Proposed changes to the policing of IR35 in the public sector are set to go ahead, HMRC confirmed at a recent compliance seminar attended by many contracting stakeholders.
Contractors working in the public sector need to start considering the consequences on them personally right now and plan to mitigate themselves from unnecessary financial tax risk running into the thousands of pounds.
The consultation, Off-payroll working in the public sector, follows on from former Chancellor George Osborne’s initial announcement during his 2016 Budget, and sets out plans for issuing end engagers and agencies with the responsibility for determining a contractor’s employment status for tax purposes. The proposals have been met with widespread criticism, with various industry experts highlighting the disadvantages public sector contractors will face.
However, speaking at the Brave New World seminar hosted by contracting trade body PRISM – held on 22 July – HMRC representative Philip Horswill commented: “The reforms are about ensuring parity across the whole of the tax system, regardless of the way that people are engaged.”
IR35 reforms ‘not a tax grab’
Horswill went on to emphasise that the reforms are “not a cash grab” from HMRC, despite referring to the taxman’s estimate that £400m was lost to non-compliance with IR35 in 2015-16. HMRC claims this is a result of just 10% of contractors paying the correct tax. He explained that they are only attempting to collect the taxes that should have been paid anyway.
This, as IR35 guru Kate Cottrell pointed out, is in spite of the fact that, as recently as 2012, an evaluation of off-payroll rules in the public sector found that 90% of public sector contractors were compliant with the legislation. Cottrell also disputes the taxman’s estimate that roughly 20,000 contractors will be impacted by the changes, suggesting that far more contractors will feel the effects due to the broad scope of the public sector.
“20,000 is just the tip of the iceberg,” she argued, noting that the list of public sector organisations that are required to comply with the Freedom of Information Act – the legislation that defines a public sector body – currently stands at 42 pages long, according to a recent consultation.
No plans for private sector roll-out
More promisingly for the contract sector, Horswill attempted to dispel concerns that a private sector roll-out is due to follow the proposed changes, adding: “We have heard a lot of commentators saying that this is going to apply to the private sector. We can confirm there are no plans to do so.
“The reality is that the private sector is a very different beast to the public sector in a lot of ways, so it doesn’t necessarily follow that something that works in the public sector will work in the private sector.”
Less fortunate for contractors, Horswill remains confident that the public sector changes will not be affected if new Chancellor Philip Hammond follows through with his suggestion that he may use the Autumn Statement to “reset” Britain’s economic policy – an announcement that was made on the same afternoon.
Digital tool in early stages of development
HMRC still doesn’t appear to be making any notable progress with the development of its online IR35 tool, despite the fact that it intends for it to be implemented as soon as April 2017.
“The design of the tool is very much open for discussion at the moment. We have a draft of the design and we’re currently looking at the questions that we’re going to be asking,” noted Horswill, who conceded that the make-up of the tool won’t be confirmed by the time the consultation closes on 18 August, although a beta version is expected to be released following this year’s Autumn Statement.
Whilst HMRC are still in the early stages of developing a tool for Beta release, HMRC representatives demonstrated an overwhelming confidence in the anticipated capabilities of the tool.
HMRC has already confirmed in its consultation document that it will be bound by the decision determined by the tool. However, Horswill went on to suggest that the tool would be able to replicate the outcome that case law judges would issue in court.
“The questions that we ask will be based on case law. We are confident in the expertise that we have in house and we believe we will be able to ask a set number of questions and get a result that is almost certainly what the courts and the tribunals would come out with.”
When questioned about the potential for HMRC to provide training to public sector bodies to help police IR35, Horswill added that the accuracy of the tool would negate the need for any such training, stating that the tool and questions would be designed for a layperson to use.
Contracting experts are less convinced. ContractorCalculator CEO Dave Chaplin has already warned that an online tool won’t be able to provide a binary answer, whilst Cottrell pointed towards the history of IR35 as evidence that HMRC’s goal is unachievable.
“My personal view is that, if a tool could be invented, it would have been invented 16 years ago.” She added: “The fact that we pretty much know for certain that these changes will be coming into effect presents a window of opportunity for people to get ahead of the game.”
Concerns voiced over taxation method
In spite of the confidence of HMRC representatives in the proposed reforms, attendees were still able to pick numerous holes in the plans. Notably, contractors working multiple contracts simultaneously look likely to encounter problems ensuring they are taxed the correct amount.
As one attendee noted, agencies and public sector bodies aren’t going to know what tax bands a contractor’s earnings fall into, and whether they have personal allowance available. When quizzed on this, Horswill said the agency would tax the contractor’s earnings based on what information they have available to them.
HMRC has also confirmed that contractors deemed to be within IR35 will be taxed as employees subject to a deemed payment calculation. However, as PRISM CEO Crawford Temple highlighted, for a contractor engager or agency to implement this method would pose problems in the form of contractor expenses and pension contributions.
“Under the current deemed payment calculation, contractors can offset expenses against the deemed payment, which would reduce the taxes that are due. If you ask the agencies or end clients to make this calculation, there’s no way that they’re going to know what those figures are. In the end, they’ll just be taking a standard payment against tax which will just mean that, come the end of the year, the contractor will have overpaid tax.”
“According to HMRC’s own figures, it’s looking at 20,000 instances of tax being reclaimed at the end of each year,” added Chaplin. “Every single tax statement will be incorrect.”
‘Sticking plaster’ legislation won’t have desired effect for the taxman
HMRC, however, remains defiant that appeals from contractors – and thus the resources it will have to use to respond to appeals – will be minimal. For Rhiannon Jones of the Confederation of British Industry (CBI), this is indicative of the ‘win-win’ outcome HMRC seeks to create for itself by reducing resources and sourcing more revenue.
“HMRC relies heavily on taxes that are easier to collect. 32% of its revenue is sourced from income tax, compared to just 8% from Corporation Tax,” she commented. “The latest consultation just feels like another sticking plaster.”
However, for Jones, the proposals will be anything but beneficial for the taxman in the long run: “HMRC isn’t viewing the issue in a holistic way, and that’s what we’re really worried about. It will actually cost the taxman more in the long run, in the form of tribunal costs as many contractors will challenge the decision that has been made.”
She concluded: “The end engagers and the agencies will still need clarity because the underlying rules haven’t necessarily changed, which will clog up HMRC resources. So it won’t be able to escape many of the difficulties.”
Public sector contractors need to act now
HMRC are adamant that the new rules will come into force in April 2017. Agencies will face tax risk if they fail to judge the contractors status correctly and fail to collect the tax. The likelihood is that they will err on the site of caution and insist that contractors remain inside IR35, even if this creates false employment for the contractor.
Contractors working in the public sector who have contracts that are likely to be in force from April 2017 will need to consider their options. For the time being, they should ensure they have sufficient evidence that they are outside IR35, and can start by using our online status tool. Procrastinating on this issue could end up costing contractors thousands of extra pounds each year in tax.