British expat contractors working in the public sector who have their own company for tax purposes in the UK may be in for a financial surprise next April when new laws come in which could see their status changed.
The rules also apply to expats working in the UK public sector who have formed their own company but not to expats working in the private sector.However, HM Revenue & Customs (HMRC) has announced a public consultation on the proposals so expats affected by the move can have their voices heard – though they only have until 18 August 2016 to reply.
For those who are concerned, IR35 covers contractors who do not meet HMRC’s criteria for ‘self-employment’. The rules mean the contractor pays more tax and has a National Insurance liability.
Essentially, in the Government’s April Budget it was announced that the laws regarding workers who are contracted through their own company, often referred to as a personal service company or PSC, will be reformed.
Expat workers who are 'off-payroll'
This means the IR35 rules for expat workers who are ‘off-payroll’ and not employed directly by an employer but who work through an intermediary, including their own limited company, are being changed, with the responsibility for deciding whether IR35 rules should apply switching to the employer.
Or, as HMRC explains, deciding on who has the right of ‘supervision, direction and control’ of a contractor in the workplace – even if they do not exercise the right – means a number of tax measures will apply.
HMRC says that the public sector employer, which will include agencies and other third parties, will be responsible for paying the expat contractor’s wages and they must decide whether the contractor is really an employee or not and if so, they will then be liable for paying National Insurance and any associated income tax.
The big worry here is the employer or ‘engager’ is then liable for the extra costs that come with associated tax and National Insurance Contributions while the expat’s tax burden will essentially remain the same as if they were a permanent employee of the engager – though they will not have any employment rights.
Expat contractors working overseas
The issue for expat contractors working overseas is that they may already be paying income tax and social security payments while abroad and under double taxation rules. These payments are offset against their UK tax liabilities.
But HMRC says it will automatically assume that expat contractors will fail the ‘supervision, direction and control’ test unless they can prove otherwise; this will mean an expat having a contract approved by a HMRC helpline, professional third-party or a review panel.
However, one tax measure affecting expat self-employed contractors that has already taken affect (from April 6 2016) is their right to claim subsistence and travel expenses, which has now been removed if they fail the ‘SDC’ test. The move covers expats working for umbrella companies, recruitment agencies or third parties – which effectively includes outsourcing specialists and consultancies.
In effect, this means the expat contractor cannot claim expenses for their accommodation costs or for travelling to and from work.
This removal of deductions will, inevitably, be costly for overseas contractors which will impact on a contract’s profitability.
Under the new rules, expat contractors can still claim for reimbursement of expenditure incurred and these can be repaid free of income tax and NICs. Also, if the client is willing to pay chargeable expenses for travelling between their home and the workplace then these expenses are subject to income tax and NICs.
In a report explaining the move, the Treasury’s Financial Secretary, David Gauke, said there was evidence of widespread non-compliance with the current legislation. He added: “This is unfair to those who pay their correct taxes.”
The report also points out that the Exchequer loses a ‘significant amount’ of income every year and that public sector bodies have a duty to ensure that their employees and contractors are paying the right amount of tax.
Under the current rules covering freelancers and contractors, they are responsible for determining what their employment status is for both the private and public sectors.
This is a complex area of law and experts may be needed to interpret it, but the test for whether IR35 is to be used comes down to where the expat contractor is controlled and whether they can send another person in their place on a job. There’s also a question of ‘mutuality of obligation’, which means determining whether the client is obliged to offer the expat contract work and whether the expat is obliged to take it.
The rules for IR35 covering public sector contractors
However, the Association of Independent Professionals and the Self-Employed (IPSE) says that the proposed changes to the rules for IR35 covering public sector contractors will hamper the delivery of crucial projects and increase a small company’s tax burden.
IPSE’s chief executive, Chris Bryce, said public services will inevitably suffer under the plans and government spending will likely increase should the plans be implemented rather than fall.
He added: “Of course all businesses should pay the tax owed but these plans will impose punitive and disproportionate taxes onto small businesses and cost efficient and talented experts will shun the public sector for private sector work entirely.”
IPSE says that the rule change will mean the government being forced to use the ‘Big Four’ consultancies – which are extremely expensive – more frequently in a bid to deliver the work instead.
Mr Bryce added: “This move will prevent the government from meeting its target of contracting with small businesses and will be more expensive for public sector bodies.”
Proposal to 'tax freelancers as employees'
He also pointed out that if the government wanted to boost its revenue from employment taxes then it should employ more workers rather than proposing to ‘tax freelancers as employees’ while at the same time denying them even the most basic of employment rights.
Mr Bryce said: “The proposal is unnecessary, exploitative and ill-thought out.”
