They have also chided Government Departments for not having sufficiently competent in-house resource so that the use of interim or freelance staff 'presents a risk to value for money'.
And, in the light of criticism in the report, HM Revenue and Customs (HMRC) have pledged to increase its IR35 compliance activity ten-fold. This comes after a recent report that shows HMRC is already moving in this direction. (See: IR35 investigations double and tax yield up five times - Oct 2012, Shout99). Contractors can now expect to see this stepped up considerably.
The hard-hitting report also suggested that individual Government Departments should feed back information they gather about the tax arrangements of their off-payroll staff to HMRC in order to "to inform investigations and compliance work."
The recently published report from the PAC into 'Off-payroll arrangements in the public sector' follows the scandal over the summer about the number of public sector workers - for Government and related organisations, such as the BBC - who operated through so-called personal service companies. The media and public backlash was sufficient to ensure that the Government tightened up its own act in the way it contracted with freelancers - and also, recently, threatened the commercial organisations who wanted to do business with Government Departments, to get their own house in order. (See: Firms warned to play by the Government's rules - Shout99, Sept 2012).
Now the PAC, has reported its findings after being charged with examining the nature and scope of these arrangements now known as 'off-payroll'.
Nature and scope
The PAC defined 'off-payroll arrangements' as those where 'individuals, either self-employed or acting through a personal service company, are paid gross by the employer'. The Committee supported the position that the Government has been moving towards that says that someone who is integral to an organisation or a 'controlling person' should be treated as an employee for tax purposes. Its report said: "While off-payroll arrangements may sometimes be appropriate in the public sector for those engaged on a genuinely interim basis, they are not appropriate for those in management positions or those working for a significant period with the same employer. Such arrangements reduce transparency and can be perceived as an endorsement of tax avoidance."
The report then reiterated the position taken by Chief Secretary of the Treasury, Danny Alexander, at the LibDem conference last week, when it said that the public sector must maintain the highest standards of propriety in its employment practices if it is to show leadership in the fight against tax avoidance.
The report stated that: "It (the public sector) must therefore avoid the practice of using off-payroll arrangements for staff who should be on the payroll, because it fails to meet the standards expected of public officials. HM Treasury's rules are clear that public organisations should avoid the use of tax avoidance schemes. However, the growth in the use of personal service companies across the public sector shows that these rules have been neglected in recent years."
When the media exposed this practise its focus fell on Ed Lester, Head of the Sutdents Loan Company, who was operating thorugh his own company. This case came in for particular criticism from the PAC. It said: "There were a number of errors across Government which led to the appointment of the Chief Executive of the Student Loans Company". It continued: "The information released under the Freedom of Information Act points to the Student Loans Company and the Department for Business, Innovation and Skills having pushed for the Chief Executive to be appointed using the off-payroll arrangements. They paid too little attention to the need for officials to uphold the highest standards in public life. The Department received expert tax advice that the Chief Executive should be employed on the books, rather than through a personal service company. The Department could not explain to us why that advice became any less relevant once it was clarified that the 'employment' relationship would be with the Student Loans Company itself, as opposed to the Department. In addition, the business case presented to the Treasury, which compared the cost of appointing the Chief Executive on the payroll or through the personal service company was flawed, particularly because it did not take into account the potential for lost tax revenue to the Exchequer from not putting him on the payroll. HM Treasury, the Cabinet Office and HM Revenue and Customs approved the arrangements without considering the broader tax implications. The failure of these departments to properly challenge the appointment gave the appearance of them endorsing the use of off-payroll tax arrangements."
It was after media reports about this case that the Government needed to be seen to be acting. Initially, it commissioned a review of the extent of off-payroll arrangements in central Government finding that there were 2,400 off-payroll engagements with staff earning more than £58,200 a year in central government departments and their arm's length bodies. This review was restricted to central Government and it was unclear how 'endemic' - to use the words of the PAC report - the use of personal service companies is in other parts of the public sector, including the NHS below board level, public corporations like the BBC and local government.
The BBC made headlines in the PAC report by admitting that it employs around 20,000 people who are on the BBC payroll and that in addition, in a typical year, it employs around 25,000 people using off-payroll arrangements, comprising around 12,000 off-air staff and 13,000 on-air talent. It has 3,000 personal service company contracts.
The BBC explained that this was part of the nature of the broadcast industry, which often required production staff to work for short periods on programmes. However, the report found that 148 of the 467 presenters are employed by the BBC through personal service companies, despite them often being employed long-term, and the BBC acknowledged that their contracts can share characteristics with typical PAYE contracts.
IR35 activity to be increased ten fold
HMRC came in for some back-handed criticism over its inactivity on investigating these cases - which resulted in a commitment from the taxman to step up IR35 challenges ten-fold. It would seem that HMRC had been relying on the very existance of IR35 to act as a deterrent - which the PAC found questionable.
