CHAPTER 4: HMRC'S ADMINISTRATION AND
THE EFFECT OF RECENT REFORMS
Introduction and Background
102. Over the course of our investigation, we
heard from a wide range of witnesses who believed that there were
significant problems with the administration of the IR35 legislation.
The decrease in the number of annual investigations from over
1,000 a year in the tax years 2002-04 to only 256 in the tax year
2012-13[96] was noteworthy,
and the vast proportion of respondents and witnesses called for
a greater emphasis in aiding understanding, either of IR35 generally,
or of new resources to support understanding and assessment.
103. In light of HMRC's own estimate of the personal
service company population being in the region of 200,000,[97]
it is understandable that they might be unable to investigate
all the cases in which there may be a medium or high risk that
IR35 might apply, particularly as it must be considered on an
individual contract basis. Furthermore, HMRC maintain that the
overall size of the personal service company population does not
help in targeting those who may fall into the higher risk categories.[98]
Although we were told that risk profiling informs their compliance
investigations, the number of people HMRC have assigned to the
compliance task (40 at the last estimate) and to the Contract
Review Service (three people who also staff the IR35 helpline)[99]
seems rather low when compared with the overall number of operating
personal service companies.[100]
When this is viewed in the light of a falling number of annual
investigations, it seemed to us that IR35 is currently of greater
value to the Exchequer as a deterrent measure rather than as a
measure which is designed to provide a yield simply through voluntary
compliance. This is supported by HMRC's estimate of £520m
as the Exchequer protection, a figure more than 17 times that
of the actual yield collected from IR35.
104. There is a danger, however, that the value
of this protection will diminish if taxpayers believe that HMRC
are not willing or able to risk profile effectively in order to
inform their compliance investigations. As has previously been
noted, the value of the legislation hinges on the credibility
of the Exchequer protection figure provided by HMRC; anything
which has the potential to reduce this figure should be closely
monitored.
Enforcing the legislation
105. Increased activity on the part of HMRC was
called for by a variety of bodies including the ACCA, the FCSA,
the IMA and the CBI, though there was no consensus surrounding
the degree to which they believed efforts should be scaled up.
Conversely, the PCG suggested that compliance and enforcement
activity should not be increased until further steps have been
taken to improve the clarity of IR35, arguing that an unacceptable
ambiguity still remains and that suspension of the rules is the
best short-term remedy.[101]
106. The IoD and CBI suggested that although
HMRC had sufficient legislation at their disposal to address these
matters, they had dedicated insufficient resources for the task
at hand. The FCSA suggest that IR35 is now operating as effectively
as it has been for some time, and that the key challenge is to
enforce the legislation robustly and effectively. However, the
Committee were told by HMRC that they plan to continue with roughly
the same number of investigations as they have conducted in the
recent past: "Currently we broadly intend to maintain compliance
coverage i.e. around 250 cases per annum, as we did last year
and have done for the current year".[102]
107. In opposition to this light-touch policy,
David Kirk, a Chartered Accountant and Chartered Tax Adviser who
specialises in the intermediary sector, argued that for IR35 to
have a deterrent effect, HMRC would need to conduct in the region
of 10,000 enquiries per year, as opposed to the 250 that they
are currently aiming to undertake, and that the resources to deliver
this level of activity would not be realistically available. Once
again the deterrent effect of IR35 was cited as important.
108. Professional Passport suggested that focusing
on the enforcement of existing legislation with fast, robust,
visible and effective action would result in much greater returns
for HMRC as well as raising the level of compliance. They argued
that HMRC must be put in a position where it can act and react
as quickly as the market. The FCSA believed that enforcement,
rather than reform, was required and G4S plc argued that IR35
is technically sound, when understood and applied correctly. The
twin issues of a need for clarity and a greater effort to enforce
the existing legislation were recurring themes in the evidence
we received.
