Personal Service Companies - Select Committee on Personal Service Companies Contents


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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