HMRC research into off-payroll reform in the public sector
25 June 2018
IFF Research and Frontier Economics were commissioned by HMRC to gather evidence on experiences of the public sector bodies in implementing the reforms. The research considered implications for employment, costs incurred and any process changes required.
To follow is a summary of the report; however, the full report can be accessed here.
The off-payroll working rules, also known as IR35 or intermediaries legislation, were originally introduced in April 2000 as a counter tax-avoidance measure. The rules ensure that, where an individual would have been an employee if they were providing their services directly rather than through an intermediary, such as a Personal Service Company (PSC), they pay broadly the same tax and National Insurance Contributions (NICs) as an employee.
The Finance Act 2017 introduced reforms to how the off-payroll rules operate in the public sector from 6 April 2017. Where a public authority engages a worker through an intermediary, the responsibility for deciding whether the rules apply was transferred from the contractor’s intermediary (their own PSC) to the public authority. If the rules apply, and the public authority is directly engaging the contractor’s PSC, the public authority are required to deduct the relevant income tax and NICs before making any payments. If the contractor is engaged through an agency, the public authority will pass on their decision and the agency who are paying the contractor’s intermediary are then required to deduct the relevant income tax and NICs before making any payments.
The reforms were expected to increase the employment taxes collected on behalf of individuals who, pre-reform, were off-payroll contractors working through an intermediary, such as their own PSC. Contractors affected by the reforms could pursue a number of alternatives to continuing to work through their PSC within the off-payroll working rules. For example, becoming an employee of the public body or an employment agency, moving to work through an umbrella company, or leaving their role (potentially for a self-employed role in the public sector, a role in the private sector, or stop working altogether). It is possible that some contractors may have sought increases in their pay rates to cover the relevant employment taxes.
IFF Research and Frontier Economics were commissioned by HMRC to gather evidence on experiences of the public sector bodies in implementing the reforms. The research looked at the key sectors of Public Administration & Defence, Education and Health & Social Work sectors, and considered implications for employment, costs incurred and any process changes required.
The research consisted of a quantitative survey of 117 central bodies (covering 4,095 sites) and 100 individual sites in the public sector, all of which had recent engagement with off-payroll contractors; and qualitative follow-up interviews with 30 respondents whose responses indicated they had been affected by the reforms.
Survey fieldwork took place between August and October 2017. Given that the off-payroll working reforms only came into effect in April 2017, the findings are focused on the bedding-in period immediately after the reform came into effect and so reflect public bodies’ very early experiences.
Throughout the report, the term ‘central bodies’ refers to organisations who deal with the administration of off-payroll working reforms for more than one site. For instance, an NHS trust could be responsible for managing the reforms across a number of different hospitals and practices. Research findings for central bodies are reported separately from individual sites that are only responsible for the administration of off-payroll working reforms at their own site.
Survey results suggest that so far, the reforms have had minimal impact on how public bodies recruit, within year changes primarily attributed to wider factors, such as natural fluctuations in the workforce and long-term financial constraints.
In line with expectations, public bodies reduced their use of off-payroll contractors. Central bodies reported that they employed a mean average of 12 fewer off-payroll contractors in August 2017 than they did in March 2017, while sites reported employing four fewer contractors. The median change suggests the reforms typically had little overall impact on the use of off-payroll contractors (central bodies: zero, sites: one fewer).
However, survey data showed that where public sector bodies provided paid employee figures for both March and August 2017, there was a fall in employee headcount. Central bodies reported employing a mean average of 21 fewer employees in August 2017 than they did in March 2017, and sites reported employing 19 fewer, on average. Nevertheless, the median change between the two periods was zero among central bodies and sites; suggesting the scale of change was negligible overall.
While the evidence shows reductions in the number of paid employees and in the use of off-payroll contractors, results show that amongst central bodies off-payroll contractors made up a smaller proportion of the workforce after the reforms came into effect. On average, there were 102 paid employees for every off-payroll contractor in March 2017 compared to 185 paid employees for every off-payroll contractor in August 2017. This indicates that amongst central bodies the number of off-payroll contractors fell at a faster rate than the number of paid employees between March and August 2017.
