Contractors have won the first battle over IR35. Sadly, it has taken over ten years and caused considerable ‘collateral damage’ along the way, mainly to genuine contractors. But this is only the first battle in what promises to be a long drawn out war. And already HMRC is regrouping, under the guise of the IR35 Forum, to develop new strategies to target greater numbers of contractors more effectively.
In a little over ten years since IR35 first launched, the group of taxpayers known as the contracting sector has successfully taken on HMRC and won. An early result of this victory has been the number of ongoing IR35 investigations slowing to a trickle, an indication of HMRC’s retrenchment. But that retrenchment is likely to be temporary.
Contractors secured this victory through a combination of timing, technology and determination. And they had to fight much harder than should have been necessary, due to some pretty mighty misconceptions held by HMRC and its masters at the Treasury.
Had there been no internet, had market conditions been different, and had HMRC not started from where it did, the story might have been very different.
Let’s deal with the misconceptions first. From the outset, IR35 was vague about precisely who it was meant to catch. This led to HMRC targeting any one-person limited company freelancing for a single client. In other words: pretty much every IT contractor out there. But the minutes of the first meeting of the IR35 Forum suggest HMRC has learned its lesson well.
The taxman’s initial error of not segmenting and targeting a specific class of taxpayer was compounded by the requirement to use the existing tests of employment to determine employment status, and therefore determine IR35 status.
Things became even worse when HMRC made the huge mistake of assuming that all contractors would simply roll over and comply, no matter how unfair, unreasonable or downright incorrect the tax demands on them.
When we add the internet and the market conditions of the early ‘noughties’ to the mix, it becomes clear that HMRC was onto a loser. The internet enabled contractors to rally, communicate and quickly create what was to become a powerful lobbying organisation and special interest group, the then Professional Contractors Group (now known simply as PCG).
The early ‘noughties’ was also a boom time for IT contractors. It was right in the middle of the dotcom boom, when in fact market conditions were such that IT contractors were a scarce and much sought-after resource. What this meant was that many agencies and, to a lesser extent, clients bent over backwards to offer IR35-friendly contracts.
Because work was plentiful and rates buoyant, large numbers of contractors opted to declare themselves inside of IR35 (even when they weren’t), pay their deemed payment or chose to trade through umbrella companies. But many more totally ignored or circumvented IR35, some through ignorance, others because they were incensed at the unfairness of IR35, and yet more because they saw so many genuine ‘disguised employees’ getting away with it.
Over time, as the contracting sector has become progressively more IR35-savvy and a service industry has sprung up and matured, IR35 has become increasingly marginalised.
It’s fair to say that the taxman picked a fight with a class of taxpayer that would not let itself be bullied, and also had the expertise and resources to fight back and win. IR35 is still on the statute book and we know there it will remain for the foreseeable future. But the number of IR35 investigations has, for the moment at least, slowed to a trickle and the few recent cases have resulted in victories for the taxpayer.
Had the Treasury and HMRC taken some more informed choices and made fewer assumptions, had IR35 been introduced pre-internet and during an IT sector recession, then the story might have been very different.
The contracting sector must be on its guard to ensure that the next chapter in this story does not go badly for contractors. Despite growing demand for contractors in many disciplines, the contracting market and the economy is still performing far short of the boom times of the early ‘noughties’. And you can bet that HMRC won’t make the same mistakes about how it targets contractors a second time.
Contractors have won only the first battle, but not the war. HMRC is currently in ‘strategy mode’, biding its time before it emerges with a new arsenal of segmentation and risk methodologies to blast contractors with. This time it might just get it right and successfully target those genuine contractors it set out to catch in the first place ten years ago.