The government’s proposal that public sector organisations should be responsible for ensuring that personal services companies (PSC) they engage pay the correct level of tax has been branded unsatisfactory.
On Budget day George Osborne was expected to launch a full IR35 consultation, but in the event the only major announcement on the subject was the proposal affecting only limited company contractors working for public sector clients.
Many AccountingWEB readers may already be familiar with the proposals to transfer compliance responsibilities to the client, where there is no intermediary, or the intermediary nearest the personal service company where there is one.
On Budget day the Chancellor said: “Public sector organisations will have a new duty to ensure that those working for them pay the correct tax rather than giving a tax advantage to those who choose to contract their work through personal service companies".
Chapter 2.40 of the Red Book states that the new duty will apply from April 2017, following consultation on a “clearer and simpler set of tests and online tools”. The rules will remain unchanged for those working in the private sector.
HMRC also issued an accompanying consultation document, with examples including Grace, a senior analyst at the Ministry, Charlie, a locum social worker.
Example 2 – Local Government using an agency – rules apply to the agency
Charlie is a locum social worker within the Child Protection team at a County Council. The Council contracts with an agency to supply Charlie for 9 months. He is not an office holder under the Local Safeguarding Children Board Regulations (otherwise he would be automatically required to be on the payroll under the current legislation). The agency contracts with Charlie’s PSC. The agency checks HMRC’s new tool to see what the tax position is and finds that the off-payroll rules apply.
The agency must deduct tax and NICs on the payments it makes to Charlie’s company. Charlie’s PSC charges the agency £1500 per month for his services. Charlie’s company is not registered for VAT. The agency treats £1500 as Charlie’s earnings and deducts £123 tax and £99 employee NICs. It accounts for this via RTI and pays the tax and employee NICs to HMRC along with £114 employer NICs. Charlie’s PSC receives £1278.*
Charlie receives a credit against employment and dividend income drawn out of his PSC so he does not pay tax twice. The corporation tax liabilities of his PSC will remain unchanged by the measure.
* for simplicity, examples do not include 5% expenses which we will be consulting on.
While the consultation is not the final outcome, experts expect the final changes will not be too different to the current proposals.
Proposals ‘unfair’
Speaking to AccountingWEB about the consultation document, employment tax expert David Kirk labelled the proposals unfair for a number of reasons.
“There was a discussion document issued last summer about this," said Kirk, “but no summary of the responses. HMRC are not required to issue summaries of responses, but in this case we cannot make an informed decision about how to respond without it.”
Kirk also expressed concerns that the message may get out among the contracting fraternity that IR35 only applies in the public sector. “While professional accountants and HMRC will obviously know that this is not so, we can’t control the gossip in the pub”.
Another troubling aspect of the proposals for Kirk was that agencies are unlikely to accept responsibility. “Many of them do not operate payrolls at the moment and they don’t want to”, said Kirk. “They will therefore insist that umbrellas are used, thus reducing contractors’ pay still further."
According to Kirk, contractors are likely to take one of two views: Some will not see the need for their companies and so will be paid directly by umbrellas; others (those who do shorter term contracts, alternating between public and private sectors) will struggle to organise their PAYE, having to sign off one payroll and go on to another one, and then back again.
“I can see people refusing to take public sector contracts because of this," said Kirk.
Agencies also do not always have the information to decide whether IR35 applies, particularly where the contracts do not reveal much about control and mutuality issues: the people with the information to do so are the clients and the contractors.
“We shall now have the intermediary nearest the client responsible for compliance where the agency rules apply, and the intermediary nearest the PSC responsible where IR35 applies,” said Kirk. “This is a recipe for confusion – what happens when they disagree?”
And, most importantly of all for Kirk, the proposals do not solve the fundamental injustice of the law, which is that it forces employees to pay employer’s NI.
Citing HMRC’s examples, Kirk states that in example two what is likely to happen is that instead of Charlie’s company ‘charging the agency £1,500 per month for his services’, the negotiation will be the other way round.
“The council will say to the agency: ‘we pay you £1,750 a month for Charlie – sort the rest out with him’. As the agency will probably want £250 for its margin as well as having to pay £100 of employer’s NI, it will tell Charlie that he is getting £1400 a month, not £1500.
“Actually it won’t. It will say to Charlie that it is paying £1,500 to the umbrella of his choice, which will then set his gross pay at £1,400, and probably give him an incomprehensible payslip that makes it impossible to understand exactly that has happened to his money.
“Either way he will see that somehow or other he has ended up with the bill for employer’s NI, he will perceive as unjust (correctly in my view).
David Kirk's book: Employment Status - the Tax Rules is now in its third edition.