Some freelancers and contractors working in the public sector may be taxed at source via PAYE following changes in legislation. Mahmood Reza explains what has changed and the implications.
If you are a freelancer or contractor providing services to a public sector body via an intermediary, such as a limited company or a partnership, a change in personal service company (or intermediaries) legislation, commonly known as IR35, may affect you. IR35 basically means that income is taxed at source via PAYE.
Before 6 April this year, freelancers (or ‘workers’ - the term used in the legislation) were responsible for evaluating the ‘status’ of their own working relationships with their clients.
The status of the relationship between a worker and their client is not based on how the respective parties wish to describe it, but on certain realities. For example, a freelance worker has the right to send someone else to do the work in their place, and the right to decline to perform certain work. The level of financial risk is being borne by the worker, and whether the worker takes responsibility for rectifying work in their own time and at their own expense, are also relevant to the evaluation.
If a status assessment found that a worker’s relationship with their client was one of genuine self-employment, IR35 didn’t apply, but if the worker was deemed an employee of the client, IR35 did apply.
An undesirable consequence of this change in legislation is that some workers may stop working within the public sector, with their skills and expertise being lost
Since April 6, the responsibility will fall to the public sector body to carry out this status assessment. So either the freelancer’s public sector client will make the judgment, or an agency. (Though an agency is likely to pass that responsibility back to the public sector body.)
HMRC has released an online Employment Status Service tool to help public sector organisations decide whether workers fall under IR35 tax legislation. The online tool has come in for a lot of criticism from many who have questioned its reliability and accuracy, with some of the outcomes being in conflict with established legal cases, as well as delivering ‘unknown’ results.
The categories of worker included in the assessment include employment by spouse, entertainer, media industry and the catch-all category of ‘other’. If you are within the category of entertainer or media industry, the tool will normally direct you to HMRC film and production, and TV and broadcasting units instead.
The tool’s conclusion is wholly dependent on what boxes are ticked by the user. The areas the tool looks at are substitution, control over how and where the work is done, level of worker’s financial risk, and business structure.
There is no real reference to what employment lawyers call ‘mutuality of obligation’, which is one of the key tenets in determining employment status. Mutuality refers to the legal obligation of an employer to provide work and pay for it, together with the obligation of the employee to personally do the work.
I have put varying scenarios into the tool and a significant number generate an unknown answer, saying that “The worker’s employment status cannot be determined by this system…”, and then adding “It is important that the correct employment status is established without delay. An opinion on status will have to be provided by a member of the HMRC Status Customer Service Team.”
If your public sector client makes the decision that IR35 applies to you, your income will be taxed at source via PAYE as though you are an employee. You will be taxed as an employee but will have none of the rights or benefits of an employee, such as holiday pay, sick pay or a work-based pension.
If you disagree with the assessment you can ask them to re-evaluate it, but whether they will or not depends on their policy and approach.
On the positive side, if IR35 does apply to you, you will end up with a smaller business tax bill, and your National Insurance contributions potentially allow you access to a wider range of state benefits.
There is a real possibility that the law of unintended consequences will come into play. Public sector bodies are likely to be risk-averse and to take a cautious view of a worker’s status. If a worker is assessed as a ‘deemed employee’, the cost to the client will dramatically increase due to additional employer’s National Insurance, payroll and administrative costs. Workers will have less net income due to taxation and the inclusion of employee’s National Insurance, and may want to negotiate for fee increases to compensate for the reduction in take home pay .
As public sector funding is squeeezed, an undesirable consequence of this change in legislation is that some workers may stop working within the public sector, with their skills and expertise being lost.
It is possible for a worker operating through an intermediary to avoid the impact of IR35 by making changes to their business and working practices. This could include negotiating a fixed fee with a client for carrying out a project, diversifying and widening their client base, ensuring that they sign the visitor’s book when they work on the client’s premises, advertising their services, and rewording any current contracts.
It’s worth taking advice: the fuller impact of this change is yet to be seen, and it is likely to be later this year that the fallout and difficulties will be known.
Mahmood Reza is owner and manager of Pro Active Resolutions and Knowledge Grab.
This article is sponsored and contributed by Pro Active Resolutions, is the first in a series sharing insights into accountancy issues in the arts.