Under proposals announced in the Budget 2016, from April 2017 staffing companies that supply the services of personal service company (PSC) contractors to public sector bodies could be required to:
- assess whether contractors providing services via PSCs fall within or outside the IR35 tax legislation;
- if a contractor's assignment is assessed to be within IR35, deduct deemed employment income tax and employee National Insurance contributions (NICs) from the contractor's fees; and
- pay the tax and employee NICs deducted as well as employer NICs to HMRC through the Real Time Information system.
The current position
Currently, the IR35 legislation applies to any worker who personally performs services via a PSC who would, were it not for the PSC (and any other entities in the contractual chain, such as a staffing company or a managed service provider), be regarded for income tax purposes as an employee of the end user client. If a worker falls within IR35 and:
- has a material interest in the PSC; or
- receives payment from the PSC which can reasonably be taken to represent remuneration for services provided by the worker to the end user client,
after the deduction of limited allowable expenses, an amount of salary will be deemed to have been paid by the PSC to the worker. Employment income tax and NICs will be payable on this deemed salary.
Prior to the introduction of IR35, contractors remunerated themselves mainly by drawing down a dividend (rather than salary) from their PSC. This significantly reduced their tax burden, but was frowned upon by HMRC which considered many PSC contractors to be "disguised employees". Now, only contractors whose assignments fall outside IR35 can remunerate themselves this way. However, HMRC and the government believe that there is significant non-compliance with IR35 because many contractors incorrectly or falsely assess their tax status as being outside IR35. The Budget proposals could prove more lucrative for HMRC which lacks the resources to pursue small entities like PSCs.
The Budget proposals
If, following consultation, the changes are introduced as proposed, staffing companies will be burdened with assessing IR35 status as well as making tax and NICs deductions and payments for contractors within IR35. They will also have to monitor status (which may change during an assignment) and live with the worry of potentially having incorrectly assessed some assignments as outside IR35. HMRC intends to introduce objective tests and develop a new digital tool to make it easy to assess IR35 status and provide HMRC's view of the correct tax treatment. However, if it was simple to establish IR35 status, surely such a tool and tests would have been developed long ago? The recruitment industry and contractor community will be hoping HMRC does not adopt any of the tests for assignments to fall within IR35 suggested in last summer's IR35 Discussion Document, such as:
- assignments of a certain (relatively short) duration; or
- where it cannot be shown that the manner in which the worker provides the services is not subject to (or to the right of) supervision, direction or control by any person.
Potential impact of the proposals
Staffing companies with public sector contracts and the PSC contractors whose services they supply will already be used to a certain amount of scrutiny and requests for assurances about contractors' IR35 status and tax affairs from public sector bodies. However, the proposed changes to the IR35 legislation impose a greater burden on staffing companies. If staffing companies do have to take on this new burden, will they have the option to make their own assessments of IR35 status instead of using HMRC's new tests and digital tool? If so, will staffing companies adopt a cautious approach and make assessments that assignments are inside IR35 in cases where it is not clear cut, or will they even refuse to engage PSCs altogether? Contractors may react by requesting rate increases. These are unlikely to be given, particularly for assignments which are subject to fee caps. Contractors may take on direct permanent roles instead. However, it seems more likely that some contractors will simply refuse public sector assignments and favour private sector ones where they can. If, as seems likely, these proposals are eventually rolled out to the private sector, contractors may well leave the country altogether. This could potentially prove damaging to the British economy. It was only recently that its flexible workforce was hailed as being one of the reasons Britain was able to recover from the recession more quickly than other European countries.
So should this burden be placed on staffing companies at all? Surely the end user client is in a better position to assess status? Under the proposals, if a public sector body contracts directly with a PSC, it is the public sector body that must assess whether or not the assignment falls within IR35 and, if it is within IR35, deduct and account for the employment income tax and NICs. If there is a staffing company in the contractual chain, the proposed changes require the public sector body to check the staffing company's compliance. Although recruitment industry trade associations and others are lobbying hard against the proposals, the government is unlikely to drop them altogether. A lobbying stance might therefore be that the burden of assessment as well as that of deducting and accounting for tax and NICs should be borne by public sector bodies in all circumstances, including where there is a staffing company in the contractual chain.
The current detail of the proposals is available here. We will have to wait for publication of the Consultation Document, expected this summer, and draft legislation for more details of the proposed changes to IR35.