Off-payroll working in the public sector: Reform | KPMG | UK
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Off-payroll working in the public sector: Reform of the intermediaries legislation (IR35)

Off-payroll working in the public sector: Reform

The draft Finance Bill 2017 sets out the proposed new rules that will apply to public sector bodies hiring off-payroll workers via personal service intermediaries.


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The draft Finance Bill 2017 sets out the proposed new rules that will apply to public sector bodies hiring off-payroll workers via personal service intermediaries.

Summary of proposal

  • Public sector bodies will be responsible for identifying and reviewing the employment status of all workers engaged through personal service intermediaries (referred to hereafter as personal service companies or PSCs) including those provided via an agency.
  • Where, in the absence of the PSC, the worker would have been regarded as an employee of the public sector authority (under the IR35 rules), the public sector body or the agency will be required to treat payments made to the PSC as if they were earnings paid to the worker from an employment with the public body ("deemed employment payments").
  • The public sector body or the agency will be required to account for PAYE and National Insurance (both employee and employer) to HMRC on the deemed employment payments made to the PSC.


The Government are committed to reducing the tax gap arising from off-payroll working arrangements and the proposed reforms are expected to generate additional tax and National insurance (NIC) of around £25m per annum. 

The new rules apply to public sector bodies as defined by the Freedom of Information Act 2000 and Freedom of Information (Scotland) Act 2002. Whilst restricting the rules to the public sector leads to potential inequity between the private and public sector, the Government has confirmed that there are currently no plans for these rules to be extended to the private sector.

Agencies and 3rd parties

One of the issues raised during the consultation was how agencies could obtain sufficient information on the day-to-day delivery of services by workers in order to form a judgement on employment status. In response the Government has decided to place the onus on the public sector body to review and notify the employment status of the worker to the 3rd party or agency. This means that even where PSCs are supplied via agencies it will still fall to the public sector body to determine whether an employment relationship would have existed with the worker but for the PSC. If such a relationship would have existed, the worker will be treated as receiving deemed employment income and the agency will be required operate PAYE and NIC on the payments made to the PSC.

Where this information about the worker's status is not supplied to the agency, the agency may submit a written request that must be responded to within 31 days. If a reply is not forthcoming within 31 days, the public sector body will be responsible for accounting for PAYE and NIC, not the agency. The supply chain can be complex and it is not always easy to establish whether a 3rd party is supplying labour which will be caught by the new rules or services which fall outside of the rules.  We understand that HMRC intend to provide additional guidance on determining when labour or services are supplied.

Further complexities arise where several 3rd parties are present in the supply chain and, in these situations, it is the agency that pays the PSC that will need to account for PAYE and NIC.

Where there is a supply chain and the 3rd party or agency that pays the PSC is based offshore, the last UK resident party in the chain (relative to the public sector body) will be responsible for accounting for PAYE and NIC. This could be the public sector body itself in certain circumstances.

Exclusions (not exhaustive)

  • Workers who are subject to PAYE and NIC as employees of an agency or umbrella company; and,
  • Workers supplied by compliant managed service companies.

Enforcement (on public sector authorities)

Financial sanctions will be applied on public sector bodies where there is a failure to respond within 31 days to a written request from an agency in relation to a worker's status under IR35 and the worker is ultimately deemed to be an employee.  In this situation, the public sector body will be responsible for accounting for tax and NIC on payments to the PSC.


  1. Review supplier lists to identify all personal service intermediaries that fall within the legislation as defined at new chapter 10, part 2 ITEPA 2003;
  2. Review the employment status of the worker supplied by the PSC (see below);
  3. Where the worker is deemed to be an employee, calculate the cost of materials and allowable expenses to arrive at the deemed employment payment (see below);
  4. The public sector body or the agency (depending on the particular facts) will need to process the deemed employment payment through RTI and account for PAYE and NIC on those payments (including Employer's NIC). 

The RTI process will be confirmed by HMRC in the near future.

