How does the recent IR35 changes in the public sector affect UK contractors?

The latest changes to IR35, which have now been rolled out by the Government, has caused chaos and uncertainty amongst public sector contractors.

This has had a direct impact on public sector bodies such as the NHS, who are reporting difficulty in finding people to fill positions.

The Intermediaries Legislation, most commonly known as IR35, was adopted by the Government 17 years ago, in a bid to stop the perceived problem of people claiming they were operating a business when they were in fact behaving like employees, in order to pay less tax.

However, the legislation proved to be fundamentally flawed with large numbers of genuine businesses having their IR35 status questioned by HMRC, leading to long and costly investigations.

And, as of this month, those working in the public sector could find their IR35 status challenged after the Government rolled out two major changes.

The first is who holds the responsibility for determining the IR35 status of an engagement. Individual contractors themselves used to consider the IR35 status of their engagements – and this still applies in the private sector.

But for those who have a contract with a public sector organisation, this no longer applies. Instead, the individuals’ IR35 status will be determined by the client or agency that is paying for the service.

The second major change in the rules is if the client or agency decides that IR35 does apply, then employment taxes will automatically be deducted at the source – similar to those who are in employment.

Although changes are being made to the way in which IR35 status is determined, the factors that are considered when determining this status remain the same, such as; if a mutuality of obligation exists between the client and the individual and if the individual has control over their work.

The changes have had a substantial impact on the industry, with genuine contractors walking out. Public bodies such as the NHS, the MOD and Metropolitan Police have been left struggling to deliver projects as a result of highly skilled contractors leaving mid-way through projects.

So why are public sector contractors terminating their contracts early?

There is genuine concern that public sector bodies will not make the right decision when it comes to determining individual IR35 statuses.

Part of the reason for this view is because IR35 is extremely complex, and with public sector bodies lacking experience in dealing with it, it makes it more likely that wrong determinations will be made.

Moreover, there is a clear incentive for organisations to declare such engagements as being ‘inside’ IR35 as it removes the risk of being handed a hefty tax liability if it is later discovered that the engagements were wrongly determined as being ‘outside’ IR35.

IPSE has found that since the changes have come into force, there seems to be a sense of chaos and uncertainty in the public sector.

In fact, numerous public sector bodies have informed contractors – either directly or via an agency – that they only have the following three options:

1)      To move on to the payroll

2)      Accept an IR35 ‘caught’ status and be subjected increased taxes

3)      Operate their business through an umbrella company

Another issue that is cropping up is paying the Employer’s National Insurance tax, should it be determined that IR35 applies.

The client or agency has the responsibility of shouldering this cost, which is an additional 13.8 per cent of the gross pay. So if the client pays your firm directly, then they will pay the Employers NI; if an agency pays your company, then they will pay it.

However, early reports have suggested that some clients have tried to pass the employer’s NI cost to the contractor and as a result, many individuals are finding themselves in a difficult negotiations. 

So what should you do?

IPSE has pointed out that the legislation clearly states that the fee payer is responsible for the employer’s NI, meaning you have the right to resist it.

Also, make use of the Employment Status Service (ESS) online tool. HMRC has said it will stand by any determination made through this system. So if the ESS determined IR35 does not apply to your engagement, show the results to your client or agency.

If the client or agency insists on applying IR35, even in the face of evidence, you can challenge the determination at a tax tribunal, but this will take some time.

It is a deeply unsatisfying situation, which is why so many contractors are leaving the public sector, and it is why public sector bodes are struggling to fill roles and deliver services.

In the end, this latest measure will benefit no-one.