109. HMRC told us about the recently increased
resources available to them for this operation:
"Our compliance interventions are done by
our specialist employer compliance teams. There are now four teams,
totalling 40 people, who spend not all but a substantial amount
of their time on IR35 cases, and they work on other broader employment
and avoidance risks. Those 40 people are part of a much broader
employer compliance field force that look across employers more
generally, including other intermediaries such as umbrella companies
and managed service companies".[103]
110. In opposition to much of the evidence we
received however, they did not hold that increased resources would
be of much benefit. In response to a question about how extra
resources would be used, we were told:
"I do not think we would want to make a
direct correlation in that way. It is not simply about increasing
the resources because, as I say, I do not think there is necessarily
a direct correlation between the resources you invest and the
effectiveness, particularly in this sort of area. I think a lot
of it is about the quality of the interventions and the way we
target them and run our interventions".[104]
111. It was also regrettable that HMRC were unable
to provide precise costing for the current compliance and administrative
work that directly relates to IR35. We were told that spending
on the current compliance team of 40 people costs approximately
£700,000 a year, a team which collected £1.1m in 2012-13
as a result of uncovering non compliance with IR35. HMRC, however,
made it quite clear that these individuals work as part of a much
broader employer compliance field force which works with legislation
other than IR35.[105]
In light of the 2011 report of the House of Commons Treasury Select
Committee on Principles of Tax Policy,[106]
we felt that the overall practicability of the tax measure and
the value for money that it delivers for the taxpayer needed to
be further articulated by HMRC. Concrete figures of how much the
IR35 rules cost to enforce and administer were not forthcoming;
consequently, a cost-benefit analysis of HMRC's compliance activity
could not be carried out.
112. Her Majesty's Revenue and Customs did
not convince us that the resources currently allocated were sufficient
to ensure compliance with the IR35 legislation.
113. We recommend that Her Majesty's Revenue
and Customs articulate with greater clarity the costs they incur
from IR35 compliance efforts and administration, and the relationship
between those costs and the overall yield gained from the legislation.
(Recommendation 7)
114. John Whiting made the point that IR35 was
never fully intended to be enforced:
"I have always felt that IR35 was never
actually designed to be used, in the sense of really being applied.
In many ways the intention was that people would recognise that
they were caught and say, "Okay, it's a fair cop; I will
go back on the payroll", but that rather missed the point—we
are back to my push and pull—that people were often being
pushed off the payroll. My point is that when IR35 was designed
in 1999-2000, to me the way in which it was going to be applied
and policed was not really thought through because it was rather
expected that the deterrent, to come back to your term, would
be sufficient; everyone would be back on the payroll and, frankly,
we would not be sitting here".[107]
115. We heard that the time taken from opening
to closing an IR35 investigation had been dramatically reduced.
Taking on board the points made in the OTS review that external
stakeholders were often concerned about the length of time taken
to complete an investigation, particularly where it was discovered
that there was no liability, HMRC told us that:
"In 2012-13, for cases that we opened since
April 2012, it took 28 weeks on average from opening to closing
a case. That compares in earlier years to 110 weeks and over 140
weeks … we are very committed to dramatically reducing the
intervention time".[108]
Professional Passport claimed to have seen inquiries
closed quickly where contractors provided evidence of professionally
carried out assignment reviews that HMRC accepted, although the
quality of these professional reviews varied widely. They considered
this a positive development.
116. Furthermore, we were assured that investigations
are targeted across a wide range of employment sectors: "We
constantly reflect on whether we are properly targeting our inquiries
and the extent to which we should be looking at particular areas
and particular skill sets".[109]
The reduction in the average investigation time of cases believed
to fall within IR35 and the broad scope of targeting is clearly
a positive step forward.
Taking the Risk
117. Angela Williams, a Chartered Accountant
and Chartered Tax Adviser, stated that many now take the chance
that they won't be investigated by HMRC.[110]
This willingness to take a risk suggests that the deterrent effect
of IR35 is diminishing. Professional Passport echoed this sentiment,
considering that their estimates of 200,000 personal service companies
and only 250 IR35 investigations a year suggested that the majority
of contractors would still be prepared to take the risk and base
their decisions and behaviour on being outside IR35. The Giant
Group suggested that the assignment by assignment, contract by
contract nature of IR35 made it inefficient, and also effectively
impossible to police by HMRC. This might mean that some will take
the risk of not being caught. John Whiting told us that "People
hear in the pub or golf club, 'Oh, you don't need to worry about
it. You just do such and such'. I think HMRC is beholden to do
all that it can to alert and to raise IR35's profile".[111]
118. We were told about the growing prevalence
of 'IR35 proof' contracts and the numbers of private review services
which profess to give individuals assurances that their contractual
arrangements are not caught by IR35. Whilst a market has grown
up around the provision of these supplementary supports, we heard
that the quality and reliability of the advice provided by different
companies varies.[112]
119. Witnesses[113]
told us that HMRC's Contract Review Service, a telephone helpline
established to advise individuals of the likelihood of a particular
contract falling within IR35, was not widely known about and was
often approached with a certain degree of suspicion and trepidation;
there was a fear that a case brought to HMRC for advice might
be later reported to the IR35 case investigation team and the
individual might thus become the subject of a formal investigation.