Employment status: HMRC's online employment status service tool

Whilst it is envisaged that this will be determined by HMRC's online employment status service tool, employment status is a grey area and it will still be important to understand the decisions made by the tool.  The tool is currently being tested by HMRC but is expected to be available for public testing before 6 April 2017.

Deemed employment payments

Deemed employment payments are calculated as follows:

  1. The invoiced amount excluding VAT;
  2. Deduct so much of that amount that represents the direct cost of materials;
  3. Deduct an amount that represents expenses that would have been deductible if the worker had been an employee of the public sector body and the expenses had been met by the worker out of the deemed employment payment. 

It should be noted that:

  • The 5% business expenses deduction will not be available;
  • The off-payroll rules will take precedence over any deductions otherwise required under the Construction Industry Scheme;
  • The Apprenticeship Levy will need to take into account the additional payroll costs arising from payments made to off-payroll workers under the new rules.

Preparing for the new rules

Preparation for the new rules by public sector bodies will involve a number of key stakeholders from HR, finance, legal, procurement and payroll to:

  • Identify the PSCs that are currently engaged via a review of accounts payable data and other sources;
  • Identify agencies that supply labour and obtain details of PSCs provided by that agency;
  • Review contracts with agencies and PSCs to identify those caught by the new legislation;
  • Review current systems and how to determine employment status to identify gaps;
  • Review and, where necessary amend systems, including checklists, process maps, internal guidance, contracts and policies to demonstrate a clear audit trail for presentation to HMRC in the event of a review;
  • Roll out internal instruction material for all key stakeholders - this could also include workshops and presentations;
  • Draft communication material to be issued to PSCs outlining the new rules;
  • Consider the additional cost of Employer's NIC on existing and future contracts with PSCs that are caught by the IR35 rules.

Interaction with HM Treasury rules

The reporting and assurance rules relating to public sector appointments introduced by HM Treasury in 2012 will continue to operate and are independent of the new rules outlined above. The new rules however capture a larger number of engagements and it is expected that HMRC will review information reported under Treasury rules in enforcing them.


One of the concerns raised during the consultation was that 6 April 2017 does not provide sufficient time for public sector bodies (and agencies) to introduce changes to deal with the new rules. However, HMRC have pushed ahead on the basis that they consider that the reforms need to be introduced as quickly as possible to protect the Exchequer.

Our view

The size of the task (particularly given that the new rules take effect from 6 April 2017) may lead some public sector bodies to have done with it and simply put all workers with PSCs on the payroll as salaried employees. 

But this, in turn, would crystallize additional employer NIC cost across the board for all contractors currently engaged via PSCs and provide far less labour flexibility for the public sector body. And indeed, contractors for whom the IR35 rules do not apply may decide instead to work in the private sector where they can judge the matter for themselves and so not have PAYE and NIC deducted where it is not due (and also retain the 5% business expenses deduction).  That is, unless perhaps the public sector was to increase pay rates - something which would seem very unlikely when most are acutely short of cash. According to HMRC these reforms will bring in an additional £20 - £25 million of tax annually which seems relatively small beer for such a great upheaval, impacting on so many contractors, public sector bodies and agencies. HMRC itself will also be impacted as and when contractors seek to unwind any PAYE and NIC they consider has been deducted in error.

And yet, in the summary of the responses to the consultation on the new rules, the Government say that "it is important to implement reform as soon as possible to protect the Exchequer [and] HMRC will be providing guidance prior to implementation in April which will help affected stakeholders to prepare". And, indeed, an earlier estimate by HMRC included in the May 2016 consultation document for non-compliance with IR35 was £440 million for the tax year 2016-17 alone. So how does a £20 - £25 million tax saving per year reconcile to an estimated £440 million loss of tax in 2016-17? The answer may well lie in the Government's comment that they have "no current plans to extend the reform beyond the public sector". But plans can change, quite quickly sometimes!

If you would like to discuss these changes further, please get in touch with your normal KPMG contact or email

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