Celebrating IR35’s 18th birthday
We’ve come a long way since the personal service company rules were introduced. Sarah Ghaffari considers recent developments, touching on public sector reform, the private sector – as well as a practical example – and where things might go next.
In April 2018 IR35 turned 18. The personal service company rules (known as IR35 from the number of the press release in which they were first announced) were introduced in 2000. Since then, IR35 has continued to challenge the tax profession, although very few cases have reached the courtroom, let alone the front pages.
However, the issue of employment versus self-employment and the different tax costs associated with employment status have always been simmering in the background.
The rise of the gig economy and the recent reform to the rules for off-payroll working in the public sector have brought this very contentious issue back into the spotlight. It is clear that as we await the consultation which will explore extending the off-payroll rules to the private sector, the tension is mounting, for good reason.
Public sector reform
Finance Act 2017 introduced changes to the operation of IR35 within the public sector. Since 1 April 2017, it has been the responsibility of the end client, in this case the public sector body (PSB), to determine the tax status of individuals providing services through an intermediary. If the contract is more akin to one of employment, the PSB must account for and pay the relevant PAYE and national insurance (NIC) to HMRC.
Unsurprisingly, a number of problems have been identified with the new regime, some of which we raised in ICAEW Rep 127/16 when the proposals were originally mooted in May 2016. Problems identified include:
- PSBs are not necessarily best placed to determine the tax status of the individual – in many PSBs, the staff dealing with procurement are separate from those administering the payroll.
- If the individual does not agree with the status they have no right of appeal.
- HMRC’s check employment status tool (CEST) fails to take mutuality of obligation into account in determining status.
- The accounting treatment of the contract fee in the personal service company (PSC) remains unresolved, as discussed below.
A true and fair view
A number of our members have queried the accounting treatment of the fee in the personal service company and ICAEW has been discussing the issues with HMRC and the Financial Reporting Council (see the letter to HMRC in ICAEW Rep 37/18). It would appear that in formulating the policy, the government team did not appreciate the implications of the new rules on the accounts; again, something that we raised in our response to the original consultation document.
One of the first questions that arises is, what is the price agreed for the work per the contract? And then, what figure should be recorded as turnover?
Consider the example of Hilary and her company H Ltd. If the PSB looks at the work involved and decides that it must treat the contract as being caught by IR35, it will only pay £60,000 to Hilary and use the other £40,000 to settle her PAYE and employee’s NIC liability. How will turnover be recorded in H Ltd?
Hilary provides services to a public sector body through her company H Ltd. She has negotiated a contract price of £100,000 for a contract on which the PSB has decided it must pay class 1 secondary NIC. The PSB must also deduct PAYE and class 1 primary NIC, estimated to be £40,000. H Ltd therefore only receives £60,000.
Dr debtors £100,000
Cr sales £100,000
To record the invoice to the PSB
Dr sales £40,000
Cr debtors £40,000
To record the PAYE and employees NIC that is payable by the PSB and not the PSC
Dr cash £60,000
Cr debtors £60,000
To record the cash receipt in the PSC
One argument, as shown in the example, is to record turnover at £60,000. This is with reference to FRS 102.23.3, which states that 'an entity shall measure revenue at the fair value of the consideration received or receivable'. As the PSB is obliged to deduct the PAYE and NIC, the PSC has no legal right to receive the £40,000 deducted. However, the fair value of the service provided by the PSC has not changed. Or has it?
The deduction of taxes does not represent a deduction in respect of a reduced value of the services. The deduction represents the fact that the PSB, rather than the PSC, is paying over tax to HMRC on behalf of the employee. Year on year, and transaction to transaction, there will be an inconsistency in the way that revenue is measured according to the amount of tax deducted at source as this is calculated by the PSB on an employee by employee basis.
On the flip side, s474, Companies Act 2016 defines turnover as 'amounts derived from the provision of goods and services… after deduction of trade discounts, value added tax, and any other taxes based on the amounts so derived'.
Although not explicit, the deductions appear to refer to the discounts and taxes of the company, not deductions made in respect of (and recoverable by) the individual providing the service. This would suggest that turnover should be recorded at £100,000.
This causes complications further down the line as only £60,000 will ever be received by H Ltd. So what happens to the balance of £40,000 recorded in turnover and debtors that will never be received? Writing it off to a bad debt expense account seems illogical as the bad debt relates to the personal tax of the individual and not the company. Recognising it as an expense in staff costs might be an option.
Until a sensible solution – which takes into account both the requirements of company law and accounting standards – is found, we have a problem. And of course, as the services provided will be a taxable supply, there will be VAT underpayments showing on the PSC’s VAT account as VAT will be due on the gross sum while the company will receive VAT based only on the net-of-taxes figure actually received.
Care should also be taken when considering how to withdraw the cash from the PSC. While a dividend might be the most tax-efficient way, there must be sufficient distributable reserves in the company to declare a dividend.
The interaction of the tax rules and accounting standards makes this an unusually complex situation. However, we believe there is a need for clarity about the accounting treatment and the Tax Faculty is working closely with our Financial Reporting Faculty and HMRC to resolve the issues. We will keep our members up to date on any developments.
Private sector – watch out
While there appears to be no consensus regarding the accounting treatment, it seems obvious that until the reform in the public sector is shown to be a success (and how to deal with the bookkeeping and VAT issues), the changes should not be rolled out to the private sector. In addition to the problems we have highlighted in this article, the private sector operates differently to the public sector. Supply chains can be much more complex and often the end client will not have access to specialist advice, so determining the status of the individual providing the services will be much harder.
The road ahead
The elephant in the room is the age old problem of employer NIC and until this is addressed we will surely just go round in circles. Making low level changes to the administration of IR35 is not the answer to resolving the issue of employment versus self-employment. Perhaps a tax on labour is the answer. Perhaps it is time for a national debate.
In the meantime, ICAEW has a number of resources in this area available to members, although some can only be accessed by members of the Tax Faculty. We are currently building a new hub for IR35 on our website, which will include articles, webinars and TAXguides plus useful links to external resources.
Once the consultation on off-payroll working in the private sector is launched, we will announce details of a round table event in which we hope to be able to gather members’ views to feed into the consultation response. We plan to host an IR35 webinar later in the year although members can still watch the webinar presented by David Kirk in 2016.
David Heaton recently updated his comprehensive guide to employment intermediaries, see TAXguide 16/17.
The Tax Faculty will also be responding to the Good Work consultations that were published as part of the government’s response to the Matthew Taylor report.
About the author
Sarah Ghaffari is a technical manager at the Tax Faculty with responsibility for SMEs