Summary of Conclusions and recommendations
1.Our witnesses described how workers become self-employed for many different reasons. We agree with HMRC that the growth in the numbers of self-employed people and of PSCs is evidence of a significant shift in how the UK labour market operates. (Paragraph 14)
2.The growth of the gig economy in recent years has increased self-employment, particularly for lower-paid workers. It is regrettable that in some cases this has come at the expense of employment protections for workers. (Paragraph 15)
3.The tax system needs to adapt to these significant labour market changes. However the challenges posed by these changes go well beyond the tax system. Trying to address them from a tax perspective alone is unlikely to deliver the optimal solution (Paragraph 16)
4.Off-payroll rules build on a flawed system—IR35. They separate employment status for tax purposes from employment status under employment law. This distinction is unacceptable, not least because it fails to acknowledge that contractors bear all the risk for providing the workforce flexibility from which both parties benefit. (Paragraph 31)
5.We support IR35’s original policy aims of trying to ensure greater fairness in the tax system, and of preventing some contractors and client businesses gaining an unfair tax advantage. However, we are concerned that the rules have proved to be ineffective over a prolonged period and that, notwithstanding its reviews of IR35, the Government has not done more to tackle such problems, or to find a better alternative to these rules. Furthermore, with the emergence of the gig economy in the intervening years, the nature of employment has changed. This puts the issue of “fairness” in a new context. (Paragraph 44)
6.There was significant support from our witnesses for the recommendations in the Taylor Review—and significant disappointment that work on them seems to have stalled. (Paragraph 45)
7.It is concerning that the Government has pressed ahead with the off-payroll working rules at a time when the Taylor Review, which it commissioned, recommended a more holistic solution than these rules can offer. This is a solution with which the Government has said that it agrees, and on which it had launched a consultation. The lack of strategic co-ordination on this issue across Government and between Departments is highly regrettable. (Paragraph 46)
8.We recommend that the Government carry forward its work on the Taylor Review, to develop the review’s ideas into legislation which is responsive to the changing labour market and works across both tax and employment law.(Paragraph 47)
9.In some parts of the public sector (including the NHS) the off-payroll working rules were not applied properly. As a result of blanket assessments, contractors are likely to have been miscategorised and taxed incorrectly. Some contractors ceased working in the public sector altogether, causing recruitment and retention problems. (Paragraph 62)
10.It is regrettable that no proper evaluation has been carried out into the effect of the off-payroll working rules in the public sector. Such an evaluation should have preceded and informed any decision to extend the rules to the private sector. (Paragraph 63)
11.We are not convinced that the Government has learnt lessons from the application of IR35 in the public sector. If the Government continues with its plan to introduce the off-payroll reforms in April 2021, we recommend that the Government undertake an independent review of the implementation of the off-payroll rules in the public sector and an analysis of the impact of those rules on the labour market. (Paragraph 64)
12.Given that the off-payroll rules do not change the substance of the IR35 status determination requirement, we conclude that HMRC is imposing a heavy burden on businesses by requiring them to determine status using a complex, fact-specific test. We agree with our witnesses that the support offered by HMRC in determining status—and the CEST tool in particular—falls well short of what is required. (Paragraph 81)
13.The new rules make no changes to the IR35 test of employment status. In the light of the widely reported complexity of the case law test, this will leave businesses with significant challenges in determining the status of contractors. (Paragraph 86)
14.Large- and medium-sized businesses are being made responsible for enforcing a regime which HMRC has struggled with over the last 20 years. Effectively, therefore, the Government is privatising tax compliance. (Paragraph 87)
15.We question whether the CEST tool as currently constituted is fit for purpose. It offers limited assistance to businesses, which need to spend considerable time and money clarifying the status of their contractors as a result. We believe that the costs to businesses of implementing the changes have been severely underestimated and that HMRC has not fully understood the impact of these measures. We therefore welcome HMRC’s commitment to review the methodology that it uses to model these costs. (Paragraph 88)