Kate Cottrell told us that:
"On the contract review service there is
a huge lack of trust of HMRC … There have been some articles
in the contractor press recently saying, 'Whatever you do, do
not send your contract to the Revenue'. The problem is that because
the Revenue is still working with the original legislation, it
is asking to do things when reviewing a contract that there is
no time to do. They want you to have signed the contract first,
whereas most people, when they have a contract, want to know what
is in it, what is bad, what they want to change, and whether it
is properly reflective of the relationship. There is quite a lot
of work to be done on the contract review service to get people
to use it, if indeed they would".[114]
120. The ICAEW suggested that the Contract Review
Service should be publicised to greater effect,[115]
and that further guidance for non tax specialists should be introduced.
The IMA suggested that IR35 briefing information could be sent
out, alongside new company forms, by Companies House, and G4S
plc suggested that more could be done to raise awareness of IR35
amongst small businesses. The FCSA felt that HMRC should be more
'opinionated' in stating what constitutes good and bad practice,[116]
and that they should seek to exert more influence over end-users
and agencies.
121. It was encouraging to hear that HMRC were
aware of the suspicion that surrounds the Contract Review Service
and that they maintain the independence of the helpline from the
compliance teams, though little appears to have been done to assure
concerned parties:
"We are looking again at the contract review
service to better understand why it is not used more widely. Part
of that may be that people are not aware of the service, but part
of it may also be that people are worried about its confidentiality,
although I assure the Committee, as I assure everyone, that it
is confidential and that the team operating the helpline and the
contract review service are quite separate from our compliance
team, so information is not shared".[117]
122. We conclude that many individuals simply
take a risk that Her Majesty's Revenue and Customs will not look
into their employment status, an attitude that is fostered by
the decreasing number of compliance investigations.
123. We recommend that the Contract Review
Service be publicised to greater effect, that Her Majesty's Revenue
and Customs investigate ways to encourage individuals to use the
service and that they look into ways to bolster confidence in
its independence and impartiality. (Recommendation 8)
Recent reforms: The Business
Entity Tests and the IR35 Forum
124. There was a general consensus that there
is insufficient guidance provided by HMRC for those who operate
through personal service companies. The introduction of the Business
Entity Tests (BETs) and the establishment of the IR35 Forum have
generally been seen as positive steps in improving guidance and
channels of communication with interested stakeholders. We heard,
however, that there is still more to be done.
125. The BETs were published by HMRC in May 2012.
The 12 tests are contained within a document which also includes
case studies and an explanation of the risk based approach that
lies behind the tests. HMRC make quite clear in the publication
that the scoring from the completion of the tests provides an
indication of risk, not a concrete judgment on whether an engagement
lies within the IR35 legislation. The tests cover the following
areas: business premises; professional indemnity insurance; efficiency;
assistance; advertising; previous PAYE; business plan; repair
at own expense; client risk; billing; right of substitution; and
actual substitution. Each test asks at least one question and
a 'yes' answer scores points. Different tests give different scores
and the individual adds up the points at the end of the tests.
A score of less than 10 is categorised as high risk, more than
20 as low risk and the scores in between as medium risk. The 'yes'
scores range from 35 for the assistance test to one for the business
plan test. The questions asked in the tests require the individual
to look at various features of their engagements.
126. Some respondents were encouraged by recent
attempts on the part of HMRC to improve administration in this
general area. The FCSA felt that the changes introduced in 2012
were encouraging, with improved guidance, the focused IR35 helpline,
revised organisational approach and the introduction of the BETs.
John Whiting felt that the BETs had had a positive impact; whilst
not offering complete certainty, they allowed contractors to secure
a relatively quick in/out take on IR35:
"My sense is that they have had a positive
impact: they do not deliver absolute certainty to the taxpayer,
but that is probably impractical (as circumstances change). There
are also a lot of factors which no doubt appear complex and long
to the personal service companies user but we are in an involved
area. I feel that in the great majority of cases they will serve
to give a quick and reliable 'in'/'out' answer, if approached
with reasonable knowledge of what is going on".[118]
127. Since their publication however, the BETs
have been met with various forms of criticism. Although some have
expressed how useful they find them in clarifying which type of
contracts are caught by IR35 and which are not, others have expressed
their strong opinion that they simply add another layer of confusion.
