HM Revenue & Customs (HMRC) is under fire for publishing an incomplete example of how payments between end-clients and personal service companies (PSCs) will work under the reworked IR35 rules, by neglecting to include VAT costs and employers’ national insurance contributions (NICs).
The error occurred during a webinar hosted by HMRC on 24 February 2021 to educate contractors, employment agencies and end-clients on how the responsibilities of “fee-payers” will change in the private sector once the IR35 reforms take effect in April 2021.
During the hour-long webinar, attendees were shown an example of how chain payments will work between end-clients, employment agencies and PSCs when an engagement is deemed to be inside IR35.
In the example used, the PSC contractor is shown to provide its services to an end-client through an employment agency. The contractor’s weekly rate is £1,000, plus £200 VAT, and the agency charges the end-client a further 10% fee for finding and supplying the contractor to the end-client.
The example goes on to show the end-client paying the agency £1,300 to cover the contractor’s weekly rate and the agency’s 10% fee, but no explanation is offered as to where employers’ NI should be accounted for in this calculation.
This is important because the reforms will usher in changes regarding where liability will rest within the extended end-client, employment agency and PSC labour supply chain for covering the cost of secondary class 1 NICs, known as employers’ NI.
Under the current version of the rules, when a contractor is classified as working inside IR35, the limited company or PSC deducts employers’ NI from the sum of money paid to the contractor for the services they have provided to their end-client through the employment agency.
However, once the reforms come into play, responsibility for covering employers’ NI will shift to whoever is responsible for making the payment to the contractor’s PSC, which – in the example given during the HMRC webinar – will be the employment agency.
“Up to now, the PSC should have been paying employers’ NI, and that is going to change, in that the agency does,” chartered accountant and tax adviser David Kirk told Computer Weekly. “So, in other words, there will be some price changes coming all the way down the line [within the labour supply chain].”
This means that the employment agency will be liable to pay employers’ NI at 13.8%, which – in the example above – would work out at about £115, but there is no allowance made for that sum in HMRC’s example calculations.
“That is more than the agency margin, so based on the HMRC example, the agency makes a loss,” said a session attendee, who flagged the omission to Computer Weekly on condition of anonymity.
Live chat logs from the webinar, shared with Computer Weekly, show HMRC’s presenters were repeatedly asked by session attendees to explain where employers’ NI was factored into the calculation and for details on how agencies are supposed to cover it.
In response, the webinar host stated several times that it was “the deemed employer that calculates and pays the employers’ NICs,” but a follow-up request for further clarity on “where does this money magically appear from” went unanswered.
Another question raised on this issue asked HMRC to clarify whether factoring in employers’ NI would reduce the net sum received by the contractor’s PSC, and the webinar host did confirm that it will, despite no mention of that being made in the example.
“The deduction of tax and NICs by the deemed employer will reduce the net fee which is then paid to the PSC,” the webinar host replied. “The PSC will receive a similar fee to what they would have received if they were an employee of the client and not providing their services via their own intermediary.”
Computer Weekly shared HMRC’s webinar calculation with Kirk, who said session attendees were right to query the example given during the broadcast, which also failed – he confirmed – to factor in the agency’s VAT costs.
“Employers’ NI is the responsibility of the fee-payer – usually the agency – but they’ve got to have the money to pay it,” he said.
“The way it works is that the PSC invoices the agency, and the agency invoices the client – and everybody’s got to make sure they’re getting the right money out of that.”
In the HMRC example, its figures were “all over the place”, said Kirk. “VAT has to be charged on the agency mark-up as well, so the total they will charge the client is £1,320, but the agency is guaranteed a loss on this, as it has to pay £113 in employers’ national insurance. Their £100 mark-up does not even cover that, never mind their own costs.”
He added: “I am quite shocked to hear of HMRC displaying such a poor understanding of tax rules that they themselves have drawn up and now have four years’ experience of operating [the IR35 reforms] in the public sector.”
The omission of employers’ NI from the example given by HMRC during the webinar is also concerning given that end-clients, agencies and contractors rely on these broadcasts to inform their IR35 compliance strategies, said the session attendee who shared the chat logs with Computer Weekly.
“Hundreds of people are watching these webinars, and if agencies follow HMRC’s advice, they will lose money,” the source added.
Dave Chaplin, CEO of contracting tax authority ContractorCalculator, said the omission was “clearly an oversight on HMRC’s part” and one that needed to be rectified urgently.
“Hopefully, it will be fixed in due course, otherwise agencies following it will start processing payments wrong and lose money,” he said. “HMRC has made lots of effort with these webinars, and it is a complex subject.”
Computer Weekly put Kirk’s comments and the concerns of the session attendees to HMRC, which responded with a statement confirming that it will correct the example given during the webinar.
“On a recent webinar, attendees raised concerns about one of the simple examples used to illustrate how a particular area of the policy works,” said the HMRC spokesperson in the statement.
“We looked into these concerns and are sorry if the attendees were confused. We have corrected the example for future webinars and are also including an explanation about employer national insurance contributions in other support materials we are publishing.”
On that point, HMRC published a comprehensive update to its Employment status manual on 3 March 2021 that fleshes out its guidance on where liability for employers’ NI should fall, and how it should be calculated and deducted within the context of the incoming IR35 reforms.
Even so, HMRC’s decision to initially exclude employers’ NI from the “simple examples” it is using to demonstrate how the IR35 reforms will work is baffling, said Chaplin, given that the “entire purpose of IR35 and off-payroll is to claw back” secondary class 1 NICs.
In the UK government’s Tax after coronavirus report, published in February 2021, John Cullinane, tax policy director of the Chartered Institute of Taxation, described employers’ NI as the “elephant in the room” during a discussion about what should be changed to ensure self-employed people are taxed in the same way as employees.
“People often talk about the few-percent differences on employees’ national insurance, or not having national insurance on dividends, as being what it is all about, but the elephant in the room is the employer’s national insurance of 13.8%, which is being taken out of the system by having somebody move off payroll, whether they are incorporated or not,” he said.
“The amount of money that self-employed people are able to charge in the market no doubt reflects the fact that they are less heavily taxed than if everything was run through an employed basis.”
On this point, Chaplin added: “Employers’ NI accounts for circa 82% of the extra tax that needs to be paid. It’s the ‘elephant in the room’ that has had flashing lights and alarms attached to it for 20 years.”