It’s been almost three years since the government rolled out its controversial IR35 reform to the public sector, affecting contractors up and down the country across dozens of industries. Flexible workforces across the NHS, BBC, and Network Rail have all felt the brunt of blanket IR35 determinations, causing many genuinely self-employed workers anxiety over being able to find work - despite HMRC's frequent assertions that IR35 will not hurt any honest contractors.
There have been many criticisms of the legislation, including the somewhat limp promise to review the implementation of the off-payroll rules made by Chancellor Sajid Javid after the latest general election. Many have protested - most recently, James Poyser of offpayroll.org.uk supplied hard, cold data as to why the reform is a bad idea in the form of a letter to Sajid Javid - but the IR35 private sector reform appears to be going ahead as scheduled on April 6th.
The good news is that it's entirely possible to continue successfully operating as a limited company contractor in the public sector with a little bit of preparation.
IR35 public sector reform explained
HMRC's off-payroll tax legislation (known as IR35) aims to combat so-called 'disguised employees' – contractors who work through their own personal service company (PSC) and pay less tax but would otherwise be employees of the client if they didn’t work through an intermediary. If found to be a disguised employee, and therefore operating 'inside IR35', the contractor would end up paying the same income tax and National Insurance Contributions (NICs) as if they were employed.
Genuine limited company contractors pay corporation tax on their profits at a flat rate of 19%. They can also treat their salaries are a deductible business expense, which means most choose to take a small salary and draw most of their income from the business in the form of dividends. This approach reduces the amount of NICs they have to pay, which allows for money to be set aside to provide for themselves all the employment safety nets that permanent employees receive through their jobs. This includes pension savings, buying and maintaining their own equipment, putting aside funds for time off work or sick days, and other general business overheads.
Until 2017, it was up to contractors in the public sector to determine their own IR35 status; their limited companies were liable for any unpaid taxes and penalties if HMRC investigated and decided that they were indeed operating inside IR35. However, the IR35 reform shifted the compliance burden and potential liability for unpaid tax further up the supply chain to public sector employers. Panicked by the prospect of huge tax bills for wrong determinations, many public sector organisations responded by enforcing blanket IR35 determinations. Contractors were pushed to PAYE or umbrella arrangments, or were culled as a workforce altogether.
IR35 in practice in the public sector
If you’re a contractor in the public sector, your client or recruitment agency is most commonly responsible for determining your IR35 status.
They will decide on your employment status to see if the off-payroll working rules apply. There are a few routes they could take to do this; some use HMRC’s online CEST tool (read here as to why that isn't the best option), some enlist professional IR35 consultation, and some will carry out assessments themselves in-house. The off-payroll rules will usually apply if you provide your services to the client through an intermediary, such as your PSC, but would be classed as an employee if you were working for the client directly.
What happens if I'm found to be inside IR35?
Your client or recruitment agency must tell you what they’ve determined and if they believe the rules apply or not. They should aim to do this before you enter into a new contract or when you start work, if that’s later.
If you’re found to be operating within IR35 (which means the off-payroll tax rules apply), then the following will usually happen:
- Your client or agency will calculate, report and process tax at source via PAYE on each payment made to you. This means they will pay a net amount to your limited company which you can then pay yourself with by way of a tax-free dividend or salary;
- If there is no agency, the responsibility for processing your tax rests with the hirer and the same process applies;
- Your agency or client is liable for tax if an incorrect IR35 judgement is made.
Which public sectors organisations does the IR35 reform apply to?
The off-payroll working rules apply to most public sector organisations, including:
- Government departments, including their executive agencies;
- Companies owned or controlled by the public sector;
- Schools and universities;
- Local authorities;
- Parts of the National Health Service (NHS), including NHS Trusts.
The rules also apply to the:
- UK Parliament;
- National Assembly for Wales Commission;
- Northern Ireland Assembly Commission.
Hospitals, GP surgeries, and dental practices also need to check if the rules apply to their contracted workers. This includes contractors who provide ophthalmic and pharmaceutical services to the NHS, although it’s worth noting that the IR35 reform changes don't generally apply (for now) to retail businesses providing ophthalmic and pharmaceutical services to the NHS, including high-street pharmacies and opticians. This will change from April 2020 when the IR35 reforms hit the private sector too.
How to continue operating as a contractor in the public sector post-IR35 reform
There is no denying the IR35 reforms have hit contractors in the public sector hard. Freedom of information requests found that out of 4,000 CEST assessments across five public sector bodies, 94% of contractors were found to fall within IR35. Between August 2017 and June 2018, the National Audit Office found that 92% of freelancers at the BBC were deemed 'employed for tax purposes.'
However, limited company contractors still have options. Some find it's possible to continue working through a limited company outside the scope of IR35, as long as they can prove that they'd be classed as a genuine contractor and their client or agency is willing to take reasonable care when making their status determination. Others now work through umbrella companies to ensure tax compliance, which means they still benefit from the flexibility that contracting work offers, but the umbrella company takes care of their invoicing, administration and tax processing.
Either way, it's prudent as a public sector contractor to protect yourself from the impact of a damaging IR35 investigation. There are insurance like our IR35 Tax Investigation and Liabilities Insurance available, which covers the cost of professional representation for an HMRC enquiry as well as any back tax, interest, and penalty liabilities if you lose your case. It’s also worth getting any current and future contracts checked by a professional to ensure they comply with IR35.