Conversely, amongst sites, results indicate that the number of paid employees fell at a faster rate than the number of off-payroll contractors between March and August 2017. On average, there were 76 paid employees for every off-payroll contractor in March 2017, compared to 65 employees for every off-payroll contractor in August 2017.
Qualitative interviews showed that in some cases, off-payroll contractors had left public sector bodies after being declared within the rules, but were replaced with other off-payroll contractors willing to work within the off-payroll working rules, resulting in no overall change to contractor numbers. In a few cases, numbers decreased because more off-payroll contractors were moving onto payroll as paid employees, or because off-payroll working reforms had prompted public bodies to review the extent to which they needed to use off-payroll contractors.
The research explored how the impacts of off-payroll working reforms differed between off-payroll contractors who were engaged directly by public sector bodies and those engaged via agencies. Public bodies reported using fewer directly engaged off-payroll contractors in August 2017 than they did in March 2017 and fewer contractors engaged via agencies. However, the size of the changes was not significant in each case.
Most central bodies (75%) and sites (82%) had used umbrella companies at any point in the past but reported no increase in their use since the reforms came into effect. Despite being considered a potentially hassle-free alternative work structure, exempt from off-payroll working rules, only a small minority of central bodies (11%) and sites (6%) had increased their use of umbrella companies, although all of those who reported that they had done this said that this was due, at least to some extent, to the off-payroll working reforms.
The research found little evidence of contractors turning to self-employment to avoid off-payroll working rules.
The research looked at how the reforms affected public bodies’ ability to fill vacancies, given that some off-payroll contractors may be unwilling to work inside the off-payroll working rules if they perceive it to impact their take-home pay. Most public bodies (central bodies: 58%, sites: 70%) reported that their ability to fill contractor vacancies had not changed since April 2017, when the reforms to off-payroll working came into effect. However, approximately one in three central bodies (32%) and one in five sites (22%) reported that it had been more difficult to fill contractor vacancies.
Qualitatively, some of those that had reported difficulties in filling vacancies felt there were fewer suitable contractors available in the marketplace since the reforms and that the process of filling contract vacancies had become more time consuming after the reforms came into effect. It was felt by some that difficulties in filling vacancies were more pronounced among roles where there had been pre-existing challenges with recruitment, for example, for doctors and social workers.
Some public bodies stated that some of the challenges that the off-payroll working reforms presented in filling vacancies were short-term and that contractors and agencies had become more accepting of the changes after the initial bedding-in period.
Use of off-payroll contractors
The most commonly mentioned roles that central bodies filled were in education, administration and medical roles. For sites, the most common roles were in education, facilities management, and IT.
Typically, public bodies directly engaged off-payroll contractors for roles where only a small number of specialists were required (e.g. engineers and lawyers), while agencies were used to recruit roles required in larger numbers (e.g. nurses and social workers).
Public bodies used off-payroll contractors for a variety of reasons. Some needed them to deliver projects or fill roles which required specialist skills or knowledge, or to fill temporary vacancies. Others mentioned they needed contractors on a long-term basis because of shortages in supply in some areas of the labour market, or because it was considered a convenient way to procure workers by offering flexibility in workforce planning.
The research also explored what impact the reforms had on the gross-hourly rates paid to contractors, due to the potential of off-payroll contractors who fall inside the off-payroll working rules increasing their pay rates to cover relevant employment taxes. The majority of public bodies reported that the reforms had no effect on the gross-hourly rates paid to off-payroll contractors (central bodies: 63%, sites: 78%). A minority (28% of central bodies, 20% of sites) reported that the reforms had led to them increasing the gross-hourly rates paid to off-payroll contractors.
Qualitative evidence showed that where off-payroll contractors or their agencies had requested that rates be increased, it was to cover reductions in take-home pay after contractors were assessed to be within the off-payroll working rules.