The Recruitment and Employment Confederation (REC) told us that
that the tests are ordered so as to necessitate a greater deal
of work on the part of the individual. In their opinion a simple
reordering could mean that on the consideration of the first two
tests (the assistance test with a 'yes' score of 35 and the actual
substitution test with a 'yes' score of 20), the individual is
immediately highlighted as being of low risk.[119]
The BETs have been discussed in the IR35 Forum but there is disagreement
on whether or how they should undergo substantive reform.
128. Kate Cottrell noted that the BETs were only
a test for IR35 risk, rather than IR35 applicability; this understanding
was not always present amongst those using the tests: "The
problem with the business entity tests really is that they are
being used as a status test. All the business entity tests are
actually saying is, "What is your level of risk of investigation
for IR35?"[120]
This point was echoed by APSCo who cited their wider use within
the public sector:
"If APSCo could change one thing, it would
be the business entity tests … the weighting of those tests
means that they are ultimately now not being used as a risk identifier,
which is what they were originally there for—a filter of
risk. We are particularly concerned that within the public sector,
many departments are using the business entity tests as a way
of deciding whether somebody is in or outside of IR35, because
of the guidelines from the Treasury on payroll arrangements".[121]
There is certainly room for an increased emphasis
on the part of HMRC that the use of these tests is only to be
seen as a guide as to whether a case falls within the IR35 legislation
or not.
129. John Whiting pointed out that the document
detailing the tests is not easily accessible to those who may
be searching for it online: "It is instructive to search
HMRC's site. A search for 'IR35' and 'IR 35' (i.e. with a space
between IR and 35) returns different things; neither search immediately
turns up the 'Business Entity Tests' document".[122]
Digital by default as a wider Government policy was also the subject
of discussion, with evidence being provided that certain groups
of people may not be able to access the necessary information
online.[123] HMRC told
us that work was underway on this issue in the IR35 Forum;[124]
there is clearly more work to be done in making the tests more
accessible.
130. Both the FSB and the REC were of the opinion
that the BETs have added more confusion than clarification over
whether a contract falls within or without IR35. The PCG also
argued that the tests require revision, suggesting that they are
too sensitive to small changes in the circumstances of an individual
and that the scoring of the tests is unrealistic and unfair:
"I would like to see these tests refined,
assuming IR35 is not to be repealed or suspended. PCG, at the
time, proposed a different scoring methodology, which I think
would make things a lot clearer. We proposed a further six questions
on top of those that were adopted, which, again, I think would
be a useful addition. PCG feels very much that IR35 itself can
be refined to a certain extent".[125]
131. An alternative approach to case by case
examples as provided in the 47 page BETs document was explained
by Professor Judith Freedman, who shared the Australian approach
with the Committee. That system did not receive unqualified support
from Professor Freedman:
"There is an 80% test, so that, essentially,
if at least 20% of your work comes from other than one client,
you will have a safe harbour. You have some definite lines in
the sand. However, I do not think it is working brilliantly well
… As soon as you provide a very clear line in the sand, some
people—not everybody—will game that line. There is
a tension between having a very clear rule, which is helpful for
the majority of people, and stopping avoidance. I would not say
that the Australian system is simple. I went to check it before
I came here, and the basic booklet to explain it to people is
64 pages long".[126]
132. We were encouraged to hear that HMRC are
aware of the dissatisfaction with the BETs, a view that has been
made clear by the work of the IR35 forum,[127]
and that a review is being considered:
"Feedback has been mixed. Some people say
that they find the business entity tests, which were launched
at that time with case studies, useful, but we have also had a
lot of feedback through the IR35 Forum that people are not happy
with them and they are being used wrongly as an unemployment status
test or being manipulated to contrive a score … [The BETs]
were only ever intended to provide a guide to the likely risk
that they would be within IR35 or the risk of having an IR35 compliance
investigation, so they were developed with the IR35 Forum as an
attempt to give contractors greater certainty in IR35, because
we were conscious that one of the criticisms of IR35 was that
it caused uncertainty … When we introduced them, we made
it clear on our website that we were piloting these and that we
might come back to them and update them. Indeed, we are now looking
at them again as part of our review of all the processes that
were introduced as a result of the OTS review. That will include
us looking at the business entity tests to see if they are fit
for purpose or whether they could be improved to be more useful".[128]
133. We accept that the guidance will never
be able to give absolute certainty to taxpayers of their status
in relation to IR35 but we agree that the current guidance is
far from satisfactory.