16.Since both clients and contractors have driven the increase in the use of personal service companies and benefited from the resulting tax treatment, it seems unfair that the contractor will effectively bear the brunt of the client’s National Insurance Contributions in addition to their own, greater, employment taxes. (Paragraph 99)
17.We received clear evidence that the blanket status assessments made in the public sector following the IR35 reforms there were being replicated in the private sector in advance of the private sector rules being implemented. (Paragraph 100)
18.We also heard that some organisations, many of them large businesses, are already refusing to engage any freelance contractors—and are thereby side-stepping the new rules. (Paragraph 101)
19.We call on HMRC to engage more with business and tax professional bodies about the risks associated with engaging umbrella companies. (Paragraph 102)
20.While it is not possible to quantify the potential behavioural effects of the new rules, our evidence was remarkably consistent in suggesting that any such behavioural consequences risk an adverse impact on the economy. We agree with this analysis, and urge the Government to carry out a full assessment of how its proposals will affect the decisions that businesses and contractors make. (Paragraph 103)
21.In the short term at least, it is likely that the off-payroll changes will cause disruption to the UK’s labour market. We are therefore concerned that the outcomes of extending off-payroll working to the private sector seem to have been assessed primarily in terms of increasing compliance. The Government needs to consider the damage that may be done to the diversity and flexibility of the labour market. Any future review of the impact of the measures must take into account the wider impact of the changes on the UK’s labour market and the broader economy. (Paragraph 115)
22.We agree with our witnesses that revenue-raising is the major driver of the proposed changes. According to HMRC’s own forecasts, improved compliance could bring as much as £4.1 billion by 2024/25 to the Exchequer. The value of this potential tax take requires any measures to improve compliance to work effectively for contractors, clients and HMRC. (Paragraph 125)
23.HMRC has acknowledged the challenges that IR35 has faced in improving compliance. However, under the new rules IR35 itself will not change. Instead businesses will now have to shoulder the compliance challenge. We share the concerns of our witnesses that the rules put too great a burden on businesses. (Paragraph 128)
24.We expect compliance with the off-payroll working rules to improve when responsibility passes to large- and medium-sized businesses, and that the tax take will increase as a result. However, we are apprehensive that some contractors will wrongly be categorised as within the rules. (Paragraph 129)
25.It is unfair that contractors within the rules are treated as employees for tax purposes but do not qualify for employment rights, thus creating a class of “zero-rights employees”. The Government is replacing one unfairness with another. (Paragraph 130)
26.Flexible working by contractors is a legitimate and important part of the UK labour market. However, contractors are in a different category to employees, and should therefore be treated differently. Unless the Government accepts this distinction, the off-payroll rules could eliminate by stealth contractor flexible working, or force contractors to use umbrella companies without adequate legislative protection. Both outcomes would be unacceptable. (Paragraph 131)
27.The Government’s review of the private sector reforms came barely weeks before the rules’ planned implementation, and had a very short timetable and narrow remit. There was limited scope for proper consideration of stakeholders’ concerns about the new rules—and less scope for proposing material changes. (Paragraph 137)
28.HMRC’s publication of updated guidance on the new rules is welcome, but it is regrettable that guidance on key aspects of the rules was published only six weeks before their expected commencement. (Paragraph 138)
29.While we welcome the Government’s commitment to commissioning external research into the impact of the reforms, the proposal that this research be carried out six months after the rules’ implementation does not give enough time to measure the true impact of the reforms. HMRC should defer any such research until 18 months after the rules have been in operation. (Paragraph 139)
30.Towards the end of our inquiry the scale of the adverse economic effects of the COVID-19 pandemic became clearer, as well as the restrictions imposed by the Government in response and what they might mean for business. This is the greatest shock that the UK’s economy has experienced since the Second World War. (Paragraph 142)
