Figures taken from an illustrative example within HMRC’s ‘Off-Payroll working in the private sector’ consultation show that 84% of the perceived tax shortfall resulting from IR35 is avoided by the hiring organisation, with just 16% attributable to the contractor.
This statistic may come as a shock to many, given that the taxman’s rhetoric surrounding IR35 and the new Off-Payroll tax has centred on tackling perceived tax avoidance among contractors. The news will be less surprising for contractors, who pay a level of tax on their income proportional wit employees following the April 2016 changes to dividend taxation.
Non-compliance among public sector hirers has meant many organisations are yet to feel the full financial impact of the new Off-Payroll tax. However, a private sector rollout of the new legislation would prove costly for hiring firms, who can expect to spend roughly 10% more when engaging contractors.
Off-Payroll: hirer non-compliance costing contractors and HMRC
HMRC has long used contractors as scapegoats for its perceived tax shortfall, portraying them as the tax avoiders. However, the Off-Payroll tax, which is new legislation in Chapter 10 of the Income Tax (Earnings and Pensions) Act, now legally requires that the hirer makes employer’s NI contributions on top of income paid to each contractor considered to be caught by the tax law – as they would for an employee.
Tax avoidance among public sector hirers: who is to blame?
Non-compliance among hirers could be attributed somewhat to HMRC’s rhetoric and its failure to proportion the perceived avoided tax between contractor and hirer. Many organisations seem to believe that employers’ NI is legally deductible from the contract rate. It isn’t.
The emphasis that HMRC places on tackling supposed non-compliance among contractors, evidenced multiple times within its consultation and the accompanying ‘off-Payroll factsheet’ , only serves to promote this misinterpretation.
For the time being, HMRC has little incentive to offer any further clarification regarding the Off-Payroll tax. The taxman’s efforts to extend the new tax into the private sector would be met with far greater resistance if UK plc was aware that it was to assume liability for employer’s NI on top of the earnings paid out to each contractor.
Certain public-sector organisations have circumvented the tax and passed the liability on to the contingent workforce. The NHS is one of many organisations which has blanket assessed its entire contingent workforce as “deemed employees”, and forced its additional tax burden onto the worker, without providing them with any employment rights.
But though the NHS is saving money, the cost in real terms is far greater. The severe tax hikes suffered by locums are compounded by the fact that travel and accommodation expenses can no longer be claimed. As a result, travelling for work becomes a less viable option for locums, meaning skills shortages are intensifying. As workers leave the sector in their droves, the healthcare sector is losing the flexibility on which it greatly depends.
Off-Payroll in the private sector: the cost of non-compliance
As with the NHS, private sector firms are warned that failure to do right by their contractors will likely yield a similar outcome. The first step to avoiding a repeat of this scenario is to budget and plan for the impending increased business costs that the Off-Payroll tax will bring.
Unlike the NHS, the vast majority of private sector firms aren’t running a monopoly. Whereas the NHS has retained thousands of staff due only to the fact that these workers have few alternative options for healthcare employment, attempts in the private sector to oppress contractors through employer’s NI deductions will only cause them to find contracts with compliant firms.
Free-market pressures will likely lead to the renegotiation of rates. These can be hard to predict, but a good starting point is to consider the additional employer’s NI liability that will be due on current contract rates.
HMRC’s example calculation suggests that a hiring firm pays roughly £5,000 on a contract paying out £50,000, which indicates a 10% rise in the cost of engaging contingent labour