IR 35 changes could have disproportionate impact on infrastructure and energy sectors

He was commenting as Pinsent Masons submitted its response to a government consultation on proposed changes to the off-payroll working rules in the private sector.  

The government is considering making private sector businesses responsible for accounting for tax and national insurance contributions (NICs) if they engage a contractor through an intermediary such as a personal service company (PSC) and the contractor would have been regarded as an employee for income tax and NIC purposes if they were engaged directly. This rule has applied since April 2017 in the public sector.

"If the government decides to roll out the public sector rules to the private sector, businesses in the infrastructure and energy sectors in particular will have the huge task of considering the circumstances of each individual and deciding whether tax needs to be deducted," Thomas said.

"It seems likely that the government will want to press ahead with the change, given that the rule already applies in the public sector. This means businesses with large numbers of off-payroll contractors need to be gearing up now and considering how they will approach the task," he said.

Even though the government considers that the roll out of the off-payroll sector rules to the public sector has been successful and has not caused too many problems for public sector bodies using PSCs, Chris Thomas said this does not mean the same will be the case for the private sector. Public sector bodies tend to be larger than private sector ones and will usually have large payroll departments who will be better able to cope with the challenges of determining the status of each contractor, he said.

"How on earth will small businesses cope with such a significant change to the tax regime, which is likely to come hot on the heels of Making Tax Digital and could coincide with Brexit? Thomas asked.

The consultation document does not suggest when the change could be introduced.

"If the government decides to go ahead with this change it must not be rushed in. 2020 should be the earliest date contemplated," he said.

Under the current rules, a private sector business does not have to deduct tax under PAYE from payments made to the PSC, and importantly, does not have to pay employer's (NICs). Employers' NICs are currently payable at 13.8%.

The intermediaries rules, commonly referred to as 'IR35', impose an obligation on the PSC to decide whether the individual would have been an employee if they were engaged directly. If the answer is that the individual would have been an employee, there is a deemed payment of employment income by the PSC, which must then account for both tax and employer and employee NICs charges. However, a client contracting with a PSC is not liable for the tax, and importantly does not bear the employer's NICs.

"Businesses will be faced with a significant compliance and financial burden if they are required to assume IR35 tax risks for contractors engaged through PSCs. Given that profit margins for infrastructure and energy are often very slim, the financial impact is expected to be particularly onerous for engagers within these sectors. Contractors may well find that they will not be able to pass on the cost to their client," Chris Thomas said.

"Engagers are also unlikely to be able to reduce the amount paid to the contractor to factor in the fact that it now has to pay employer's NICs as well as dealing with the administration of PAYE. We have made it clear in our response to the consultation that we think the government needs to give further consideration to the impact on existing contracts," he said.

According to the consultation document, the changes are being proposed because HM Revenue & Customs (HMRC) estimates that only 10% of PSCs that should pay tax under IR35 actually do so. It estimates that the cost of non-compliance will increase from £700m in 2017/18 to £1.2bn as the number of people working through PSCs continues to grow.

The government also wants to make it less labour intensive for HMRC to investigate PSCs. A single client may have thousands of individuals using PSCs. Under the current rules, in order to enforce IR35 compliance, HMRC needs to enquire into the tax affairs of each individual PSC, which is very resource intensive.

"HMRC would like the businesses which uses the services of the contractors to be on the hook for the tax. It is way easier for HMRC to deal with big businesses which are more likely to pay up when it comes knocking. In contrast, tracking down and separately investigating the myriad of individual PSCs and then trying to get the cash out of them is an administrative nightmare for HMRC," Chris Thomas said.

The public sector rules rely on the engager using HMRC's check employment status for tax tool (CEST) to determine the individual's status.

"We have concerns about the increased reliance on this tool which attempts to apply complex case law to a set of facts. CEST will not produce an answer in a significant number of cases. That then leaves the engager having to seek further guidance from HMRC and/or taking a risk on the classification," he said.

As an alternative to rolling out the public sector rules, the consultation document suggests that businesses could be required to perform more due diligence on off-payroll contractors.