IR35 – the view from an employment law expert

Copy Of Ir35 Law

Louise Gapp news & events, blog, Supply Chain...

From April 6th 2017, the crackdown on IR35 takes full effect. In our last newsletter we questioned whether HMRC was fully prepared for the potential consequences of a public sector brain drain and if it might pose a threat to the future of flexible working for all.

We also asked over 140 contractors currently working in the public sector for their views on IR35 and the likely impact for them. The results make for sobering reading, with almost half claiming they were not ready for IR35 and 65% considering withdrawing their services from the public sector altogether. A third of respondents claimed they did not understand the new legislation.

With this in mind, we spoke to Laura Horovitz, a senior associate with public sector employment law specialist, Capsticks and an expert in IR35 to get her insight on this matter. Capsticks works primarily with NHS bodies and third sector clients so represents the client voice in this issue.

Can you give us a little background on IR35 and what happens after April 6th?

IR35 in its initial form was introduced in 2000 and was designed to apply where contractors worked via a personal services company (PSC) to mitigate a tax burden. Initially IR35 was intended to identify payments deemed to be earnt as employment income, requiring the PSC to deduct PAYE and National Insurance Contributions from those payments made to the contractor,  thus preventing the contractor from taking dividend payments from the PSC to inflate take-home income. 

However, it transpired that the rules were not consistently applied; not all PSCs were accounting for tax and NICs on the full extent of earnings, so it then fell to the Treasury to figure out a solution.

As a result, it was decided that from April 6th 2017, where services were provided via a PSC to a public sector body, it would become the responsibility of the public sector body (rather than the PSC) to determine the tax status of the contractor, and to deduct tax and NICs at source from payments made to the PSC, if the arrangement fell within IR35. Public sector bodies will also be liable to HMRC for this tax and any penalties if they fail to comply.   

Where another body pays the PSC, such as an agency, it will still be the responsibility of the public sector body to determine the tax status of the contractor, but it will fall to the body paying the PSC  to deduct and account for the correct tax and NICs from payments made to the PSC. 

Notably, though, the basis of calculation of the “deemed payment” will be different from the calculation under IR35 in the private sector.

What have been the key questions your clients have around IR35?

A lot of clients have queried whether the new regulation applies to them, for example if they are a community interest company or similar. As it stands, from April 6th, IR35 regulation applies to any public body that is covered by the Freedom of Information Act. 

We have also had a lot of questions around what contracts are caught under this, how clients should amend their  payroll processes and how to ensure ongoing compliance. Over the last few weeks we’ve been helping clients review contractor and agency agreements to ensure they have robust contracts in place that protect them from potential claims and fees, for example from HMRC, agencies, contractors or outsourced payroll providers.

IR35 has been around since 2000, why do you think HMRC has chosen to crack down now? And why do you think self policing hasn’t been effective?

Temptation! The old system made it far too tempting for contractors to take dividends rather than a full salary from their PSCs, since the tax is lower and there was just no incentive to declare the “right” tax. With the new system, tax should be deducted at source from payments made to contractors via PSCs; payments  should be properly taxable as employment income rather than dividends, where the contractor is working for all intents and purposes as an employee of the public sector body. HMRC guidance is that 9 out of 10 contractors working via PSCs should fall under IR35  so this is potentially a huge source of tax revenue that is currently not being collected – at a time when public sector finances are stretched and under greater scrutiny. There have been a couple of high profile cases recently where HMRC have been seen to crack down i.e. over minimum wage payments in retail and care homes. Whilst I think there will be a short grace period after April 6th for full compliance, I expect that HMRC will monitor this closely.

What are some of the key concerns your clients have about the introduction of IR35 and the potential impact on public sector projects and services?

There are some wider concerns about what happens if essential personnel threaten to leave the public sector and the implications for things like patient safety – for example with senior medical staff. There have also been quite a few instances of contractors seeking  higher rates to offset perceived “losses” due to IR35, which is putting further financial pressure on a sector already under significant strain.

There is a potentially significant increase too in administration burdens and costs, as the public sector will need to assess contracts and the nature of an assignment,  collect personal tax information from contractors, and process payments through a payroll system and through their normal supplier payments system. In addition,  the public sector will bear the cost of Employers’ NICs, which are not insignificant, at 13.8%.