31.We welcome the Government’s decision to postpone the start date for extending the off-payroll rules to the private sector to April 2021. A deferral is necessary, but business is likely to need considerably longer than a year to recover from the disruption caused by the COVID-19 pandemic. It is right not to impose unnecessary burdens on business at such a difficult time. (Paragraph 143)
32.A delay gives time for further consideration. The Government should commission an independent review of the introduction of the off-payroll rules in the public sector and undertake an analysis of how introducing off-payroll rules to the private sector will affect the labour market. In addition, the delay provides time to tackle the ongoing deficiencies of CEST and the status determination process, and to revisit the Government’s assessment of the costs to business of the proposals, which our evidence shows were significantly underestimated. (Paragraph 144)
33.The extra time should also be used to consider alternatives to the off-payroll rules that are fairer and less risky, and which do not treat individuals as employees for tax purposes when they do not enjoy the rights of employees. Once completed, the Government should present Parliament with a clear strategy to address the issue of fairness in the tax system and foster a flexible workforce in which contractors play a vital role. (Paragraph 145)
34.To give certainty to business, the Government should announce by October 2020 whether it will indeed implement the off-payroll rules in April 2021, or whether any on-going impact to the economy resulting from the COVID-19 pandemic will require their implementation to be delayed further. (Paragraph 146)
35.-We do not believe that its resistance to alternative approaches has served the Government well. The more intractable and difficult the problem, the more the Government needs to be flexible and open to a range of ways of tackling it. Yet the Government continues to focus on the off-payroll proposals—which are substantially the same as the existing IR35 rules, with all their inherent problems—as the only solution. (Paragraph 151)
36.We heard a number of proposals for alternatives to the off-payroll working rules. While these proposals would need to be developed in more detail, fully costed and rigorously tested, they could represent a less complex approach than the off-payroll rules, while giving contractors and clients certainty about their position. (Paragraph 172)
37.Several of the proposals would meet the Government’s stated objectives for the off-payroll reforms: delivering fairness between employees and contractors working in similar situations, and bringing in tax revenue that is currently unpaid. However none is as comprehensive as the Taylor Review proposals, which we believe offer the best long-term solution, and which provide the opportunity to consider tax, rights and risk together. (Paragraph 173)
38.We have argued that the main purpose of the off-payroll reforms is to raise revenue. In April 2021 the private sector is likely still to be recovering from the COVID-19 pandemic; the Government will therefore need to consider carefully the merits of various approaches to revenue-raising. Pending the outcome of further work on the Taylor Review, and the development and implementation of a comprehensive solution, we propose that the Government implement one of the simpler, less burdensome alternatives to the off-payroll rules that stakeholders have advanced. (Paragraph 174)
39.We recommend that the Government design a short-term means of raising revenue that will not prove burdensome for businesses as they emerge from the COVID-19 pandemic, and a long-term alternative solution to the off-payroll working rules. In so doing, they should apply the following six principles. (Paragraph 176)
40.Any alternative to the off-payroll working rules should be:
- Certain—the complexity of the off-payroll rules and the limitations of the CEST tool mean that it is difficult for clients and contractors to be certain about their position. All parties should have certainty about the tax treatment that will apply.
- Simple—the off-payroll rules are too complicated. Any solution should be as simple as possible.
- Fair—the proposed off-payroll rules are unfair because they treat contractors as employees for tax purposes only, essentially creating “zero-rights” employment. Treatment as an employee for tax purposes should only apply where there are employment rights and risk-sharing between employer and contractor.
- Supportive of growth—any solution should respect and preserve the flexibility that exists within the UK labour market.
- Administratively straightforward—the burden that the off-payroll rules imposes on clients is unreasonable. Any alternative needs to be straightforward to operate, and not excessively burdensome to administer.
- Enforceable—with limited resources IR35 became impractical for HMRC to monitor and enforce. Any new proposal should be manageable for HMRC. (Paragraph 177)