IR35 and Public Sector bodies: the expert’s opinion

IR35 and Public Sector bodies - the expert’s opinion

Following revelations two years ago that NHS Digital had been fined £4.3m by HMRC and more recently, that DWP was fined almost £88m for “historic errors” and the Home Office £33.5m (including penalties of £4m have been suspended), HMRC has been deemed “careless” in its implementation of off-payroll working rules.

One might wonder which public sector body will be next.

However, as all these revelations have come via the publication of their accounts, it would be impossible to make any predictions; yet scope for error clearly exists and that is largely due to a lack of complete understanding of the rules that exists in the public (and private) sector as well as the lack of clarity around outsourcing.

What we do know is that public sector bodies and the arm’s length bodies do engage significant numbers of contractors and HMRC has successfully challenged the IR35 status of some of these, which may well have been a prompt for the DWP to reassess 10% of its engagements during the last tax year.

But there are also outsourced services, where a public sector body passes on a project to a 3rd party which becomes responsible for its resourcing. This could be a potential focal point for HMRC; i.e. are these genuinely outsourced services?

HMRC guidance

HMRC offers guidance on outsourced services in their Employment Status Manual – 10010 and the third and fourth paragraphs sum up the position:

“Where a person enters into a contract for a fully contracted out service, they will not be the client. This is because the worker’s true client is the party who the work has been contracted out to; the ‘service provider’. The service provider is the party most akin to the worker’s employer. The person receiving the fully contracted out service has not meaningfully entered into a contract for the supply of the worker. 

A person who receives a fully contracted out service does not need to apply the off-payroll working legislation, as they will be above the client in the contractual chain and will have no obligations under Chapter 10, Part 2 ITEPA 2003 in relation to that contract. The service provider providing the fully contracted out service must consider if it is a public authority or medium or large-sized entity to see if it is within scope of the off-payroll working rules.” 

This guidance also needs to be considered by the private sector as one imagines that HMRC will want to test whether outsourced work going to consultancies involves an element of avoidance, which results in the end client being released from any obligations to go through the IR35 decision-making process and effectively pushes the decision-making and liability for IR35 down on to the contractor under Part 2, Chapter 8 ITEPA2003 (“Old IR35” rules). 

Statements of works

Anecdotally we are aware in both the public and private sectors of requirements to fill specific roles being issued as ‘statement of works’ and this being considered as sufficient to be outsourced provision.  However, as ESM 10010 notes: “labelling a contract as a contracted-out service or a ‘statement of work’ when in reality the contract contains a provision for labour will not prevent the off-payroll working rules from applying, and the reality of the arrangements should be considered.”

Again anecdotally, we have been made aware of the off-payroll rules being misinterpreted. For example, individuals engaged as sole traders in education and in Trusts being assessed under the off-payroll working rules which are designed to address the engagement of contingent labour via intermediaries (i.e. the contractor’s own limited or personal service company). Yes, it is correct that self-employed engagements should be assessed to check their status and HMRC have made it clear that the Check of Employment Status for Tax (CEST) Tool can be used to do so.

However, if the outcome is that the engagement represents employment, then a public sector body cannot ask the individual to invoice work from which it will then apply PAYE under the off-payroll working rules. They would have to continue the arrangement on the basis of employment. In tax terms, an individual is either self-employed or employed. The ‘hybrid’ position that exists of a PSC issuing an invoice as an independent contractor and then having tax and NICs deducted at source as an employee (for tax purposes only), does not exist.

Whilst this scenario has not been an issue in the private sector as far as we can tell; it is evident from discussions with business owners that they do not appreciate that engaging the self-employed is not a position of choice or agreement between the parties, but something that must be tested against case law and established principles.

Some engagers do not necessarily appreciate that they are on the hook if HMRC undertake a compliance visit and deemed an independent contractor to be an employee. This being the primary reason why most businesses had engaged their contingent workforce through a limited company prior to the IR35 rule changes in April of this year.

Perversely, because construction businesses don’t want to engage with IR35 (which trumps CIS), we are being fed back comments from the construction sector that the engagement of subbies via CIS is on the increase.

The private sector

In terms of the private sector, the issue has been a lack of readiness – perhaps it is the fact that HMRC have stated that they will approach the new rules via a light touch regime. This generally means there will be no penalties levied, but it doesn’t mean that there won’t be tax and interest levied if errors are found. How HMRC will undertake their compliance activity is not yet fully clear. HMRC have two potential routes to check on compliance: the quarterly intermediaries reporting which recruitment agencies undertake and in which they must highlight entities which have been paid gross; secondly, undertaking a compliance visit into a known engager of contractors.

The reason I would favour the latter is that all routes lead back to the end client engager as that is where the legislation effectively starts. End clients must:

  • Make the IR35 status decision
  • Take reasonable care to do so
  • Issue a Status Determination Statement (SDS); and
  • Have a client-led disagreement process for challenges by contractors to the SDS

Failure to do so and HMRC can confer the liability upon the end client as noted in their Employment Status Manual – 10014:

The client must take reasonable care when determining whether the worker would have been an employee if they were engaged directly. If the client fails to take reasonable care, the responsibility for the deduction of tax and NICs, and the payment of the apprenticeship levy and paying these to HMRC will rest with it. That liability will always remain with the client unless it takes reasonable care in reaching its conclusion set out in the SDS. Reasonable care means clients should act in a way that would be expected of a prudent and reasonable person in the client’s position.”

What does the future hold?

Only time will tell exactly how HMRC will undertake their compliance activity. And that is the message to all parties: compliance is key – get that right and you should have nothing to fear from HMRC. Yet, we are aware that compliance comes at a price and some engagers may have to up rates to keep the best talent, particularly when an engagement is deemed inside IR35 and the contractor will want compensating for the tax consequences.

Markel provides both IR35 compliance services and insurance against the costs of a HMRC enquiry – even the tax loss that might arise for the fee payer. Nevertheless, as relevant and important as our Fee Payer Protect insurance will be in this market, insurance is not a substitute for robust compliance procedures.

To find out more about IR35, visit our IR35 hub today.

About the authorPaul Mason - Head of Tax Partnerships at Markel Tax.

Paul Mason is the Head of Tax Partnerships at Markel Tax. Paul joined the Markel Tax team in 1997 and has ben closely involved with IR35 since 2001, providing advice on the subject to contractors, end clients and fee-payers.

Paul is a regular speaker on IR35 and works closely with Markel Tax’s investigations specialists to ensure freelancers get the best defence in an IR35 enquiry.

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