What's wrong with the Budget's PSC tax clampdown
The March 2016 Budget was expected to launch a full IR35 consultation, so what surprised many in the contractor sector was the most major announcement proposing changes only for limited company contractors working for public sector clients.
Importantly, the announcement of a consultation is not the final outcome, although if HMRC follows recent tradition, we can expect changes similar to the current proposals.
Having scrutinised HMRC’s technical note issued immediately after the chancellor’s speech, here and exclusively for ContractorUK, Duncan Strike, director at specialist contractor accountant Intouch Accounting, unpicks what the outline proposals are; who they will affect and reveals some important anomalies not addressed by HMRC.
What the government plans to do with public PSCs
From April 2017, the government proposes to make public sector bodies and agencies responsible for operating the tax rules that apply to off-payroll personnel working through limited companies (also known as PSCs) in the public sector.
The key proposals are:
- If you work for the public sector, through your own limited company, the business that pays your company (let’s call them ‘the paying agent’) will have to assess the status of your working practices.
- Where practices are deemed employment, the paying agent will deduct income tax and employee's National Insurance (NI) before transferring the net funds to the limited company.
- Income Tax and NI will be based only after allowing expenses that are available to everyday employees, so expect travel and subsistence (T&S) tax relief to be lost.
- HMRC are not convinced that a 5% flat deduction (adopted by the existing IR35 rules) is appropriate and will consult on that part.
- The tax deductions are paid by the paying agent to HMRC together with the employer’s NI, which is no longer the liability of your limited company.
- Your company will still have to pay corporation tax under normal rules, but if you have taken money as salary or dividends, then an offset will be available to avoid double taxation.
Who will this affect?
These rules will hit teachers, local authority, social and care workers, NHS workers and all UK and local government workers providing their services via their own limited company. There is no limit to the nature or scope of services provided, so it doesn’t matter whether you work in IT, project management, financial services or anything else for that matter. The question is: do you work for a public sector body?
Anomalies: the fundamental five
Having looked at the small print and considered the implications, these proposals have some rather glaring anomalies that are not answered in HMRC’s technical note:
- Firstly, if the employer's NI becomes payable by the paying agent, then the contract must already reflect this in its terms and rates. As a contract is drawn up typically before working practices are correctly assessable, how will the treatment of employers’ NI be known, therefore, before it can be established where the employer’s liability lies?
- Secondly, these changes are not changes to IR35 generally, they are referred to as new rules. How can there be simplification if a limited company contractor has to potentially contend with IR35 for non-public sector work, and IR35 ‘mark two’ for public sector assignments?
- Thirdly, if the limited company is to be subject to corporation tax in the normal way, then how will retained funds be taxed? The paying agent deducts income tax and NI; this does not determine that salary is taken. If the company can only deduct the actual salary paid, then there will be double taxation. This can only be overcome by matching salary deductions with a presumed salary, but that may not reflect actual outcomes.
- Fourthly, this creates a two-tier system. For example, an IT contractor working for Google will be potentially subject to a different set of rules to the IT contractor doing similar work for a public sector body. Care workers in the public sector will be different to care workers in the private sector. Whatever happened to ‘levelling the playing field’?
- Fifth, will the paying agent be truly experienced and skilled enough to assess status? This was one of the biggest issues facing the IR35 discussion document. Will the paying agent only be allowed to rely on facts presented by the engager? Will that engager understand what is relevant?
Further (unanswered) questions
The whole issue is simply too subjective to expect anyone other than a specialist to get the answer consistently right. Is HMRC aware of this?
Producing guidance – as HMRC is expected to do - is good news, but only if that guidance can be understood and applied consistently. Online tools will be good news too, provided they are complex enough to address the different skill-sets and the different roles undertaken in the real-world, without over simplification. At the same time, they need to be simple enough for people to use and understand. Can HMRC strike this difficult balance?
In addition, will the online tools and guidance suggested truly be developed alongside stakeholders? That would require HMRC to actually embrace stakeholders’ views, but to date they have continuously failed to do so. Why will this change now, and if so, how?
Plus, it appears that little consideration has been offered from HMRC whether any appeal process will exist or if it will, how it would apply. Imagine for a moment that the paying agent suffers the employer’s NI and deducts income tax and NI. The worker appeals and proves he is not an employee. How would the financial and legal contractuals issued be resolved in such circumstances? Or is there to be no right of appeal? Surely not?
This all seems to be a theoretical solution creating a practical disaster. We can only hope that the consultation process is undertaken with discipline and is a true consultation rather than the traditional, HMRC view of the world, regardless of fact or fiction. As another adviser has said, we need a taxman "in listening mode."
I wouldn’t be surprised if this consultation strays into areas that concern IR35 generally. It’s clear from HMRC’s comments that all workers would be able to make use of the status tools so that there will be commonality in the assessment and this could be a precursor to wider changes from HMRC.
There’s no doubt that would-be contributors to this future consultation should recognise the wider implications to the whole market, and be cautious that views given concerning the public sector workers are not translated by HMRC as applying to the whole PSC market.
Indeed, HMRC and the government are likely to see the public sector as within their domain and will develop and test out new systems, processes and controls on that sector to identify and address any loopholes or gaps; this will be done before rolling the changes out more widely in 2017.
So it seems a pretty good assumption that changes affecting the public sector will be a good indicator of where HMRC views the future of IR35 generally. It will be especially important therefore to address concerns at every opportunity and we will be pressing hard the interests of our clients and the PSC market as a whole. And of course, we intend to be submit a response to the consultation once it’s announced and have offered to HMRC our industry experience as a stakeholder to help them create meaningful, fair and appropriate tests. Any contractor wishing to contribute is welcome to contact us with their views so we can feed your comments, anonymously, to HMRC.