In our March 2016 issue of Recruitment Watch, we reported on the changes to the IR35 tax legislation proposed in the Budget and the potential impact of these changes on the recruitment industry. On 26 May 2016, HMRC published a consultation document on the proposed changes. This document sheds more light on the Government and HMRC's intentions for reform in this area.
What does the Consultation Document add to the Debate?
What is proposed?
The proposed changes will move the obligation to assess IR35 status, and the associated deemed employment income tax and NICs liabilities if a public sector assignment is within IR35, from the personal service company ("PSC") to:
- the public sector end user client; or
- if there is a supply chain, the party closest in the contractual chain to the PSC.
This puts staffing companies that place contractors on temporary assignments with public sector bodies firmly in the firing line for this new tax burden.
How will IR35 status be assessed?
The IR35 discussion document published in July 2015 suggested that the test for assessing IR35 status could be changed to one based on:
- the length of the assignment (with press leaks before the 2015 Autumn Statement suggesting that assignments lasting more than a month could fall within IR35); or
- the supervision, direction or control test adopted in other recent changes to tax legislation.
However, according to the consultation document, the Government considers that the existing employment status test is still appropriate for IR35 assessments. HMRC intends to develop a new interactive online tool to make determining IR35 status as simple and certain as possible. The consultation document proposes that the assessment of IR35 status is simplified using a process of up to three steps:
Step 1: Do the IR35 rules apply? If 20% or more of the contract is for materials supplied as part of the contract (the consultation document provides the examples of a plumber supplying bathroom fittings and pipes and a shop-fitting business providing shelves, window glass and flooring) or the contractor does not own his/her own company, the IR35 rules do not apply.
Step 2: If the IR35 rules do apply, is the contractor within IR35? This is assessed by asking two questions:
- Right to personal service: is the contractor required to do the work him/herself?
- Control: does the engager decide, or have the right to decide, how the work should be done?
If the answer to both questions is yes, the contractor is within IR35.
Step 3: If the engager is unable to answer yes to both questions at step 2, the engager must use HMRC's new digital tool to assess whether the contractor is within or outside IR35.
HMRC will be bound by the result of the online test if the engager has entered accurate information reflecting the true facts and the circumstances do not change during the course of the assignment. If the circumstances do change, the new circumstances must be entered into the digital tool for a re-assessment of IR35 status.
Security and confidentiality are often key aspects of public sector assignments. It therefore seems likely that many contractors will fall within IR35 at step 2. Step 2 is a dramatic oversimplification of the employment status tests. Even if contractors make it to step 3, although certainty on status seems positive on the face of it, oversimplification of the employment status tests could produce the wrong results. Employment status can only fairly be assessed on a case by case basis. This fact is acknowledged in the consultation document which concedes that there will be a statutory right for PSCs and engagers to appeal against a determination that the contractor is within IR35 and the resulting tax and NICs liability.
Anti-avoidance provisions will be put in place. It is intended that the new rules will, for example, apply to consultancies and outsourcing specialists that place contractors on assignments as well as staffing companies. This is so that the effect of the proposed changes cannot be avoided by using a service provision contract rather than a contract for the supply of a worker. If there is a supply chain and the entity that contracts with the PSC is based outside the UK, it is proposed that liability to comply with the new rules should fall on the party closest in the chain to the PSC which is resident in the UK.
What should staffing companies do now?
Assess the impact
For the potential impact of the changes on the recruitment industry, please see our earlier article here. Staffing companies should assess the impact of the proposed changes on their business and use this assessment to plan an appropriate strategy for dealing with the changes.
Work out which assignments will be caught
Staffing companies should ensure that they know which assignments will be caught under the new rules. The Government intends to use the very broad definitions of “public sector” set out in the Freedom of Information Acts. Organisations covered include:
- government departments, executive agencies and non-departmental public bodies; local authorities and devolved administrations;
- the armed forces; the NHS; police and fire authorities; educational establishments including universities; and
- the BBC and Channel 4; and the Bank of England.
It will be key for staffing companies which place PSC contractors with end user clients via recruitment process outsourcers, or other third parties such as IT consultancies, to establish whether the ultimate end user client is a public sector body. This information is not always provided and staffing companies should consider adding a contractual obligation for the end user client's identity and what type of entity it is to be disclosed.
Consider different contracting models or bite the bullet
Staffing companies should start to assess the appropriateness of different contracting models. Some may choose to avoid risk by treating all public sector assignments as being within IR35. Engaging contractors as PAYE agency workers may be another route for the risk averse. This model, however, brings increased compliance burdens in relation to social security benefits and certain employment law protection rights, such as the entitlement to paid holiday and the 48 hour weekly working time limit.
"Margin only" contracts are another potential route. Under this model, the end user client engages and pays the PSC directly and pays the staffing company its margin only. This moves the new IR35 liability to the end user client. It also makes the Agency Workers Regulations an irrelevant consideration because the "margin only" model takes PSCs completely out of scope of these Regulations. The downside is that the staffing company potentially loses ownership of the contractors. However, appropriately drafted restrictions in client contracts and, where the Conduct Regulations do not apply, in contractors' contracts could prevent this.
Ultimately, if staffing companies do have to take on responsibility for assessing IR35 status for public sector assignments next April, a balanced approach should be taken to ensure that contractors genuinely operating outside IR35 are not denied that status. This may be hard to do, particularly as contractors and end user clients are surely in a better position to assess status than staffing companies. However, if staffing companies are not prepared to invest time assessing IR35 status, they are likely to find that skilled resource will either go to staffing companies that do not deny contractors their outside IR35 status or favour private sector assignments over public sector ones, with the result that key clients are lost and contractor bases eroded.
Respond to the consultation and lobby
Those wishing to submit a response to the consultation document have until the closing date of 18 August 2016. The consultation document can be found here.
Any resulting changes to the IR35 legislation will be subject to a short technical consultation. If the legislation is amended as proposed, it will apply to public sector assignments from April 2017.
It is not currently proposed that the rules will change in relation to the private sector, but it can only be a matter of time. In addition, the consultation document states that the new interactive online tool that HMRC will develop to assist in the assessment of IR35 status will be made available for use by individuals who provide services via PSCs in the private sector as well as entities subject to the new public sector rules. Therefore all staffing companies, including those that do not supply into the public sector, would be well advised to respond to the consultation document and attend the round table discussions HMRC will be holding over the summer. By these means they can both attempt to influence the course of these proposed changes and contribute to the development of the online IR35 status assessment tool.