HMRC made available the draft legislation regarding how changes to IR35 will be applied to public sector engagements in December 2016 following the Chancellor’s Autumn Statement. Alongside the legislation, HMRC produced a technical guidance note to support the interpretation of the legislation.

At first glance, the legislation is quite unwieldy as it runs to almost 400 pages, but as this is the proposed Act which will bring into force a lot of the Chancellors financial measures for 2017 (ranging from IR35 adjustments to soft drinks tax) there is a lot to cover off. Along with the 287 page explanatory document, one could easily be forgiven for simply reviewing the Technical Note at just 29 pages.

So what is changing? 

Answer – more than you would think and far more than anyone really expected.

Recruiters off the hook?

In our previous blog on the IR35 changes announced in the March budget in 2016, it was thought that both recruitment agencies and end clients would be on the hook for determining a contractor’s IR35 status. However, at first glance it appears that recruiters may have been given a welcome reprieve as the IR35 decision rests solely with the public sector hirer.

Whether this is good news or not, only time will tell. But my gut feel is there is going to be quite a lot of pain in the first 12 months and the worker is likely to feel most of this. The Hirer won’t get off lightly as any client who tells a contractor to take a 20% pay cut isn’t likely to find much favour.

Under the current proposed wording of the legislation, recruiters are not entirely out of scope for the IR35 changes, as they will need to ensure the public sector client’s IR35 decision is carried though by deducting PAYE at source (or ensuring the worker is engaged through an umbrella company which is deducting PAYE at source) to ensure that workers only receive net pay, even if they continue to work through their own limited company.  This is where a degree of uncertainty lies regarding the risk to agencies.  The potential risk lies in the fact that the recruiter is treated as the deemed employer for payroll purposes and if the payroll is incorrect, the deemed employer will bear the risk.  We therefore, need some clarity to understand the implications of the public sector body incorrectly determining that an assignment falls outside of IR35 (enabling the recruiter to pay a limited company worker gross) and HMRC subsequently taking a different view. Whilst HMRC has suggested that they are keen to secure ‘meaningful’ input into the IR35 process from end clients, we are likely to only find out in the final draft legislation whether there will be any obligations on end clients to provide true and accurate information to recruiters and whether there will be any penalties if the end client provides incorrect information which the recruiter subsequently relies on when making payment to the PSC.

Where there is more than one recruiter in the supply chain, it is the recruiter at the bottom of the chain (closest to the PSC) which bears the liability for ensuring the correct PAYE deductions are made, which is different to previous legislation affecting recruiters in a supply chain which put the onus on the recruiter closest to the end client (known as Intermediary 1).

How will it work for contractors who continue to work through their own limited company (PSC)?

If you have a contract within the public sector, it will no longer be your decision as to whether you comply with IR35 from 6 April 2017.  Should the public sector body you are working for determine that the assignment is subject to IR35, your limited company will receive a payment which is net of PAYE. Therefore, what you are paid by the recruiter or public sector client (less any VAT), is yours to draw out of the company and spend however you want i.e. all tax due (except VAT) will have been paid at source. This for many contractors will result in a reduction in take home pay of up to 20%.


Contractors who are VAT registered (including those in the flat rate VAT scheme) can continue to charge VAT on their services irrespective of their IR35 status. Public Sector hirers and recruiters should continue to accept VAT invoices for a contractor’s services and VAT will continue to be paid over to HMRC in accordance with the current quarterly timetable and proposed VAT rates.


If your company has made payments into a pension scheme, there are provisions being made for you to reclaim any tax and National Insurance Contributions which have been overpaid in this regard.  We are awaiting guidance to clarify how this will work and whether it will result in any cash flow issues.

Inequality between public and private sectors

As a result of these changes, there will inevitably be some inequality between the public and private sector as a result of who bears the IR35 risk.

Public sector bodies are notoriously risk averse as they are putting their public funding in jeopardy rather than their own personal wealth, this could result in the public sector body determining an assignment falls within IR35 when in reality it doesn’t. Individual contractors are a more inclined to invest the time and seek advice to ascertain the correct IR35 status of an assignment; meaning we are likely to see more contractors in the public sector being captured by IR35, at least initially.

Calculation of IR35 reform liability

The way in which the PAYE liability for contractors caught by IR35 in the public sector is also being amended.  Currently your taxable pay is reduced by a flat allowance of 5% to recognise the general costs of running your limited company.  Whilst this 5% allowance will continue to be available for private sector contracts, it is being removed for contracts in the public sector.

Employers NICs

Recruiters may start to negotiate rate increases from public sector clients in order to cover the perceived increase in tax payments due (to cover the employers national insurance contributions). This may soften the blow slightly for contractors. Although, I think many public sector clients will refuse to pay this on the basis that the rate agreed with the recruiter will be an ‘all-inclusive rate’ to cover employers and employees NICs, holiday pay and any other benefits provided by the Hirer. Therefore, contractors are likely to feel the hit of the employers NIC cost from their rate as well the additional PAYE being withheld.

How will you know if you are working for a public sector body?

The proposed legislation uses the Freedom of Information Act (and its Scottish equivalent) as a benchmark. If the Hirer is listed in these Acts, then they are caught by the proposed IR35 changes.  You still need to be careful as some hirers have been added to these Acts after the initial publication date, for example Network Rail was brought within the scope of the FOI Act in 2014, so it in not included within the original text of the Act, but may still be considered a public body for IR35 purposes.


Unfortunately, the draft legislation does not include any details regarding an appeals process for contractors who disagree with the public sector body’s IR35 decision.  There is also no mention of this in the guidance.  Whilst there is a process for querying the IR35 decision of the public sector client, this does not go far enough in the event of a disagreement over status.  This is disappointing as there are likely to be instances where a public sector body determines an assignment to be within IR35 and therefore triggering the withholding of PAYE from the payment but the contractor disagrees.  Taking this a step further, the contractor is likely to seek an IR35 review which, if concluded the assignment is outside of IR35, should entitle the contractor to reclaim the PAYE deducted.  The lack of any guidance in this area is a significant omission from the legislation and guidance and we hope that further guidance will emerge over the coming months.

Alternative options

Some workers using a PSC may consider moving into an umbrella company. Where a worker solely works in the public sector and is likely to be caught by IR35 and take-home pay is their sole driver for using a company for their income, then an umbrella payment model is likely to come out on top. Whilst this may feel counterintuitive, it results from the PAYE calculation which will apply to IR35 in the public sector no longer allowing the 5% deduction for general expenses. Also, any Flat Rate VAT benefit will be eroded from 1st April 2017 for labour-only business.

The key distinguishing factor between PSC and umbrella will be the costs incurred by the contractor. For limited company workers, this will include accountancy fees and insurance; whereas for umbrella workers this will just be the umbrella margin which is likely to be lower than accountancy fees. In addition, umbrella working doesn’t need the contractor to take on any of the director’s responsibilities currently imposed, such as ensuring accounts and tax returns are submitted on time and the correct amounts of tax are paid — these are done by the umbrella company.

As a result, there are still options available for contractors in the public sector which do not require them to take up an employed role with their end client and which enable them to continue to work flexibly.