Testing IR35 status – why you need to consider third party solutions

We believe a paper trail demonstrating that the client has genuinely considered the contractor’s IR35 status should be enough to warrant ‘reasonable care’. This may not extend as far as securing a professional contract review.

Kermode suggests using HMRC’s Employment Status Service (ESS) should be deemed sufficient, but highlights concerns over its frequent inability to provide a firm judgment – ContractorCalculator recently tested the ESS against historical IR35 cases and found it returned an ‘unknown’ judgment more than a quarter of the time:

“A common question we’re hearing from agencies is: ‘What should we do when the ESS can’t provide a definite decision?’ Clients and agencies need to remember that the ESS isn’t obligatory, and there are alternative solutions available that can provide a more accurate and clear determination of IR35 status.”

Agencies urged to consult with clients over IR35

With the client responsible for assessing IR35 and the agency assuming the tax risk, there is further cause for contention. Kermode notes that many agencies are concerned that their clients are incorrectly assessing contractors as outside IR35.

“Being the fee payer in that scenario, there’s obviously an element of risk for the agency if they take the client’s word for it, so they would understandably be reluctant to do so.

“This creates a difficult situation. I would urge agencies to discuss these matters with their clients in order to understand why there is a difference of opinion and possibly reach an agreement, because no agency wants to fall out with their client or contractor.”

Should public sector contractors move to umbrellas?

Many PSBs are encouraging contractors to engage via umbrella companies to avoid compliance responsibilities. Though contractors are understandably reluctant to be taxed via Pay As You Earn (PAYE) without being assessed for IR35, in many cases it may be the best option available:

“There are all sorts of schemes enticing contractors with very high take-home pay that just aren’t realistic,” notes Kermode, who highlights the job board avoidance scheme as an example. “Contractors should choose an umbrella certainly above these schemes, or else risk incurring a huge debt with HMRC.”

HMRC doesn’t have an official appeals process for contractors who feel they have been working outside IR35. However, Kermode says contractors can choose to challenge the amount of tax they have paid via their self-assessment tax return at year-end, though how effective this will prove awaits to be seen.

How to identify a good contractor umbrella company

“The upside for contractors going through umbrellas is that they have full employment rights,” she continues. “Contractors keep saying they don’t want this, but if you’re going to be taxed as an employee you might as well pick up the benefits.”

Contractors taking this route need to pick their umbrella company carefully though. Many umbrella companies have been set up to cater for public sector contractors who don’t have the experience to fulfil the role. Kermode offers several pointers for contractors seeking an established, compliant umbrella:

  • Check that the umbrella has compliance accreditation
  • Be wary of umbrellas claiming to be ‘HMRC approved’ – HMRC doesn’t offer a stamp of approval
  • Agencies should have a preferred supplier list (PSL) – umbrellas on here should be pre-vetted

Public sector IR35 reforms – a word of warning for private sector contractors

Public sector contractors and agencies are reminded that outstanding invoices need to be paid by 5 April to avoid being subject to the new rules, whilst Kermode concludes with a warning for contractors in the private sector:

“HMRC insists the changes won’t be applied to the private sector, but contractors might want to keep an eye on how it pans out in the public sector. I’d be surprised if HMRC doesn’t eventually look to roll out these measures, so contractors need to take note.”

Published: 03 April 2017

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