Off-payroll working in the public sector reform | KPMG | UK
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Off-payroll working in the public sector: reform of the intermediaries legislation (IR35)

Off-payroll working in the public sector reform

The Finance Bill contains significant changes to the taxation of off-payroll workers in the public sector which are due to come into effect from 6 April 2017.



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Who should read this? 

All public authorities who hire off-payroll workers, all agencies, third parties and intermediaries involved in the supply of off-payroll workers to the public sector and all workers who provide their services to a public authority via a personal service intermediary.

Summary of proposal 

The proposed changes are contained in clause 7 and schedule 1 of the Finance Bill and are designed to amend the UK tax treatment of off-payroll working in the public sector.

Broadly speaking, the Finance Bill provisions do this by requiring public authorities to identify and review the employment status of all workers engaged through personal service intermediaries (referred to hereafter as personal service companies or PSCs) including those provided via an agency or third party.

Where, in the absence of the PSC, the worker would have been regarded as an employee of the public authority (under the IR35 rules), then the ‘fee-payer’ is treated as making, and the worker is treated as receiving, a payment which is to be treated as earnings from employment. 

The fee-payer is a defined term, introduced to deal with complexities encountered in the supply chain. Generally speaking, the fee-payer will normally be the person who makes the payment to the PSC. However, where that person is non-resident (say), special rules treat the next person in the supply chain as the fee-payer (and so on up to and including the public authority itself if required). We look at this in a little more detail below in the context of agencies.

The fee-payer (as defined above) will be required to treat the payments made as if they were earnings paid to the worker from a deemed employment with the fee-payer. Therefore, the fee-payer will be required to account for PAYE and NIC (both primary and secondary) on the deemed employment payments.

The new rules apply to public authorities as defined, inter alia, by the Freedom of Information Act 2000 and the Freedom of Information (Scotland) Act 2002.  It should be noted that this definition appears to be wider than many appreciate and some private sector companies may be caught depending on the terms of their contracts with public authorities. Anecdotally, this is likely to be a particular issue for those involved with the NHS.

Agencies and third parties

One of the issues raised during the consultation was how agencies and third parties could obtain sufficient information on the day-to-day delivery of services by workers in order to form a judgement on employment status. In response the Government has decided to place the onus on the public authority to review and notify the employment status of the worker to the third party or agency, and in doing so, the client must take ‘reasonable care’.

This means that even where PSCs are supplied via agencies it will still fall to the public authority to determine whether an employment relationship would have existed with the worker but for the PSC. If such a relationship would have existed, the worker will be treated as receiving employment income and the agency will be required to operate PAYE and NIC on the payments made to the PSC (see comments above regarding who is the fee-payer).

Where this information about the worker’s status is not supplied to the agency, the agency may submit a written request to the public authority that must be responded to within 31 days.  If a reply is not forthcoming within 31 days, the public authority will be responsible for accounting for PAYE and NIC, not the agency.  

Supply chains can be complex and it is not always easy to establish whether a third party is supplying labour which will be caught by the new rules or services which fall outside of the rules.  We understand that HMRC still intend to provide additional guidance on determining when labour is supplied (also see below regarding the new ESS tool).

Further complexities arise where several third parties are present in the supply chain and for these reasons the concept of ‘fee-payer’ has been introduced. As discussed above, it is generally the third party paying the PSC that will be classified as the fee-payer and so will need to account for PAYE and NIC. However, where there is a supply chain and the third party or agency that pays the PSC is based offshore, the last UK resident party in the chain will be responsible for accounting for PAYE and NIC, up to and including the public authority itself. 

Exclusions (not exhaustive):

Workers who are subject to PAYE and NIC as employees of an agency or compliant umbrella company are excluded from the impact of the new provisions.

Enforcement (on public sector authorities)

Where there is a failure by the public authority to respond within 31 days to a written request from a third party in relation to a worker’s status under the new rules, the burden of operating PAYE and NIC (if applicable) shifts to the public authority.

Employment Status: HMRC’s online employment status service tool

Whilst it is envisaged that this will be determined by HMRC’s online employment status service tool (ESS), employment status is a grey area and it will still be important to understand the decisions made by the tool.  The tool itself was released earlier this month and HMRC have promised to stand by the result given unless a compliance check finds the information provided isn’t accurate.

Unfortunately, reports to date are that it is generating some results that may not accord with decided court judgments and, in some scenarios, is generating an ‘Unknown’ result.

Key changes from the draft legislation

The Finance Bill was published on 20 March 2017 and contained a number of changes from the draft Finance Bill published on 5 December 2016.

