UK government consults on extending off-payroll tax rules to private sector

Out-Law News | 21 May 2018 | 3:15 pm | 4 min. read

The UK government wants to reform the 'IR35' rules which apply where individuals are engaged through a personal service company (PSC) or another intermediary.

According to a consultation document published by HM Revenue & Customs (HMRC), it is considering extending the public sector off-payroll rules to the private sector or "encouraging or requiring" businesses to ensure that those they engage comply with the existing rules.

The main tax advantage of using a PSC is that the business engaging the worker does not have to deduct under PAYE from payments made to the PSC and does not have to pay employer's national insurance contributions (NICs).

Under the current rules, often referred to as 'IR35', when an individual provides services to a private sector client through a PSC, employment taxes have to be paid if the individual would have been regarded as an employee of the client, had the individual not contracted through the PSC. However, the income tax and national insurance contribution (NIC) liabilities fall on the PSC not the client.

HMRC said there is evidence that the IR35 legislation "is not working effectively, and non-compliance is widespread". It estimated that only 10% of PSCs that should apply the legislation actually do so and that the cost of non-compliance – which currently requires HMRC to open enquiries into each PSC – will increase from £700 million in 2017/18 to £1.2bn in 2022/23.

In April 2017, the rules were changed for off-payroll working in the public sector. The changes meant that public authorities became responsible for determining the employment status of those they engaged through PSCs or other intermediaries. Public authorities are now obliged to deduct income tax and employee NICs and account for employer NICs in respect of payments to PSCs where the individual would have been an employee if engaged directly by the authority rather than through a PSC.

Following independent research commissioned by HMRC into the implementation of the new public sector off-payroll working rules, the government considered that the public sector reform has been "successful" both in increasing tax compliance and resolving the compliance challenges faced by HMRC in enforcing the off-payroll working rules in the public sector, the document said. It is estimated that an additional £410m of income tax and NICs has been collected as a result of the public sector reforms.

Extending the public sector rules to the private sector is described as "the lead option which will effectively tackle non-compliance". However, the government acknowledged in the consultation document that the public sector "faced challenges" in implementing the rules and has asked for views on whether the design of the reform and the implementation process could be improved.

"The outcome of this consultation is likely to be that businesses will be forced to take on the risk of contractors' failure to comply with IR35," said Ian Hyde, a tax expert at Pinsent Masons, the law firm behind "This is not only consistent with the public sector reforms last year but also a wider push by HMRC to put the burden of tax compliance on corporates, as we have seen with the 2017 'failure to prevent' criminal offences."

One challenge of the current rules for HMRC, identified in the consultation document, is that when making enquiries into non-compliance in the private sector, each PSC needs to be dealt with individually, even where there are numerous workers engaged and working in the same way for a single client. It said this is inefficient and results in duplication of effort, resulting in a typical case taking around 18 months to investigate. Accordingly views are sought on ways to improve the enquiry process.

"Extending the public sector rules to the private sector would give HMRC a more straightforward enquiry process," said Hyde. "Rather than chasing every PSC they will be able to start a single enquiry with the engager.  This will mean HMRC will be more effective at enforcing the rules and businesses can expect significantly more scrutiny of contractor status."

As an alternative to extending the public sector rules, views on measures that could be introduced to encourage, or require, businesses to help ensure that off-payroll workers are complying with the current rules have also been asked for.

These include rules to require clients to assure the compliance of their labour supply chains by carrying out due diligence checks, such as requiring suppliers to show evidence of PAYE returns filed and tax paid. According to the consultation paper, there could be a financial penalty for non compliance or the business could be denied a tax deduction for the costs of unchecked labour. Alternatively, compliance could be made optional but a business which was found to have used a non-compliant labour supply chain could be 'named and shamed'.

The consultation document did not specify when any reform of IR35 may come into force. The earliest date possible would be April 2019, but Hyde said that April 2020 is more likely because the new timetable for making tax legislation involves a November Budget and a Finance Bill becoming law before the start of the new tax year in April. 

"Even though we do not yet know what the government will decide to do, businesses need to consider the proposals now and take into account the possible implications for them, including increased NIC cost," said Hyde.

"For many long term projects, for example in the infrastructure sector, businesses operating as sub contractors should review their pricing to see if the additional costs can be passed on. Clearly live tenders should be reviewed to ensure the risk is priced in," he said.

"There will also be implications for the past. Switching off-payroll contractors to be on-payroll suggests that the individuals' PSCs should have been accounting for tax under IR35 for past periods," Hyde said. "There is no proposal for an amnesty for past tax IR35 irregularities and, whilst this is primarily as issue for the contractor, IR35 challenges can be significant brand issues."

Earlier this year, the first-tier tax tribunal ruled that IR35 applied to the arrangements between the BBC and Christa Ackroyd, who was engaged to provide presenting services through her PSC. In March the BBC announced it was setting up an investigation into whether the BBC has some responsibility for people facing retrospective bills from HMRC.

The closing date for comments on the questions raised in the consultation document is 10 August 2018.