The report said: "Under IR35 legislation, HM Revenue and Customs has the power to challenge whether those using personal service companies are paying the correct tax and National Insurance Contributions. HMRC told us that there is a deterrent effect from the very existence of the IR35 legislation. In recent years, however, the number of IR35 investigations that HMRCs carries out has decreased significantly from over 1,000 in 2003-04 to only 23 in 2010-11. The lack of investigations by HMRC undermines any deterrent effect of the legislation.
"HMRC plans to increase the number of IR35 investigations it carries out 10-fold in the next year. In addition, HMRC is carrying out a risk-based review of the tax arrangements of the 2,400 off-payroll engagements identified in the Treasury Review, and told us that it will look at the BBC's payments through personal service companies."
For a long time, freelancer groups have promoted the benefits of freelancers as a highly specialised short term resource which was able to fill the gap in an organisations internal capacity. However, that message had failed to reach the PAC, who took the view that Government Departments should seek to improve their own in-house capabilities rather than rely on external resources.
The PAC report said: "The Cabinet Office told us that part of the reason for 2,400 individuals earning over £58,200 being paid off-payroll is that the Civil Service has not developed sufficient skills in house, producing an over-reliance on interim staff and consultants. The Treasury, meanwhile told us that the challenge is to build and retain in-house capacity, which requires far more careful development and management focus on how you retain talented staff. The Treasury told us that it is in Whitehall's interest to have people in senior posts who are there for a reasonable length of time, not least so that this Committee can hold them to account. While there is evidence of increased professionalism in some areas, such as finance, programme management and IT skills are still in particularly short supply in the Civil Service, as shown by the scarcity of successful Government projects that we hear about."
They then went on to say that this reliance on temporary or interim resources was 'a risk to value for money'.
Conclusions and recommendations
The PAc had the following conclusions and recommendations as a result of its investigtion:
- Too many public sector staff have been paid using off-payroll arrangements for too long. The use of off-payroll arrangements for permanent employees generates suspicions of tax avoidance, places value for money at risk, and fails to meet the standards expected of public officials. It added that 'it was shocking' to hear about the numbers involved.
- The appointment of the Chief Executive of the Student Loans Company (Ed Lester) through a personal service company should not have gone unchallenged by any part of Government. Here the Student Loans Company; the Department for Business, Innovation and Skills (BIS); HM Treasury, Cabinet Office and HM Revenue and Customs all came in for criticism.
- It remains unclear how prevalent the use of inappropriate off-payroll arrangements is beyond central Government. The Committee to see the arm's length bodies, such as local authorities also to be accountable.
- The BBC has identified 25,000 off-payroll contracts, including 13,000 contracts for 'talent', but cannot provide any assurance that these individuals are paying the correct amount of tax. The BBC has said that it would be carrying out a detailed review of its off-payroll arrangements and the PAC advised that its review should specifically consider whether the contracts resemble typical employment contracts, their duration and the number of repeat contracts, and the salaries involved. It also advised that "the review should set out how it (the BBC) will gain assurance that its staff pay the right level of income tax and national insurance on their income."
- There is insufficient clarity on how Government will implement the Treasury Review's recommendations. The report noted that the Treasury had not defined what constitutes the 'exceptional circumstances' under which an Accounting Officer may still approve the use of personal service companies and was concerned that the Treasury's guidance could be interpreted inconsistently across the public sector. The report also noted that the Treasury had not set out how Departments should seek assurance that those using personal service companies are paying the right amount of income tax and national insurance on income they receive from the public purse. It recommended that the Treasury should clearly define what it means by 'exceptional circumstances', require Accounting Officers to seek Treasury approval of any such exceptions, and require Departments to pass on information they gather about the tax arrangements of their off-payroll staff to HM Revenue and Customs to inform investigations and compliance work.
- The deterrent effect of anti-avoidance legislation has been placed at risk by the reduction in the number of investigations by HMRC. The report noted that IR35 legislation is designed for this purpose but the number of IR35 investigations has decreased significantly from over 1,000 in 2003-04 to just 23 in 2010-11, which, it said was undermining the IR35 system as an effective deterrent to tax avoiders. The Report said: We welcome HM Revenue and Customs' intention to increase this to at least 230 a year and to carry out a risk-based review of the 2,400 cases found in the Treasury's Review and the 25,000 cases identified by the BBC. HMRC should report the outcome of its review to us in three months' time, and should set an optimum number of IR35 investigations that maintains an effective deterrent, including any arising from information passed to it by public bodies."
- The public sector's dependence on interim staff reflects a lack of specialist and professional skills within Government. It was noted that the Civil Service lacks programme and project management and IT skills, and, in a statement which said more about the Government's understanding of the flexible freelancer sector than anything else in the past decade, the report said, 'The frequent use of interims in these areas presents a risk to value for money. We have twice recommended in recent years that Government should plan its long terms skills needs, identify core skills gaps and develop the capabilities to meet the skill requirements. The Cabinet Office should demonstrate how the Civil Service Reform Plan will address the issues the key skills gaps that remain prevalent in Government".
(See: Public Accounts Committee - Twelfth Report Off-payroll arrangements in the public sector)
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