IR35 blanket determinations continue to plague contractors in the public sector. In the majority of cases, contractors assessed by HMRC’s CEST (Check Employment Status for Tax) tool – an online questionnaire for determining your employment status for tax – or by their own public sector clients have been determined as falling within IR35. This means that for tax purposes they are classed as employees and the organisations hiring them will deduct tax and national insurance from their pay.
Freedom of information requests found that out of 4,000 CEST assessments across five public sector bodies, including healthcare and transport, 94% of contractors were found to fall within IR35. And between August 2017 and June 2018, the National Audit Office found that 92% of freelancers at the BBC were deemed “employed for tax purposes.”
Public sector contractors losing out thanks to IR35 reforms
So how is this affecting contractors in the public sector? In short, it means they are receiving less pay as they are being taxed at a higher rate than before. One contractor told Telegraph Money that the changes to IR35 have cost him between £1,000 and £2,000 a month for the work he does for local authorities.
The trouble began in 2000 when the government introduced tax reforms, known as IR35, to crack down on tax avoidance by so-called disguised employees – contractors who operate and bill for their services through a limited company but actually work more like permanent employees.
To find out more about IR35, read our complete guide here.
Until 2017, it was up to the contractors themselves to determine whether they fell inside or outside IR35. Then the law changed in the public sector and the responsibility fell to the public sector organisations hiring the contractors to carry out IR35 assessments. In many instances, this has led to public sector organisations automatically placing all independent workers within IR35, at huge detriment to contractors. Most are forced to pay income tax and Nation Insurance Contributions (NICs) without any of the perks of being an employee, such as sick or holiday pay.
Some organisations including Network Rail have confirmed that they use HMRC’s CEST tool “in all cases without exception.” NHS Trusts up and down the country are treating locum doctors and nurses in a similar manner, with some losing up to 30% to 50% of their income as a direct result of tax hikes.
I work through a limited company. How am I affected?
The majority of contractors being caught out by this change in legislation work through limited companies and umbrella organisations.
Many contractors choose to work through their own personal service company (PSC) – a limited company through which individuals contract out their services and receive payment for their work. Limited companies are considered one of the most tax-efficient ways to operate as you tend to pay yourself a minimum salary, pay corporation tax on your profits rest, and distribute all remaining income as dividends.
It is possible to continue working through a limited company and be deemed to be outside of IR35, but you will need to prove a number of key things to HMRC, including the fact that your client is hiring your company and its services, not you as a person, and you only carry out work specified within the scope of your contract. Anything else could be interpreted as client control.
Even if you are determined to be working on a contract within IR35, there are still benefits to operating through your own limited company. For example, you can still claim an expenses allowance, you retain flexibility to take on what work you want, and you can work on contracts of any duration you want.
Should I work through an umbrella company instead?
Many contractors including locum doctors, nurses and supply teachers work through umbrella companies to ensure tax compliance. The umbrella company usually takes care of all your invoicing, administration, chasing payment, and processing your payroll.
In some instances, this set up is beneficial for contractors. For example, you don’t have any of the administrative burdens associated with running your own limited company. However, umbrella companies do not have the tax benefits associated with limited companies. They usually deduct PAYE and NICs from your salary, together with their weekly or monthly fee.
Unfortunately, too many contractors have no choice about working through an umbrella company if they want to continue contracting in the public sector. One report found that almost a third of supply teachers have been forced to join an umbrella company to get work from an agency. And their pay has been drastically reduced because of the fees they are charged.
Social workers have faced a similar fate and believe they are now paying more tax than they should.
Protect yourself from IR35 investigations
It is still possible to be a public sector contractor working through your own limited company or an umbrella company without being stung by IR35. However, many contractors now choose to take out extra precautions, such as IR35 Tax Investigation and Liabilities Insurance, which covers the cost of professional representation for an HMRC enquiry as well as the back tax, interest and penalty liabilities that are due as a result. You may also want to get current and future contracts checked by a professional to ensure they comply with the off-payroll tax rules.
To find out more about IR35 in the public sector, head to our Knowledge Hub for the latest industry insights. You can also get in touch with our team of experts for comprehensive advice on how to stay inside the legislation.