Tax: IR35 and public sector workers

Cityscape Shanghai
Donald-Drysdale By Donald Drysdale for ICAS

5 January 2017

Donald Drysdale wonders whether the new regime for off-payroll workers in the public sector will prove as troublesome as many freelancers and practitioners have feared.


The off-payroll rules, commonly known as ‘IR35’ or the intermediaries legislation, target individuals working through their own personal service companies or other intermediaries.

Where such an individual personally performs services for the client or is under obligation to do so, and would be the client’s employee were it not for the intermediary they work through, the rules aim to ensure that they pay employment taxes in a broadly similar way to employees.

Controversy has dogged high-profile individuals holding senior public appointments through personal service companies to save income tax and more particularly national insurance contributions (NICs), in circumstances where IR35 might be expected to apply but perhaps hasn’t. On the other hand, many legitimate freelancers have had to fight long, intrusive and costly battles with HMRC to avoid being drawn inappropriately into IR35.

Public sector assignments

Following government attempts since 2012 to apply IR35 more rigorously to public sector appointments, a new regime is now to be introduced.

Draft provisions for the Finance Bill 2017 were published on 5 December, and practitioners advising contractors working for public sector clients should study clause 1 and Schedule 1. Following consultation, these contain far-reaching new proposals affecting workers’ services provided to public sector bodies through intermediaries, introducing new provisions that will replace the pre-existing intermediaries rules in those circumstances.

For payments made on or after 6 April 2017 for engagements in the public sector, the new measure will shift responsibility for deciding whether the off-payroll rules apply. This will no longer be a task for an individual worker’s personal service company. Instead, the public sector client, agency or third party paying them will become responsible for deciding whether the rules apply and, where they do, for deducting and accounting to HMRC for income tax and NICs.

In a further change, the 5% allowance currently available to those who apply the off-payroll rules, to reflect the costs of administering them, will be removed for public sector contracts where the rules apply. The worker’s intermediary will still be able to claim allowable business expenses.

The new rules will apply where the services of a worker are provided through an intermediary to a ‘public authority’ – that is, a body defined as such for Freedom of Information purposes. This wide definition covers government departments and their executive agencies, many (but not all) companies owned or controlled by the public sector, universities, local authorities, parish councils and the National Health Service. It includes such bodies in England, Scotland, Wales and Northern Ireland, although some cross-border public bodies in Northern Ireland are outside its scope.

Practitioners will want to be ready to advise their public authority clients facing this new responsibility, which will have practical implications from Procurement through to Finance. Likewise, clients providing services to public authorities will need to understand how the change will affect them.

How the rules will apply

The way the new regime will work is explained in HMRC’s Technical Note of 5 December and accompanying documents.

HMRC say that a new digital tool to help identify whether the new rules apply will be made public for testing before 6 April 2017. Given the nuances of case law regarding employment status, it seems unlikely that an online tool will achieve clarity. Furthermore, in many cases the exact nature of a new working relationship won’t be known at the time a contract is signed.

Nonetheless, for each contract the public sector client must inform the intermediary, agency or other third party (either in the contract or otherwise) whether or not the contract falls within the new off-payroll rules. If not so advised, the intermediary etc. may request this information. If failing to reply within 31 days, the client becomes responsible for accounting for income tax and NICs. The intermediary etc. may also ask about the reasons for the conclusion reached.

Public sector bodies with these new responsibilities thrust upon them may try to simplify and streamline their involvement. Some may apply the new rules by default, regardless of the circumstances of each case. Those who do so and fail to respond to requests for information from intermediaries will find themselves applying PAYE on the contract payments (i.e. the new regime will apply by default), and that may prove the easiest course for them.

Where the rules apply, the worker is treated as the client’s employee for income tax, NICs and apprenticeship levy purposes. As each payment is made to the worker’s intermediary by the public authority, agency or third party (the ‘fee-payer’), the VAT-exclusive amount (after allowance for direct material costs and certain employee expenses) is treated as a deemed payment of employment income to the worker, subject to deduction of income tax and NICs. For this deemed employment, stakeholder pensions, statutory payments and certain other employment rights don’t apply. Public authorities should consider their exposure to employment law risks where they are effectively employing a two-tier employment rights system.

There is a measure of protection against double taxation. The worker’s intermediary is able to offset the amount of the deemed payment, on which tax and NICs have been paid, against the amount of remuneration from the intermediary on which tax liabilities arise.


Hitherto the question whether IR35 applies has been a matter for self-assessment, with HMRC being able to assert a different view and the intermediary having a right of appeal. Where disputes have arisen, these have focused on the intermediary’s tax return and have only involved clients indirectly – interpreting contract provisions and working arrangements.

Under the new public sector regime, an intermediary will still be able to request an HMRC review or lodge an appeal. However, as this will involve challenging the client’s decision on the application of the off-payroll rules, it is likely to prove more confrontational and may harm the commercial relationships among worker, intermediary and client.


The IR35 regime was controversial as soon as it was introduced in April 2000. It was widely condemned from the outset – described by professional bodies as poor tax law and unfair. It is too early to assess the impact of the prospective changes from April 2017, but these seem to suffer from many familiar defects – and some new ones.

Unlike public sector executives who may have sought to enter into ‘disguised self-employment’ through personal service companies, a majority of those affected by the new measure may be legitimate freelancers providing services, often to a range of clients, under contracts that are clearly distinguishable from employment.

In theory such contractors should be unaffected by the new law. In practice many public sector organisations, unfamiliar with the finer points of employment and tax law, may simply sweep all of them into the ‘off-payroll bag’ as the easiest way to deal with a difficult situation and reduce their own exposure to penalties. Alternatively, agencies may create additional bureaucracy by forming umbrella companies to handle off-payroll workers, distancing them from the public authority and the agency in an attempt to retain the status quo.

Public sector bodies may suffer as disgruntled contractors shun them in favour of the private sector, where the IR35 rules remain unchanged for now. But what next? If the government concludes (perhaps misguidedly) that the new off-payroll regime works well in the public sector, it might extend it soon to private sector contracts, fundamentally changing the IR35 landscape.

Article supplied by Taxing Words Ltd


  • Tax

Previous Page