New rules are coming into force with effect from 6 April 2017 that will have a significant impact on any company or business, including Personal Service Companies, that provides the services of workers into Public Sector organisations.
Public Sector includes; local and central government, universities, colleges, public health authorities, school academies and any organisation caught by the Freedom of Information Act.
Currently, any individual providing their services via a Personal Service Company (PSC) to an end user is required to decide whether the IR35 intermediaries legislation applies to the earnings they receive. This is because the intermediaries legislation is designed to ensure that individuals who work through their own company, but would otherwise be treated as employees, were it not for the PSC, pay employment taxes in their PSC in a similar way to employees.
The Government believes that the majority of engagements entered into by PSC’s, that should have been subject to the intermediaries legislation, have not been treated as such and, as a result, there has been a significant shortfall in Tax and NIC paid over to HMRC. The new regulations are designed to deal with this perceived loss.
Who is potentially caught by the new legislation?
- Public bodies who hire off payroll workers (particularly where the workers are employed through PSCs)
- Agencies and third parties who supply PSC workers to the public sector
- Workers who provide their services to a public body through an intermediary (usually their own PSC)
Where the end user is in the public sector, the new legislation, “Off-payroll working in the public sector” moves responsibility for deciding if the IR35 off-payroll rules apply from the PSC to the public authority, agency, or third party paying the PSC. If the public sector engager confirms that IR35 applies, the entity that pays the PSC is responsible for deducting and paying the associated deemed PAYE tax and NIC to HMRC. The individual worker will no longer be part of the decision process.
If the public authority, agency or third party fails to correctly identify IR35 intermediaries and deduct PAYE tax and Class 1 NIC from the relevant payments, they will be held responsible for the underpaid tax, NIC, statutory interest and a potential penalty.
This applies to all payments made on or after 6 April 2017 and so will affect contracts entered into before 6 April 2017 that operate after that date. Public authorities and agencies and third parties supplying PSC workers to the public authorities need to consider existing contracts and prepare for the change.
The new rules apply when:
- A worker personally performs services, or is under obligation to personally perform services for the client
- The client is a public sector entity
- The services are provided under circumstances where, if the contract had been directly between the client and the worker, the worker would be regarded for Income Tax purposes as an employee of the client, or the holder of an office with the client, or the worker actually is an office holder with the client.
This legislation imposes an employment status test. The person paying the PSC must look at the arrangements under which the worker provides their services to the public sector client. If applying the employment status tests to that engagement shows they would have been an employee of the public sector client, but for the existence of the PSC, then the engagement is caught by the new rules.
A new optional online Employment Status Service has now been provided by HMRC to help people decide whether the rules apply. Employment status is largely based on case law and can be a grey area, so if you decide to use this optional tool it will be important to understand the information requested, answers provided and the basis of the decision made by the tool. It has already become clear that is not uncommon for the tool not to come to a decision. In that case it is important that the person paying the PSC can demonstrate how they arrived at their decision on the employment status.
What does the engager/fee payer have to deduct and pay over to HMRC?
If this legislation applies, the worker is treated as receiving a deemed employment payment when they are paid for the services they provide. The fee payer must operate PAYE tax and NICs on payments made, as the fee paid to the PSC is treated as a payment of the worker’s employment income. The PAYE tax and NIC deducted is paid to HMRC with the normal RTI remittances. For tax, NICs and Apprenticeship Levy purposes, the worker is treated as having an ‘employment’ with the fee payer but stakeholder pensions, statutory payments and other employment rights do not apply as they remain with the PSC.
How to calculate the deemed direct payment on which tax, NICs and Apprenticeship Levy are paid.
- Step 1 – the amount of the payment less the amount (if any) of VAT.
- Step 2 – deduct the direct cost of materials provided by the worker.
- Step 3 – deduct actual business expenses incurred, and evidenced, that would have been deductible/allowable if the worker had been the client’s employee and the expenses had been met by the worker out of those earnings.
- Step 4 – The amount remaining is the amount of the deemed earnings payment on which to calculate PAYE tax and Class 1 NIC.
This change does not affect:
- PSC workers who only provide their services to private sector organisations
- Fully contracted-out services delivered in the public sector
- Where an agency directly employs a worker and it operates PAYE and NICs on earnings it pays to the worker
- Managed service companies.
This new legislation is going to affect a significant number of businesses, and it will be complicated to identify and administer, which means there is a high risk of errors being made. HMRC will be monitoring compliance with the new rules.
The cost of contracts are likely to increase, due to the added cost of Class 1 employers NIC being paid.
This is a very complicated issue that will be difficult to apply. If you are concerned that you may be affected by this legislation we recommend that you contact one of the Smith Cooper Employment Tax team for more specific advice.