On Friday (18 May 2018) the UK government published its long-awaited consultation on reform of the so-called IR35 tax regime, and the use of personal service company (PSC) contractors by the private sector.
- The new IR35 regime for the private sector seems likely to be based on the corresponding new IR35 regime introduced for the public sector in April 2017, which the government broadly considers to have been a success.
- As such, end-users and staffing companies will be liable for PAYE and NICs in respect of PSC contractors who "fail" IR35, with today's proposals raising the suggestion that end-users may be given even greater responsibility for ensuring compliance, on pain of various penalties.
- There should be more clarity for all about when an engagement will or will not fall inside IR35.
- HMRC's ability to enforce may be increased by giving HMRC greater rights to information.
- There may be a reduction in the right or ability of taxpayers to challenge or ignore any assessment reached by the end-user of the IR35 status of a contractor.
IR35: why is the government concerned?
- Private sector users of contract workers, and staffing companies who supply them, have been waiting with bated breath for this consultation on changes in the private sector to the tax regime known as IR35. This consultation was promised at budget time 2017 for "early 2018".
- IR35 is the regime which applies where individuals supply their services via a PSC. There has been widespread concern that there has been a growth in use of PSCs to avoid full PAYE and NICs and that the original IR35 regime had become ineffective. The consultation paper suggests that one third of PSCs in the private sector are "inside IR35", but that only 10% of that one third are currently paying the right level of PAYE and NICs under the existing IR35 regime. The paper suggests that by 2023 this could lead to a £1.2 billion tax shortfall for the UK Treasury.
The government's first attack on avoidance: the public sector changes to IR35 in 2017
- The government has attempted to eradicate this alleged tax avoidance in relation to use of PSCs in the public sector by introducing a new IR35 regime (effective since April 2017) for supplies to the public sector. Under this regime, the public sector end-user has to notify its suppliers whether a PSC contract worker they are using is effectively operating as if they were an employee and therefore inside IR35 (and subject to PAYE and NICs) or not. This 2017 public sector regime makes staffing companies and (in some instances) end-users liable for the PAYE and NICs if the PSC contract worker is inside IR35.
- The current rule in relation to PSC supplies in the private sector, however, merely makes the PSC contractor liable if they are inside IR35 – the end-user and staffing company have no liability except in very rarely invoked exceptional circumstances.
What does the new consultation say?
Some of key suggestions are as follows:
- End-users and staffing companies will be liable for PAYE and NICs in respect of PSC contractors who "fail" IR35, with today's proposals raising the suggestion that end-users may be given even greater responsibility than in the public sector regime for ensuring compliance (including being able to demonstrate that the online HMRC status test has been used for each PSC engagement), on pain of various penalties, and naming and shaming. This picks up suggestions made recently by Sir David Metcalf (head of Labour Market Enforcement) and Matthew Taylor about cleaning up the staffing supply chain.
- There should be more clarity for all about when an engagement will or will not fall inside IR35 (which picks up a theme from the Mathew Taylor report earlier this year which is also the subject of ongoing consultation).
- HMRC's ability to enforce may be increased by giving HMRC greater rights to information: the consultation mentions the difficulties HMRC has with enforcement when, to raise an assessmsnt, it has to ask various people in the contract chain for information, some of whom may not be co-operative.
- There may be a reduction in the right or ability of taxpayers to challenge or ignore any assessment reached by the end-user of the IR35 status of a contractor. This would obviously impact those advisers who currently help staffing companies and PSCs challenge "inside IR35" assessments. This seems to be a potentially complex and contentious proposal and we suspect there will be a lot of debate about it in the next few months.
Lessons from history: consequences of IR35 changes in the public sector in 2017
- Most public sector end-users, concerned to avoid liability and anxious to comply with the new legislation adopted a safety first approach of assessing all as inside the IR35 regime.
- This had an obvious immediate impact as follows:
- Some PSC contract workers received lower take home pay.
- Some PSC contract workers insisted on an increase in gross pay so that they were not left out of pocket (failing which they threatened to leave).
- The following less predictable things also happened:
- Some end users have been persuaded to frame the way they engage PSC contract workers into a so-called" statement of work" output-based engagement (in which contract workers are engaged to deliver defined deliverables rather than labour under client control). There are many benefits if this approach is adopted and in addition it falls outside the new (and old) IR35 regime, but it is not an easy fix: it requires a thorough re-design of supply models and detailed legal advice will be necessary.
- New, aggressive tax avoidance "schemes" have been set up by various so-called umbrella companies, including Rangers-style loan schemes (under which, for example, nurses and care workers were told by the umbrella that they would be paid by way of tax-free loans). Obviously these are very risky and broadly appear to be unlawful.
- Some intermediaries have decided to fight the blanket assessments of "inside IR35" by ignoring end-user assessments, carrying out their own assessment of the status of the contract workers based on their interpretation of the correct case law tests (ignoring the HMRC online tool), and betting that they would win often enough in court if challenged by HMRC, such that HMRC would back off. There have been recent IR35 cases where HMRC has lost and it is suggested that HMRC will be reluctant to have too many test cases going against them for fear of all PSC contract workers re-structuring their arrangements to fit the test case models (and avoid PAYE and NICs).
- There is a risk that all of the things that happened in relation to public sector PSC arrangements will happen in the private sector if/when the IR35 changes are rolled out in the private sector. In particular, there is likely to be an increase in new aggressive tax schemes (unless public action is taken very quickly by HMRC), and quite a lot of challenges to whether IR35 applies in particular instances.
- There is a possibility that government awareness of these points will lead it to delay any private sector roll-out until defects in the public sector regime are ironed out. But we suspect that this will be outweighed by the very strong wish to "do something" for the private sector by April 2019 not least to avoid a non-level playing field and the appearance not caring about tax avoidance.
- Many end-users who are currently heavily dependent on the use of PSC contract workers (especially in occupational sectors like IT, engineering and construction) will need to do a lot of planning:
- about how they will introduce processes to check the status of each PSC contractor, with many having to think carefully about whether making a safety-first blanket assessments of "inside IR35" might lead to a loss of talent, and if that is a worry, having to think carefully about new engagement models;
- to minimise un-provided-for increases in costs in long-term projects in sectors such as IT, engineering and construction, perhaps by re-engineering how the engage PSC contractors; and
- to avoid unwittingly having unlawful tax schemes in their supply chains, leading to potential civil and criminal liability under various new legislation such as the Criminal Finance Act 2017 and new measures suggested.