Blog: IR35 and the new Public Sector duty

The IR35 legislation has been with us since 1999 but has just hit the headlines again and may become a live issue for a number of our public sector clients.

IR35 was introduced by HMRC as a measure to prevent the tax avoidance situation whereby a contractor who would otherwise have been deemed to be an employee sets themselves up as a limited company, the idea being that they would then have a “commercial” (or B2B) relationship with their “client” (a.k.a. their employer).

The IR35 legislation effectively said that HMRC should look at what the true nature of the contractor/client relationship is, and ignore the limited company that sits between them and any other agencies who are sometimes involved .

HMRC’s test of whether someone is an employee or not is more or less the same as an Employment Tribunal will apply, the key tests being whether the person provides personal service, whether there is ‘mutuality of obligations’ and the extent to which the client supervises, directs and controls what the contractor does. This is an area that is close to my heart, as when I was a junior lawyer I was involved in one of the leading cases in the Court of Appeal on employment status.

From the contractor’s perspective, IR35 is bad news as not only do they have to pay their own tax and national insurance but they also are responsible for a payment equivalent to employer’s National Insurance.

A few years ago there was a spate of cases about whether particular engagements were “caught by” IR35, but then they went quiet in 2011 and IR35 rather slipped from the headlines.

The government has more recently noticed that the number of incorporations of limited companies has increased rapidly and they have apparently have become concerned about the possible loss of income tax revenue, so their response has been to tighten up the IR35 regime with effect from the start of April 2017.

This tightening-up is focused at the moment on the public sector. The change in the law now requires  each public sector body or intermediary agency to decide whether IR35 applies to each relationship, rather than relying on the contractor themselves.  It also requires the public sector body to deduct income tax and NICs at source, as if the contractor was an employee.  Some commentators are saying that this approach will eventually be rolled out across the private sector as well.

This is clearly quite an onerous obligation on public sector bodies, so HMRC have launched a website that helps organisations decide whether their relationship with a contractor will be caught by IR35, and it’s here: https://www.gov.uk/guidance/check-employment-status-for-tax.  HRMC have said that, provided the information supplied to the website calculator is correct, then they will agree to be bound by the decision given.  That sounds very helpful for clarity, but the problem I am hearing anecdotally is that several times the website calculator’s response comes back as “we don’t know”.  Not so helpful.

This uncertainty has led some public bodies (Transport for London, for instance) to decide that they are going to err on the side of caution and treat all their contractors as if IR35 definitely does apply to them.   Apparently with TfL this has led to problems, as contractors are apparently refusing to provide their services and so TfL is currently rethinking its approach.

We’re also aware that the MoD has decided to withhold 20% of its contractors’ fees for 12 months, just to provide them with a pot of money from which to meet some or all of the PAYE demanded from HMRC if it turns out that a contractor should have been taxed at source after all.

From a contractor’s perspective, IR35 is the worst of all worlds, since they get taxed like an employee but get very limited employment rights.  This is because an Employment Tribunal is likely to say that someone trading through a limited company is not going to be an employee for the purposes of, for example, unfair dismissal claims and the right for redundancy pay.

The change this April is meaning that apparently contractors are leaving the public sector in droves, which in turn could have an impact on the provision of services in some areas.  This may well mean that organisations will need to consider employing more staff, rather than engaging contractors.

This is a developing story and one we are going to have to keep a close eye on. If anyone wants to discuss this then please contact me using the contact details below and I would be more than happy to help.
Simon Martin
Partner