Changes to the tax rules for personal service companies in the public sector have led to some anger and confusion.
Since 6 April 2017, it has been the duty of public sector organisations to determine the IR35 status of people they engage through an intermediary. Previously it was up to the contractor to do so. Where a public service organisation considers the IR35 rules apply to a personal service company or other intermediary, they must deduct income tax and national insurance contributions from fees paid to the intermediary as if it were an employee.
Contractors have complained that some public sector organisations are adopting an overly cautious approach, refusing to engage anyone who uses an intermediary company, or deeming all such engagements to be within IR35.
Who is affected?
The changes affect anyone working for a public authority, including government departments, local authorities, hospitals, schools and universities, the BBC and Channel 4, and police and fire authorities. If the engagement is through an agency, the agency must deduct employment taxes, but the public sector organisation has to inform the agency whether the employment status test is met.
An engagement falls within IR35 if its terms are such that the contractor would have been an employee of the client but for the existence of the intermediary. Whether that is the case depends on several factors, such as the nature of the worker’s role and responsibilities, who decides what work needs doing and when, where and how it is carried out and the basis on which the worker is paid.
The Employment Status Service tool
To help public authorities decide, HM Revenue & Customs (HMRC) introduced a new Employment Status Service (ESS) tool in March, and anyone can use it to test the status of a contract. If a contractor thinks a public authority is wrongly deducting tax, they could use the ESS and show the results to their client organisation. HMRC says it will stand by the result given by the ESS, unless a compliance check finds that the information provided was not accurate. For example, the contract might not reflect actual working practices.
Where the client organisation deducts employment taxes, the fee paid to the intermediary is treated as a payment of the worker’s own employment income. The worker does not obtain any employment rights through the client, such as statutory payments, unfair dismissal and employer pension contributions, but should already have such rights through the personal service company. The deductions are, however, reflected on the individual’s tax record and contribute towards their state pension entitlement.
The client organisation only needs to deduct tax and NICs from that part of the fee that represents the worker’s services, not any cost of materials incurred by the intermediary, or the VAT charged where the intermediary is VAT registered. The payer may also deduct other expenses that would have been deductible if the worker had been the client organisation’s employee. The public sector IR35 rules take precedence over the Construction Industry Scheme.
Fees received after deduction of tax and NICs are passed on to the worker as tax-free salary or dividend. The fees are also not liable to corporation tax.
Another change that applies from 6 April 2017 is that the 5% deduction allowed to intermediaries for ‘notional expenses’ will no longer available in the public sector. This follows the restriction to tax relief for the cost of travel to temporary engagements when working through a personal service company. This change was introduced in 2016/17 and has affected people such as locum doctors, who take on engagements all over the country.
Please contact us for advice on how these changes may affect you.