CHAPTER 3: THE CONTINUING VIABILITY
OF THE IR35 LEGISLATION
Introduction and Background
65. The primary focus of the Committee's investigation
was on the use of personal service companies and the associated
consequences for tax collection. The inquiry raised broad questions
about the associated legislative framework. Within these broader
issues, the core questions which we address stem from the IR35
legislation, its interpretation and HMRC's ability to administer
and monitor it.
66. The 1999 Budget Press notice 'IR35' which
announced the introduction of the rules stated:
"There has for some time been general concern
about the hiring of individuals through their own service companies
so that they can exploit the fiscal advantages offered by a corporate
structure. It is possible for someone to leave work as an employee
on a Friday, only to return the following Monday to do exactly
the same job as an indirectly engaged 'consultant' paying substantially
reduced tax and national insurance. The Government is going to
bring forward legislation to tackle this sort of avoidance".[67]
67. We were conscious that any consideration
of the success or otherwise of the legislation should take account
of these original aims and so we sought to investigate whether
the practice outlined above was still commonplace. Whilst we heard
very little evidence of individuals leaving employment only to
return in a 'consultant' role, we did hear from some in the private
sector about the commercial benefits of recruiting individuals
through limited companies.[68]
68. We were also interested in what drove people
to incorporate more generally in the first place and the extent
to which this was motivated by a potential tax advantage. HMRC
explained to us that in their opinion, the growing phenomenon
of personal service companies could be explained "primarily
for commercial reasons but, it also has to be said, partly to
avoid or mitigate tax".[69]
In response to this, the IR35 legislation itself had been drafted
to ensure that broadly the same tax is paid by applying a tax
framework akin to that of a conventional employment relationship.
69. There appear to be particular problems in
having to apply the rules on a contract-by-contract basis, which
can make them especially cumbersome. As mentioned in the previous
Chapter,[70] the IR35
legislation applies to engagements which, but for the presence
of an intermediary (such as the personal service company), would
be regarded as conventional employment relationship. This has
the aim of ensuring that broadly the same amount of tax and National
Insurance is paid regardless of the use of an intermediary. This
judgment is applied on a contract-by-contract basis, rather than
by reference to the totality of the activity of the individual
who works through a personal service company. Consequently, contractors
find that they have to consider whether IR35 applies to each of
the contracts under which they operate rather than establish the
tax status of their personal service company.
70. Our Call for Evidence[71]
asked the following question: "To what extent does the current
IR35 legislation impose additional compliance burdens and administrative
costs?" This question sought to gather information on both
the compliance and administrative costs to Government, in the
form of HMRC, and to British business. The PCG told us of the
expensive administrative and cost implications of contractors
having to seek accountancy advice and private contract reviews.[72]
We deal with HMRC's administration costs in Chapter 4.
71. The IR35 legislation was initially justified
on the basis of a significant risk to the Exchequer of the loss
of tax and National Insurance revenue. HMRC initially told us
that the Exchequer risk was £475m but when we asked them
to provide further details we were told that the total estimated
fiscal risk was now £550m. HMRC provided the Committee with
a breakdown of this figure[73]
which comprised an Exchequer yield of £30m and Exchequer
protection of £520m, the latter figure having increased in
recent years, partly because of a reduced estimated income threshold
at which HMRC consider an individual may decide to establish and
operate through a personal service company. We were told that
the Exchequer protection figure was made up of:
(1) £115m from people who currently provide
their services through a personal service company and who would
pay a greater proportion of their income through dividends in
the absence of IR35. This is calculated as 220,000 directors estimated
to be deterred from avoiding £500 per person on average;
and
(2) £405m which is made up of people who
are currently directly employed who would incorporate and provide
their employment services through a personal service company were
it not for IR35. This is calculated as 55,000 employees who would
incorporate and avoid tax and National Insurance of around £8,000
per person on average.[74]
72. The reliability of these figures formed part
of our questioning to HMRC when they appeared before us for the
second time at the end of our inquiry. We were told that HMRC
aimed to derive a reasonable central estimate of the costs of
any measure in the Knowledge, Analysis and Intelligence Directorate
and that this was subject to a quality assurance process before
it was scrutinised further by the Office for Budget Responsibility.[75]
It was not clear to us that these figures were reliable. The 220,000
directors cited in connection with Exchequer protection was a
higher population than the figure of 200,000 which we were given
for the number of operating personal service companies and it
was not clear on what basis either this population or the figure
of £500 per director had been calculated. In respect of the
55,000 employees who would move to incorporate in the absence
of IR35, we were told that this represented 4% of employees who
earn over £50,000. We were also told that the OTS had estimated
that 1.8% of individuals with an employment income of between
£50,000 and £150,000 might incorporate in the absence
of IR35.[76] HMRC made
it clear repeatedly that these overall figures were only estimates
based on the available evidence. Given the critical importance
of these calculations in justifying the existence of the IR35
legislation, we were of the opinion that more robust work was
needed in this area.