How many contractors do you think will be impacted by the changes and what advice would you give them?

Since HMRC estimate that 90% of contractors working via PSCs will fall under IR35, many of our clients are taking  the view that contractors will be caught, unless it is clear that they are not working as employees but as genuinely independent contractors. To be sure that someone is outside of IR35 (with the result that  payments are not required to  be taxed at source), we are advising clients to consider whether the individual can send a substitute to do the work, whether they have any obligation to do the work offered, whether they are guaranteed any particular level of work, and whether they they are integrated into the organisation – ultimately, the less control the organisation has over the individual, the more likely it is that the individual is genuinely self-employed. We would always advise clients to complete the HMRC digital ESS tool to check an individual’s employment status if it is not clear, since HMRC have confirmed that this can be relied on, provided that the information entered is honest and accurate.

What might be the impact on agencies recruiting for the public sector?

Our clients are seeking assurance and confirmation from agencies that they have put in place measures to ensure that tax will be deducted at source from all agency workers falling within IR35. Our clients are also seeking indemnities from agencies, and assurances that agency rates will not increase. We are assisting our clients by drafting and amending  letters to agencies, reviewing, amending and drafting contracts, and ensuring that appropriate compliance checks are put in place to assure NHS Improvement that arrangements are sufficiently robust. Most agencies operating through an NHS Framework agreement will have set rates and caps in place already. NHS Improvement has more generally urged Trusts to reduce agency spend and introduced caps and other measures. Of course, we just don’t know what the response from the agency world as a whole will be yet…

What other advice are you giving clients about preparing for IR35?

We haven’t seen many clients take on additional resource to cope with the changes although I imagine it will be quite a stretch to get everyone onto payroll or correctly assessed by the 5th! Some clients are outsourcing payroll to contractors but this is a short term solution. What’s clear is that when you dig under the surface, IR35 contractors are everywhere in all roles across the public sector. Where particular work is classified as falling outside of IR35, we encourage clients not to be complacent even if they have a robust contract in place, since arrangements can morph over time, so it is necessary to continually monitor working practices to ensure they reflect what is set out in the contract.

At Cedar, we work with some very senior candidates who are at Board level, perhaps with a portfolio of roles. How will IR35 affect them?

NHS Improvement guidelines are that all such office holders should be on payroll, and the new IR35 rules do not change this.

Theoretically, could contractors moving to PAYE post April 6th be liable for back taxes?

The public sector client is protected up to April 5th for any back-payments of tax, as the PSC is deemed responsible up to that point, though theoretically then, yes, HMRC could open up the books from previous years. Our suspicion is that they will focus on compliance going forward though.

Could a contractor “counter-claim” for employee benefits such as holiday pay, sick pay or pension contributions?

It’s important to remember that IR35 is in place to ensure the correct NI and income tax is deducted and does not imply or confer the same rights as a fully fledged employee. Therefore HMRC have made it clear that this change to the tax legislation alone will not confer on  a contractor is not entitled to the other employment rights that other public sector workers might enjoy. However, public sector bodies might decide to offer employment contracts to contractors in some situations.

Where can I find out more?


The new IR35 rules threaten the relationship with contractors, both those contracting directly with the public sector and those supplied by recruitment companies. In addition to the reduction in earnings contractors will feel (even if they were previously treating themselves as inside the scope of IR35), contractors contracting directly with the public sector stand to experience substantial delays in receipt of payment as their fees are first passed through a payroll system then through an accounts system. All this is assuming that the public sector are able to modify their systems adequately to cope with the challenges they are about to encounter. 

IR35 has effectively created a dichotomy between the public sector contractor and the bodies they serve as the former seeks assurance that they won’t be materially worse off and the latter that their costs won’t increase. 

Cedar is working with our database provider to streamline this process in time for April, in addition to which we are able to offer contractors the facility to be paid via our own PAYE payroll or through a small selection of umbrella company providers (which are exempt from the new regulations) as a way of avoiding the complexity that they will inevitably encounter in their own administration and tax affairs. 

Stephen Perrin, Consultant CFO

This article does not constitute legal advice and readers should consult professional advice if they are affected by any of the issues raised.