Following consultation during 2018, the Government announced in the October 2018 Budget that it will reform the IR35 rules applying to the private sector to more closely align them with those that have operated in the public sector since 2017. However, the reform, which will make the engager responsible for ensuring the correct operation of the rules, will not be introduced until April 2020 and will only apply to large and medium sized businesses. There had been concern that this reform would come into effect in April 2019, with businesses understandably anxious about having insufficient time to prepare.
Although the delay to the extension of the public sector changes to the private sector is welcome, as is the more limited scope of its application, the changes will, however, bring significant increases in the administrative burden for engagers and, most likely, significant behavioural effects for the labour market.
The IR35 legislation was introduced in 2000 to address the growing use of personal service companies (PSCs) to prevent an employment relationship arising. By doing so, both worker and engagers gain potential tax advantages, including lower amounts of both NICs (for engagers and workers) and income tax. Under these rules, where the relationship between the worker and engager would have been one of employment in the absence of the PSC, IR35 ensures that the worker's income tax and NICs liability is broadly equivalent to that of an employee and imposes a PAYE and NICs obligation on the PSC.
However, the Government has been concerned for some time that the IR35 legislation is not working as it was intended. Following reports both from the OTS and the House of Lords Select Committee on PSCs, which concluded that the legislation is complex to administer and often simply ignored by those working through PSCs, the Government consulted in 2015 on potential changes to the IR35 regime. This eventually led to changes introduced in April 2017 under which engagers in the public sector were made responsible for ensuring the correct operation of the IR35 rules.
The public sector reform makes the public authority or agency that pays a PSC responsible for accounting for and paying income tax and NICs under PAYE to HMRC on behalf of the worker. Early analysis by HMRC suggests that this has had the effect of bringing an estimated 58,000 extra workers within the IR35 net.
Nevertheless, the concerns of the wider operation of the IR35 system remain and are growing. The Government points out that the number of small companies has increased from around 250,000 in 2000 to over 1m in 2015 and the cost of non-compliance increases as the number of people working through PSCs increases. The estimated tax loss to the exchequer from non-compliance is estimated to grow from £700m in 2017/2018 to £1.3bn in 2023/24.
In May 2018 the Government published a consultation document, “Off-payroll working in the private sector”, which provided both an evaluation of the public sector reform, a review of the challenges in enforcing the rules in the private sector and invites responses on how best to tackle non-compliance in the private sector. However, despite the careful wording of the consultation, it was clearly that the Government’s intention to extend the public sector approach to the private sector.
October 2018 Budget
The Chancellor confirmed in the October 2018 Budget that these widely-anticipated changes to the private sector off-payroll working rules would be introduced, but would be delayed until April 2020 and would only apply to “large and medium-sized” businesses. Small companies will be outside the scope of the rules. Small companies are usually defined as ones which do not have a turnover of more than £6.5m, a balance sheet total of more than £3.26m and do not have more than 50 employees.
The key change will be to put the PAYE risk onto the private sector end client by making them responsible for determining whether a contractor whose services are engaged via a personal service company (or other intermediary) should be treated as the end client’s deemed employee. If they are a deemed employee, the “fee-payer” (which will often be the end client) would be responsible for deducting and accounting for PAYE on relevant payments for the worker’s services. This will align the private sector rules with those applicable in the public sector.
A further consultation on the detailed operation of the reform will be published in 2019 and draft legislation is expected to be published in summer 2019.
HMRC has said that it will continue to work with stakeholders to improve further the “Check Employment Status for Tax” tool (which has been the subject of criticism) and guidance before the reform comes into effect. HM Treasury has also stated that it will not carry out targeted campaigns into previous years when individuals start paying employment taxes under IR35 for the first time following the reform and businesses’ decisions about whether their workers are within the rules will not automatically trigger an enquiry into earlier years – it will be interesting to see how this plays out in high value cases.
It is no surprise, given the perceived effectiveness of the public sector reforms, that the Government has decided to put the responsibility and liability for operating the IR35 rules onto the private sector engager. Whilst the Government accepts that some public authorities faced some initial challenges with implementing the rules, its independent research indicates that these were not unduly burdensome and largely limited to early adoption.
Transferring the responsibility to the engager means that HMRC are, in principle, able to target many more PSCs through fewer interventions, since HMRC is able to approach the engager directly in relation to a large number of PSCs. Such a change also addresses both risks of non-payment and also the perceived low level risk faced by individual PSCs. Larger engagers in particular may be much more concerned over non-compliance.
It seems certain that this reform will considerably change the behaviour of many affected private sector engagers, given the risk of non-compliance, with many businesses choosing to deduct in all but the most clear-cut situations. Nevertheless, the decision to delay the implementation by a year to April 2020 and to limit its application to large and medium businesses is to be welcomed.
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