73. We recommend that Her Majesty's Revenue
and Customs carry out and publish a detailed assessment of the
current Exchequer protection figure and of the costs that taxpayers
incur in dealing with IR35. This should enable a better assessment
of whether the legislation is having the intended effect and is
proportionate. (Recommendation 1)
The effectiveness of the legislation
74. The Committee heard from a wide range of
interested parties who consider that the current legislation is
ineffective; a large number of the written submissions made this
point forcefully. Contractor Calculator, an independent, online
guide for contractors, stated that: "It does seem somewhat
wasteful having industry experts and HMRC standing around a dead
horse discussing how they can make it win the race. It's a non-runner,
and has been since inception".[77]
The broad sentiment expressed here was echoed by many. The Association
of Accounting Technicians (AAT) and Chartered Institute of Payroll
Professionals (CIPP) argued that the legislation was poorly thought
through when drafted and remained unclear. Their argument seemed
to be a qualitative one based on the ambiguity of the rules and
uncertainty amongst taxpayers who were expected to abide by them.
HMRC acknowledged that they were aware that many find the legislation
difficult to understand but maintained that, on the whole, understanding
had increased over the years.[78]
75. A great deal of evidence was submitted which
displayed a high degree of hostility to the legislation in its
current form. Many viewed the legislation as outdated, attempting
to address a situation and market which in reality no longer existed.
We were told that HMRC were trying to apply an outdated method
of taxation to a new, emerging way of working.[79]
The IIM suggested that the 'rules' did not reflect the underlying
reality of the way freelancers worked and the Interim Management
Association (IMA) argued that the legislation needed updating
to be more reflective of the maturing labour market. The reliance
on case law as a method of assessment, and a preoccupation with
defining the tax position on a contract-by-contract basis appeared
to be the primary criticisms here and an alternative approach
is discussed in the next Chapter.[80]
76. Conversely, organisations such as G4S plc,
Amey plc and Oil and Gas UK, all responding as clients of personal
service companies, were more supportive. Amey plc suggested that
the principles of IR35 were appropriate and pragmatic, whilst
G4S plc suggested that, as a client, they felt that the legislation
was effective and efficient in managing the tax risks of using
intermediaries. We were told very clearly by various parties from
the business sector that the status quo should be maintained,
though it was less clear whether this was an objective assessment
of the situation or simply an appraisal of how the current rules
are beneficial for their current business models. We were also
mindful that Government and the public sector are significant
users of personal service companies, arrangements which can benefit
all parties in a similar way to those in the private sector. The
Confederation of British Industry (CBI) and the IoD echoed this
sentiment of approval in their oral evidence to the Committee,[81]
but again, their satisfaction was less rooted in the benefits
for the Exchequer and more in the flexibility that current arrangements
afforded to their members.
77. It is clear that in certain situations, the
use of personal service companies can be beneficial for business.
