From 6 April the way tax rules applied to personal service companies – limited companies operating in public sector organisations – will change, despite HMRC leaving many questions unanswered.
At present, employment businesses do not deduct pay-as-you-earn and National Insurance contributions at source from interim managers operating personal service companies; the companies must make the correct tax contributions. Where an interim manager operates via an umbrella company, that entity is responsibility for deducting the correct PAYE and NICs, so it lies under a contract of employment not a contract for services and thus falls outside the scope of the rules, which are known as ‘IR35’.
From 6 April, public sector organisations will be required to determine whether an engagement is inside or outside IR35 using an online tool. Those assignments deemed outside IR35 will continue as before and the company remains responsible for the correct payment of tax. However, these will only account for a small proportion of assignments going forward; perhaps no more than 30%.
The liability for the deduction of correct taxes is shifting away from the interim, operating as a limited company, to the organisation paying that person. Typically, the latter is a recruitment agency but occasionally it is the council itself. It is now the councils’ responsibility to determine the IR35 status of the work being delivered by the interim and to inform the recruitment agency of the outcome. The recruitment agency is responsible for the correct deduction of taxes and for the payment of employer’s NI back to HMRC.
Contractors and interim managers engaged in ongoing assignments deemed inside IR35 will find themselves out of pocket, as PAYE and NI will be deducted from them at source. The prevailing system has enabled contractors to tax themselves in a more efficient way to their permanently employed counterparts.
While councils have largely set out their policy positions they are far from ready for the change. Most are refusing pay rises for contractors and interim managers who will have to move inside the scope IR35 on the basis that they should have been paying full employment taxes in the first place. Some, worryingly, are saying all contractors and interims are inside IR35 and are ignoring the HMRC test. This means that many assignments will end before 6 April solely due to these changes, which will further destabilise the market. Most councils are taking case-by-case decisions on how to retain key individuals.
Changes to IR35 are already having an adverse effect on the market. While we support fair taxation, the net effect will drive away talented individuals from the public sector and increase the cost burden when public bodies hire to new roles.
Specialists with transferable skills in areas such as IT, engineering and change management will be more inclined to work for private sector clients where there is greater freedom to operate outside IR35.
Leading interim management firms have already seen increases in the pay demanded by candidates when pricing new assignments, as well as for those with ongoing assignments that fall inside IR35.
The new rule changes are reducing the flow of available talent for roles inside IR35 in the public sector and are increasing the cost of hiring to such posts by up to 25%. Those roles likely account for circa 60-80% of all appointments of interim managers or contractors and therefore the cost burden on a sector already strapped for cash is acute.
HMRC says it is failing to collect over £400m annually from IR35 and has passed this responsibility on to the rest of the public sector and the recruitment industry. Whatever additional revenue HMRC collects will be to the direct detriment of the wider public sector. The government is simply robbing Peter to pay Paul.
Neil Lupin, managing partner, Green Park