Complying with the reforms
Around half of central bodies (49%) and sites (57%) found the off-payroll working reforms easy to comply with. Public bodies were most likely to think that compliance with the reforms had been easy because they had suitable systems in place; this was reported by 45% of central bodies and 28% of sites who found complying easy. It was also common for public bodies to attribute their easy experience to HMRC’s online assessment tool (Check Employment Status for Tax Service, also known as CEST), which enabled them to make quick and easy assessments (reported by 34% of central bodies and 26% of sites). Notably, over a quarter of sites (27%) that had found it easy to comply with the reforms said that this was because they were a small establishment.
Conversely, central bodies who found complying difficult most commonly attributed this to difficulties using CEST (43%), although qualitative evidence suggested its functionality had improved since being introduced and it was now fit for purpose. Sites that found the reforms difficult to comply with most commonly mentioned not being confident in their understanding of the legislation (39%).
Qualitatively, some public bodies reported that they initially struggled with implementation due to needing to understand the legislation in a relatively constrained time period, and there was a perception that the guidance had repeatedly changed which made this task more difficult. In most cases, public bodies felt their understanding improved over time, although a few still lacked understanding about rules relating to substitution and the provision of equipment in August 2017.
The reforms to off-payroll working meant that some public bodies were required to adapt their recruitment process and spend time educating members of staff about what the changes would mean for their teams/departments.
The majority of public bodies conducted case by case assessments on existing (central bodies: 91%, sites: 87%) and new contracts (central bodies: 93%, sites: 89%). This is considered a suitable approach by HMRC.
In a few cases, where public bodies had high volumes of contractors working in the same role and under the same terms and conditions, the same assessment result was applied to all existing and future off-payroll contractors working under those same conditions. This approach is considered by HMRC to be compliant.
Sources of advice and guidance
The majority of respondents (central bodies: 91%, sites: 79%) had used CEST since the reforms came into effect. It was the most commonly used source of information, advice or guidance among public bodies.
Whilst some public bodies reported qualitatively that late availability of CEST was problematic at the time, and initially encountered issues with inconclusive assessments and inconsistent outcomes, most agreed that it was now ensuring employment status decisions were more straightforward.
The research also explored the extent to which off-payroll working reforms led to disputes with contractors or agencies, as it was expected that some off-payroll contractors would perceive the reforms to affect their take-home pay and therefore show some resistance to the changes. At least half of public bodies had not had disputes with contractors or agencies about the outcome of contractor assessments (central bodies: 51%, sites: 68%).
46% of central bodies and 31% of sites reported having disputes with contractors or agencies about assessments. Amongst those that had disputes, most of these concerned contractors being assessed to fall within the off-payroll working rules (central bodies: 62%, sites: 67%).
Six in ten central bodies (60%) and sites (59%) reported that staff had spent more time on the administration of off-payroll contractors since the reforms. Qualitative evidence showed that time was needed to understand the reforms, disseminate information to staff and implement systems to manage the changes.
Conducting assessments required time and resource in the lead up to the reform, although this reduced once the initial block of assessments had been conducted. A few public bodies had reallocated work to existing staff in cases where contractors had left because of the reforms and were struggling to fill the vacancies, though generally, this was uncommon.
Set up costs and administrative costs
On average, central bodies spent £7,550 setting up the systems and processes required to implement the reforms. Sites spent an average of £3,250.
Around half of sites (52%) and central bodies (56%) experienced either no change (37% and 44% respectively) or a decrease (15% and 13% respectively) in relation to the ongoing administration costs of off-payroll contractors between Q4 2016/17 and Q1 2017/18, while around four in ten central bodies (44%) and sites (41%) reported an increase. The mean average change in costs was an increase of £50 for central bodies (median: £250) and £1,600 for sites (median: £250).
In qualitative interviews, some public bodies said that they expected the administrative costs associated with the reforms to off-payroll working to decrease over time. These public bodies had incurred costs in assessing existing off-payroll contractors and dealing with disputes. However, going forward the volume of work required from staff was anticipated to be much lower.
Listen to a short webcast to find out what options are being considered in the consultation on how to tackle non-compliance with the off-payroll working rules in the private sector. The Policy team will also be publishing a survey in due course to gather your views and experience to help inform our response.