The oral evidence given by Amey plc summarised the potential benefits
well:
"We need access to specialist skills, commonly
at short notice, for a limited duration. To have that level of
resource on the books permanently is expensive and inefficient
if we have people sitting around waiting for a particular project
to happen … if we need somebody for three months or six months
and we give them an employment contract, that raises a whole host
of issues that are disproportionate to the intended length of
the relationship and can include equality of employee rights,
autoenrolment for pensions and involvement in our flexible
benefits reward scheme. A lot of administrative structures are
built around permanent employment that are simply not appropriate
for somebody who is only going to be in the business for three
or six months".[82]
78. Serial contracting is a feature of the
modern British workforce and is supported by both businesses and
contractors. We heard that although IR35 is not a significant
issue for businesses, it can arouse considerable hostility from
contractors.
79. Moreover, we note that compliance with
the rules can demand a great deal of time and effort on the part
of contractors. We acknowledge that it can be difficult for individuals
contracting through personal service companies to define their
tax and National Insurance position quickly and accurately because
of the contract-by-contract nature of IR35 and the need for a
sound understanding of case law.
The Call for Reform
80. We were aware that there were strong opinions
on the complexity and appropriateness of the IR35 legislation.
As noted in Chapter 2, the Government asked the OTS to look at
alternative approaches as part of its Review of Small Business
Taxation which reported in 2011. Our Call for Evidence asked the
following question: "Should the current intermediaries legislation
be reformed and if so, what would be the alternatives?"
81. The OTS's suggestion of an eventual merging
of income tax and National Insurance[83]
was supported in evidence to us by Professor Judith Freedman (Pinsent
Masons Professor of Taxation Law at the University of Oxford),
AAT, CIPP and Contractor Calculator.[84]
Similar points were made by the ICAEW and Julius Hutson, a Chartered
Accountant. This was rejected by the Government in their response
to the OTS's report in 2011. [85]
82. The OTS also presented some IR35 reform options
in its 2011 report, the first of which was suspension of the legislation
prior to permanent abolition. This was supported by the PCG[86]
and others in evidence to us. On this point, Mr Whiting, Director
of the OTS, stressed the deterrent effect of IR35 which would
be difficult to quantify:
"The risk would clearly be that if HMRC
says that it is suspending IR35 and will not operate any investigations,
people might say, 'Oh, it's open season, we can do what we like'.
We recognised that, so we felt it would be possible to announce
the suspension by saying, 'We are suspending it but not abolishing
it, and if we see a marked move up in behaviour that would blatantly
be caught by IR35, the suspension will be removed'. That is the
risk that we had in mind".[87]
83. As discussed above, a key question that emerged
was whether HMRC's calculations of the deterrent effect of IR35
(Exchequer protection) are accurate and hence whether abolition
would do more harm than good. This underpins Recommendation 1
which calls for a detailed assessment of the Exchequer protection
estimates.
84. The Government chose to pursue the OTS's
option of improving the administration of the legislation[88]
and we examine these changes later in this Chapter.
85. We also heard other suggestions in evidence.
The IIM suggested that IR35 should be replaced by a straightforward
genuine self-employment certification process; a similar proposal
was made by David Ramsden of the Federation of Small Businesses
(FSB), although such a proposal was not common amongst the wider
evidence. There would be clear benefits to such a system, but
whether it would apply on a contract by contract basis and the
administrative implications of this are unclear. There are clear
arguments that people should be free to operate outside conventional
employment structures if they wish to do so.[89]
A more difficult question is whether that choice should be conclusive
for tax purposes given the tax and National Insurance incentives
that are on offer to those who operate through a corporate body.
