The government’s much anticipated consultation paper on IR35 in the private sector was published in May. Changes to the rules could affect an enormous number of individuals and businesses operating in the private sector.
Many businesses and organisations use the services of off-payroll workers who provide their services via personal service companies (PSCs). This has been a popular way of structuring off-payroll engagements, primarily because of the perceived tax and National Insurance contributions (NIC) advantages.
Back in 2000 the IR35 rules were introduced with the purpose of ensuring that individuals who are working like employees pay broadly the same employment taxes an employee would, even where they provide their services through a PSC.
The IR35 rules can, however, be complex and have proved particularly challenging for HMRC to enforce because it is the PSC that must assess whether the rules apply. Widespread non-compliance with IR35 has been suspected for many years with HMRC recently estimating that 90 per cent of the PSCs that should be within IR35 do not operate the rules properly.
In April 2017, significant reforms were therefore introduced to tackle the issue of non-compliance with IR35 in the public sector. These reforms have placed the burden for assessing whether IR35 applies on the public sector body end user of the worker’s services. Furthermore, where IR35 applies, the fee payer (which may or may not be the public sector body) is responsible for accounting for and paying the related tax and NIC, including employer NIC, to HMRC.
HMRC has now turned its attention to the private sector and on 18 May 2018 issued a consultation paper exploring potential reforms to IR35 in the private sector.
What does the consultation paper say?
The consultation paper assesses the impact of the public sector IR35 reforms and explores ways in which compliance with IR35 in the private sector could be increased and enforced.
The paper makes it clear that HMRC sees the public sector IR35 changes as a success, helping them address the historical challenges they faced in enforcing compliance and increasing tax and NIC receipts. According to HMRC, these reforms have resulted in a clear increase in the number of individuals whose earnings were being taxed and subjected to NIC through PAYE within the public sector in the first 10 months following the reforms. Also, HMRC’s conclusion, reached by commissioning independent research and through discussions with public sector bodies, is that the public sector reforms were relatively easy to implement and have generally been working well.
While the consultation paper looks at several ways in which IR35 compliance in the private sector can be increased, most are ultimately ruled out by HMRC, including the option of a flat rate withholding tax applied by businesses to all payments made under off-payroll engagements.
This leaves what feels like two remaining options for IR35 reform in the private sector; namely the (most likely) option of extending the public sector reforms to the private sector, and a lead alternative option which explores the idea of encouraging or requiring private sector engagers to assure IR35 compliance within their labour supply chains. This latter option might require the engager to ask the PSC to provide a completed HMRC Check of Employment Status (CEST) determination, and to check the outcome of the CEST determination against the underlying working arrangements. It is, however, acknowledged in the consultation document that this option would place a relatively large administrative burden on businesses.
Will the IR35 rules in the private sector change?
What is clear from the consultation paper is that changes are required to improve compliance and raise tax and NIC receipts going forward, and any changes will inevitably lead to HMRC passing the compliance burden to some extent to private sector businesses engaging PSCs. Given the content of the HMRC consultation document, it now seems increasingly clear that the preferred HMRC option is to extend the recent public sector IR35 reforms to the private sector.
If the public sector reforms are extended to the private sector, this will present the private sector with significant challenges, especially if there is little lead time to implement change. For example, private sector engagers will need to introduce new processes and potentially enlist additional resource to assess existing and proposed engagements. Changes to accounting and payroll systems will also be required and budgets would need to be revisited because of the potential additional costs (including employer NIC) for arrangements which are within IR35.
HMRC is holding workshops and is inviting the views of stakeholders and interested parties between May and August 2018 when the consultation closes. We expect to know if changes will be made, and from when, in the Autumn Budget 2018.