Key points

The Finance Bill confirms that the public authority is required to:

  • Identify contracts where personal services are provided by workers via intermediaries.
  • Carry out an employment status review in relation to the worker and contact the “supplier” (i.e. the person with whom the public authority has entered into the contract for services) to advise whether there is a PAYE and NIC withholding obligation. Put another way, they need to inform the supplier whether:
    • The worker would be regarded for income tax purposes as an employee if the contract had been entered into directly between the public authority and the worker; or,
    • The worker is an office holder and the services relate to the office; or, 
    • The new rules do not apply to the engagement.

The public authority must also demonstrate ‘reasonable care’ in relation to carrying out the employment status review and respond to challenges where this is disputed.

Where the public authority fails to comply with the above obligations, it may become responsible for the underpaid PAYE and NIC together with interest and penalties.  Where, however, the public authority has relied upon information that was supplied by the PSC (or a person connected with the PSC or an office-holder of the PSC) that is held to be fraudulent, the liability may be transferred to the PSC.

Where contracts fall within the new rules, the fee-payer will need to determine whether expenses will be taken into account for the purposes of reducing the amount of the payment that is subject to PAYE and NIC.

Timeframes for determining employment status

The Finance Bill clarified that:

  • For contracts entered into before 6 April 2017, the public sector body must advise the supplier (the worker, agency or third party) of the employment status decision they have reached before a post-5 April 2017 payment is made; and,
  • For contracts entered into on or after 6 April 2017, the public authority must advise the supplier of the employment status decision reached before the contract is entered into or (if later) before services are supplied. 

Reasonable care

The Finance Bill contains an important change to the obligations placed on public authorities who must now take ‘reasonable care’ in determining the employment status of the worker under the new rules.

The risk for public authorities who would intend to take a prudent approach and notify workers that they will be subject to PAYE and NIC from 6 April 2017, but without proper analysis of their position, is that this is unlikely to constitute reasonable care. The concern then is that the public authority could become liable for PAYE and NIC withholding (e.g. where the agency does not deduct for whatever reason) even though it considered it was simply erring on the side of caution by taking a prudent approach.

Information to be provided by the worker

The Finance Bill also includes provisions stating that the worker must notify the fee-payer (see above) whether they are operating via a PSC, partnership or individual that is caught by the rules.  This said, there are no timescales specified in which the provision must occur.  

If, however, the worker does not provide this information then the fee-payer can assume that the worker is operating via a PSC, partnership or individual that is within the scope of the new rules and act accordingly.

Preparing for the new rules

Preparation for the new rules by public authorities will involve a number of key stakeholders from HR, finance, legal, procurement and payroll who will need to:

  • Identify the PSCs that are currently engaged via a review of accounts payable data and other sources;
  • Identify agencies that supply labour and obtain details of PSCs provided by that agency;
  • Review contracts with agencies and PSCs to identify those caught by the new legislation;
  • Review current systems and how to determine employment status to identify gaps;
  • Review and, where necessary, amend systems, including checklists, process maps, internal guidance, contracts and policies to demonstrate that reasonable care has been exercised and that there is a clear audit trail for presentation to HMRC in the event of a review;
  • Roll out internal instruction material for all key stakeholders – this could also include workshops and presentations;
  • Draft communication material to be issued to PSCs outlining the new rules; and,
  • Consider the additional cost of employer’s NIC on existing and future contracts with PSCs that are caught by the new rules and/or consider renegotiating rates to make up for the shortfall.


These measures will take effect from 6 April 2017.

Concerns continue to be expressed about this timing as many, including ourselves, believe that insufficient time has been provided for public authorities (and agencies/third parties) to introduce the requisite procedural and systems changes to deal with the new rules. 

Our view 

The size of the task and the timeframe may lead some public authorities to simply put all workers with PSCs on the payroll as if they were salaried employees. 

However, this action will: 

  • Increase cost to the public authority through increased employer’s NIC and potential increased payments to contractors who may then prefer to work in the private sector as a result of these changes;
  • Impact on service and project delivery if and when such workers move to the private sector (where the new rules do not currently apply); and,
  • Pose considerable risk to the public authority itself as it will be difficult to prove that ‘reasonable care’ has been taken. This could then see HMRC seeking recovery of any underpaid PAYE, NIC, interest and penalties from the public authority itself.

According to HMRC these reforms will bring in an additional £165 - £210 million of tax annually. An earlier estimate by HMRC included in the May 2016 consultation document for non-compliance with IR35 across both the public and private sector was £440 million for the tax year 2016-17. The Government has said that it has no current plans to extend the reform beyond the public sector. But plans can change, quite quickly sometimes and we think these changes in the public sector are but a prelude to wider changes in the private sector to follow in due course.


Caroline Laffey

+44(0) 191 4013849

Michael Wilson

+44(0) 191 4013714

Colin Ben-Nathan

+44(0) 20 73113363

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