86. A number of suggestions for new 'rules',
which may act to simplify the process were also made. Amey plc
suggested that there might be a case for looking more closely
at any engagement which lasted for more than a set period of time;
other variants of this principle were also suggested detailing
differing timescales. The Giant Group suggested that a minimum
number of clients per year could be defined, or that a rule around
any one client exceeding a certain percentage of personal service
company turn-over could be developed. We were interested to hear
from Professor Freedman that a percentage system is used in Australia,
though the extent to which this is effective is unclear.[90]
87. We believe that the abolition or suspension
of the IR35 legislation as proposed by the Office of Tax Simplification,
whilst attractive, would be unwise if the legislation has the
Exchequer protection effect claimed for it by Her Majesty's Revenue
and Customs.
88. The current structure and rates of income
tax and National Insurance provide an incentive for taxpayers
to arrange their financial affairs in order to minimise the amount
of tax and National Insurance paid. This has lead to complex legislation,
such as IR35, to counter such arrangements.
89. Whilst we recognise the complexities in
merging income tax and National Insurance and the effect that
this may have on the contributory principle, we recommend that
the Government re-examine the longer term case for combining taxes
on income and National Insurance. (Recommendation 2)
Responsibility
90. In the first draft of the IR35 legislation
the onus was intended to rest with the end-user rather than the
individual in determining whether IR35 should apply to a contract.
The Committee's Call for Evidence therefore asked: "Do businesses
insist on the use of personal service companies? If so, should
responsibility be placed on them rather than the worker to decide
whether a business transaction falls within IR35?"
91. Currently, the responsibility to take due
account of IR35 and associated personal service company legislation
rests with the individual who is operating through the personal
service company. Efficient and effective tax-collection appears
to occur only when the individuals concerned are soundly advised
and aware of the complexities involved. For those who do not fall
into this category, the expectation that they will declare their
status as falling within the intermediaries legislation seems
to be rather optimistic as detailed in Chapter five. It has been
suggested that the responsibility for assessing IR35 compliance
should move from the individual operating through the personal
service company to the end-user. The Committee heard that a greater
level of responsibility could fall on the engager as was first
proposed in the Government's consultation prior to the introduction
of the IR35 legislation. The ICAEW suggested that engagers should
bear the responsibility if they insist in engaging an individual
through a personal service company;[91]
others argued that they should be held responsible for any unpaid
tax resulting from disguised employment.
92. Although taking this step would remove the
responsibility from the individual operating through a personal
service company, it would place significant administrative pressure
on engaging businesses. The CBI argued that the legal responsibility
for determining IR35 status should remain with the personal service
company; this view seemed to be shared by most of those from the
world of business and was convincingly put to the Committee by
GlaxoSmithKline plc (GSK):
"I do not think it would be appropriate
for, say, GSK to be accountable for the personal service company
paying the appropriate amount of tax. It is a decision made by
the worker … they clearly are aware of what it means to set
up a personal service company and so on, so the accountability
needs to be with the personal service company. We have no thoughts
on how to modify the rules that would change that".[92]
Although there are many instances in which businesses
undertake elements of the administrative work of collecting taxes
such as PAYE and the Construction Industry Scheme (CIS), the majority
of the evidence we received did not support placing the onus on
businesses to make judgements about whether contracts fall within
the IR35 rules.
93. We received much evidence on the questions
posed on the various tax return documents, specifically the personal
tax return SA100 and the employer tax return P35, which was used
before the introduction of Real Time Information (RTI). In the
case of the latter, we noted that similar questions must still
be answered in the year end declarations made by employers online.
In each case, HMRC references 'service companies' with questions
aimed at detecting activity from both sides of contracting activity,
but without a detailed articulation of what 'service company'
means. The SA100 form defines the term as "a company which
provides your personal services to third parties", but gives
no indication that IR35 may need to be considered. Indeed, the
guidance note SA150 limits the explanation of what constitutes
a 'service company' to the following paragraph, again without
referencing IR35:
"You provided your services through a service
company if:
· you performed services (intellectual,
manual or a mixture of both) for a client (or clients); and
· the services were provided under a contract
between the client(s) and a company of which you were, at any
time during the tax year, a shareholder; and
· the company's income was, at any time
during the tax year, derived wholly or mainly (that is, more than
half of it) from services performed by the shareholders personally.
