Does IR35 in the public sector have a ‘small company’ exemption equivalent?

As even IT contractors who couldn’t yet call themselves hardened probably know, off-payroll working rules were introduced in the public sector on April 6th 2017 via the insertion of Chapter 10 Part 2 to the ITEPA 2003 legislation, writes Danny Batey, senior consultant for Markel Tax.

Under this arm of the act, public sector bodies have to consider the IR35 status of all their limited company contractors, and they -- the public bodies receiving the services -- are liable for any incorrect IR35 status determinations, where it is proven that “reasonable care” was not taken in reaching their determination.

In this run-up to general election 2024, will £275m annual yield be something one political party says it could do without?

While the now underway general election campaign might see some speculation about their reversal, the rules are doing the job for the taxman. In fact, HMRC estimated (in a 2022 report by the NAO) a net increase in revenue of £275 million in 2018-19 as a result of the reforms to the public sector.

The rules were further extended to the private sector on April 6th 2021, affecting an estimated 130,000 contractors. The impact of the extension is that medium and large-sized companies are required to consider the status of their contractors.

IR35: What does a ‘small company’ look like for the purposes of exemption?

Whether a company is ‘small,’ ‘medium,’ or ‘large’ is quantifiable via conditions defined within the Companies Act 2006. In particular, it is directly related to the end-client company (or company group) turnover and number of true employees.

But here’s the twist. Small companies where they are the limited company contractor’s customer are exempt from these reformed IR35 off-payroll working rules, in which case the responsibilities and liabilities fall back to the limited company contractor, as they would have done prior to the introduction of the OPW rules on 06.04.21.

To qualify as a ‘small company,’ two of the following three conditions have to be met in relation to the end-user:

  • annual turnover must be not more than £10.2 million
  • the balance sheet total must be not more than £5.1 million
  • the average number of employees must be not more than 50

What if an OPW rules-exempt small company is part of larger group?

It should be noted that if a company qualifies as ‘small’, but is part of a larger group of companies, then it is the overall group size that must be assessed.

However, and here’s the further twist -- or the ‘rub’ in some contractors’ eyes, there is no equivalent of the “small company” exemption for public sector bodies.

Instead in the public sector, the IR35 legislation relies on the definition of public authorities within the Freedom of Information Act 2000. This legislation defines public authorities as “any government department”.

Interestingly, there are specific exclusions from the Freedom of Information Act, such as the Office for Standards in Education, Children’s Services and Skills. But most government or publicly funded bodies, such as the NHS and Transport for London, fall within.

Reasons why the public sector doesn’t have an equivalent to the small company exemption…

As to the reasons why the public sector doesn’t have an exemption from the IR35 OPW rules when the private sector has, here’s my take.

Government-established entities are not run in the same way that ‘normal’ private companies operate in the sense that they are not always revenue-generating. So the small company exemption would be harder to apply and justify.

Due to the fact that public sector bodies are dealing with the public’s monies, perhaps it is even politically correct that no such IR35 OPW exemption exists for these entities, in a bid to scrutinise more closely those organisations which are funded by the taxpayer.

Is the small company exemption from the IR35 off-payroll working rules here to stay?

There has been some speculation in the lead-up to Budgets and Spring Statements about the removal of the “small company exemption” for private companies, in a possibly apparent bid to align and simplify the rules. But the government itself has made no comment on this. For now then, it’s ‘business as usual’, meaning all public sector bodies and medium/large-sized companies are within the scope of the IR35 OPW rules.

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Written by Danny Batey

Danny Batey’s career in tax began 25 years ago with the Contributions Agency and then with Employer Compliance at HMRC before moving into private practice. For the last 20 years, he has been a senior consultant within two leading status consultancies. Danny’s specialism is defending clients in HMRC IR35 off-payroll and tax status disputes; he has defended hundreds of contractors without losing a case.

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