134. We recommend that Her Majesty's Revenue
and Customs undertake a full consultation on how the Business
Entity Tests could work better to provide greater certainty for
taxpayers. (Recommendation 9)
135. Views on the IR35 Forum were mixed. John
Whiting praised the work of the IR35 Forum which was founded following
the 2012 OTS Small Business Tax Review. Talking of the collective
responsibility that lies at the heart of improving the BETs, he
told us:
"I think it is the responsibility of us
all … to get the Revenue, the Treasury, business representatives
and small business advisers working together—and I think
that that remains the way forward on these tests. If advisers
find problems with one or more of the tests, those ought to be
fed in and discussed in the forum, and the tests ought to be refined".[129]
136. HMRC told us that they saw the IR35 Forum
as invaluable in improving the service that they offer to the
taxpayer:
"One of the things that we are doing through
the IR35 forum—in truth, possibly for the first time—is
trying to see matters from the taxpayer's perspective, and we
are doing that through members of the Forum who represent the
accountancy profession, contractors themselves and the recruitment
sector. We are asking them how their members, or their accountancy
bodies, feel we are communicating people's tax obligations and
reporting requirements, and we are trying to amend our guidance,
and possibly in due course even the wording on our statutory returns,
accordingly to try to make things easier for people to understand".[130]
We were also interested to hear that HMRC are working
with the IR35 Forum to investigate why the completion rates on
the various tax returns are so low,[131]
a problem which is addressed by some of our earlier recommendations.[132]
137. The ACCA saw the Forum as a positive step
forward, but suggested that the work of the group was constrained
by its terms of reference. In their view, limiting discussion
to IR35 meant that wider, relevant issues about personal service
companies more generally could not be addressed. The ICAEW thought
that the Forum worked well in developing new guidance, but that
the work of the group was limited by the poor body of legislation
within which it was working.
138. Despite the positive attitude of HMRC, a
number of written submissions reported an element of resistance.[133]
The REC explained that, within the forum, they had consistently
requested that the BETs be updated and that the associated guidance
be improved, but had seen no change in HMRC's approach. The IIM
felt that the Forum should have a wider stakeholder membership
and that there should be a greater level of assurance that topics
discussed had been taken on board by HMRC. The PCG felt that the
Forum had failed to produce meaningful change and that, more generally,
deliberations were hampered by a lack of data availability from
HMRC. David Ramsden from the FSB echoed this sentiment:
"I too sit on the forum, and I have to say
that I get the distinct impression that the Forum is there, largely,
as a box-ticking exercise. It would not be if HMRC took any notice
of what the external members of the Forum had to say".[134]
139. We commend the motive behind establishing
the IR35 Forum as an opportunity for wider stakeholder engagement.
140. We recommend that Her Majesty's Revenue
and Customs go to greater lengths to demonstrate that they are
receptive to the feedback that is provided through this group
and that they review the breadth of membership. (Recommendation 10)
96 Q 3 Back
97
Q 1 Back
98
Q 2 Back
99
Q 8 Back
100
It should be acknowledged, however, that HMRC maintain that enforcement
and compliance staff are not deployed to individual tax regimes
and so there is no tangible way of accurately measuring proportionality
in this respect. Q119 and National Audit Office HM Revenue &
Customs 2012-13 Accounts, Report by the Comptroller and Auditor
General, R31. Back
101
PCG Back
102
Q 3 Back
103
Q 121 Back
104
Q 122 Back
105
Q 121 Back
106
Treasury Select Committee, Principles of Tax Policy (8th
Report, Session 2010-11, HC 753). Written evidence from the
ICAEW suggested that in their estimation, IR35 fails on seven
of the ten tenets highlighted in this report. Back
107
Q 15 Back
108
Q 6 Back
109
Q 7 Back
110
The same comment was also made by Giant Group, written evidence. Back
111
Q 14 Back
112
Professional Passport Back
113
Q 28 Back
114
Q 28 Back
115
ICAEW Back
116
Q 61 Back
117
Q 10 Back
118
John Whiting Back
119
REC Back
120
Q 28 Back
121
Q 61 Back
122
John Whiting Back
123
Q 26 and Q 40 Back
124
Q 9 Back
125
Q 55 Back
126
Q 28 Back
127
Q 9 Back
128
Q 9 Back
129
Q 17 Back
130
Q 11 Back
131
Q 118 and Q 124 Back
132
Recommendations 3-6. Back
133
AAT and CIPP Back
134
Q 61 Back
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