Do not complete this box if all the income you
derived from the company was employment income".[93]
We were of the firm opinion that this was a missed
opportunity to raise awareness of the potential tax consequences
of operating through a personal service company.
94. We also heard that in many cases the questions
were left unanswered. HMRC told us the following:
"For 2011-12, which is the last year for
which we have the data, 1,000 individuals completed the question
on the income tax self-assessment return and 120,000 employers
answered "yes" to the question on the P35 that they
were a service company. Demonstrably, the difference between the
two figures and the difference between the 1,000 and the 200,000
figure, which we estimate as the number of personal service companies,
demonstrates that the number of people completing the question
on the income tax self-assessment return is extremely low. We
believe that is for a number of factors: in some cases ignorance,
in some cases a conscious decision not to complete".[94]
95. When asked about the purpose of the question,
HMRC told us that although they may consider any lack of completion
as a risk indicator, they do not see it as a "key question"[95]
that would render the individual liable to penalties for an incorrect
completion. We did not understand HMRC's rationale for asking
questions on the tax returns but not considering their completion
as important or insisting that taxpayers complete them.
96. HMRC's role in advising the tax-payer of
the risk of a particular engagement falling within IR35 through
their Contract Review Service and in delivering a judgment after
an investigation was a constant feature of the evidence given
to the inquiry and is discussed in more detail in the following
Chapter. Professional Passport, a membership body operating across
the flexible workforce sector, stated that the majority of individuals
now operating through personal service companies were more aware
of their responsibilities than before. It is clear that whoever
bears the responsibility for judging whether IR35 applies needs
to be soundly advised and well informed.
97. We acknowledge that businesses would generally
resist being made responsible for IR35 assessment, finding the
additional administrative pressure and liability as overly burdensome.
98. We recommend that Her Majesty's Revenue
and Customs look again at whether they require complete and accurate
responses to the "service company" questions on the
personal tax return SA100 and the RTI employer year end declaration
(formerly P35). (Recommendation 3)
99. If Her Majesty's Revenue and Customs decide
that they need the information from those questions, we recommend
that their completion should be made compulsory, backed up by
the potential for penalties to be charged for incorrect answers
or non-completion. (Recommendation 4)
100. If Her Majesty's Revenue and Customs
retain the questions, we recommend that they revise the guidance
notes accompanying the personal tax return SA100 and the RTI year
end declaration by employers to make the relationship to IR35
clearer. (Recommendation 5)
101. If Her Majesty's Revenue and Customs
decide that they do not need the information gained from the questions,
we recommend that the questions be removed from the tax returns
and declarations. (Recommendation 6)
67 Appendix 5 Back
68
Oil and Gas UK and Amey plc Back
69
Q 5 Back
70
Paragraphs 44 and 45 Back
71
Appendix 3. Back
72
PCG. Back
73
HMRC, Q2 and Q116 Back
74
HMRC and Q116 Back
75
Q 116 Back
76
Q 116 Back
77
ContractorCalculator Back
78
Q 8 Back
79
Peter Disney Back
80
Paragraph 131. Back
81
QQ 93-104 Back
82
Q 76 Back
83
The issue has been a continuous thread in the discussion of tax
reform in the United Kingdom and has recently been discussed in
a Ten Minute Rule Bill in the House of Commons which had the primary
aim of changing the name of National Insurance to Earnings Tax.
See HC Deb, 25 February 2014, cols 164-166. Back
84
AAT, CIPP and ContractorCalculator Back
85
Government Response to the recommendations of the Office of
Tax Simplification's Small Business Tax Review, 2011. Back
86
PCG Back
87
Q 14 Back
88
Government Response to the recommendations of the Office of
Tax Simplification's Small Business Tax Review, 2011. Back
89
PCG Back
90
Paragraph 131. Back
91
ICAEW Back
92
Q 110 Back
93
HMRC Document, SA150. Back
94
Q 118 Back
95
Q 118 Back
| 