The move has also been criticised by the Association of Professional Staffing Companies (APSCo) who say that the changes are disproportionate, unreasonable and workable.
APSCo’s operations director, Samantha Hurley, said one problem is that recruitment firms often do not have sight of the client’s or expat worker’s ‘day-to-day operations’, so they would need other parties to provide regular up-to-date information during the expat’s assignment so they could ascertain their ‘tax status in real time’.
She added: “This is clearly unjust as contractors could end up bearing penalties that are attributable to other people’s lack of disclosure of which they have no control.
“We believe firms will not be able to take on this unknown liability and have to assume that the contractors working outside IR35 could result in any contract as being in ‘false employment’ and lose control of their business tax affairs.
“The public sector is also likely to lose access to skills they need from contractors who will be too expensive and contractors will choose to work in the private sector.”
Ms Hurley pointed out that APSCo does not believe that there is anyone in the public sector intending to avoid their employment or taxation responsibilities and she said that large, ongoing infrastructure projects may well struggle to recruit contractors.
She added: “HMRC is not consulting on whether it is appropriate that the public sector determines its taxation responsibilities be transferred to a third party recruitment. We consider this is challengeable.”
The future of the flexible workforce
However, Ms Hurley also flagged up another potential issue that if the public sector proposals are ‘a dry run for the private sector’, then APSCo fears for the whole future of the country’s flexible workforce.
The growing concern is also reflected in news that the public consultation by HMRC is a ‘done deal’, according to the chief executive of ContractorCalculator.
Dave Chaplin said: “Despite the warnings, it seems that from day one, they fully intend to press ahead with the plan.
“The consultation exercise extinguished any hope that HMRC will listen to reason.”
The chief executive of the Freelance Contractor Service Association (FCSA), Julia Kermode, said the move to crack down on the public sector was at odds with the government’s and policymakers’ aims of valuing a flexible workforce.
However, expat contractors working in the private sector as well as the public sector are being urged to read the consultation document to understand and appreciate what is being planned currently, with fears that the plans could be extended to the private sector.
Qdos Consulting’s Seb Maley said the proposals are effectively a ‘done deal’. He added: “We spoke to recruiters and there are concerns that this is definitely going ahead, even prior to the consultation so there are no real surprises.”
He said that many firms working with contractors are now expecting a private sector rollout of the new legislation – if things go as planned in the public sector.
Mr Maley said: “It’s quite clear this is HMRC’s intention for the private sector and contractors better read and understand the consultation because it could be affecting them in the near future.”
He also pointed out that it’s unlikely that employers will have to determine the expat contractor’s status if they have been provided for assignment by an agency and the new rules could lead to a shake-up among agencies who will take the strain for the end client.
Mr Maley warned: “In the run-up to April 2017, I think agencies will become more hesitant in taking on contractors in some cases.”
HMRC has published a guidance document for expat contract workers which includes examples of those expats who may be affected by the rule change and case law.
A spokesman for HMRC said the published guidance is based on their interpretation of various court decisions taken over the years.
The guidance explains in detail how an employer and expat contractor can decide who exactly is responsible for determining the ‘supervision, direction and control’ of the contractor so their tax status can be determined.
The spokesman added: “We base our understanding on court findings and this goes through to helping define someone’s employment status.”
Growing trend for public sector workers
One reason for the rule change is the apparent growing trend for public sector workers to take up roles using personal service companies in a bid to reduce their income tax liability and National Insurance payments.
The 87-page consultation document makes it clear that the UK government wants to improve the effectiveness of legislation covering intermediaries for freelancers and contractors working through limited companies or personal service companies in the public sector.
As with most legislation, there are loopholes to get around the IR35 rules and expat contractors could obtain a contract that reflects their working practices in a friendly way or they could also become a permanent employee to help secure their future income.
Also, experts in IR35 contracts say that expats who are working overseas, or who are looking to move abroad, should consult with a specialist tax expert before leaving to ensure that they will be better off financially even under the double taxation rules.
Experts are also warning expat contractors who believe they need to do nothing because they believe the legislation could be revoked or that the rules do not apply to them to understand what their obligations under IR35 are and begin making arrangements for meeting the likely increased financial burden.
The big worry among many contractors and freelancers, however, is that many risk-averse employers will opt to use IR35 by default which would leave expats having to make a difficult decision of whether to take a big pay cut or leave their contract.
For more information about HMRC’s public consultation, visit this page, which details changes to status of contractors working in the public sector and the guidance document ‘Off-payroll working in the public sector – reform of the intermediaries legislation’. HMRC has also published a summary of responses it received to a discussion paper regarding the status of intermediaries launched in 2015.