There are seven deadly truths that justify killing off IR35. But there is no-one in HMRC, the Treasury or Government with the courage to recognise that the tax simply does not work and that it actually damages businesses, the flexible workforce and the UK’s international competitiveness, and take action. So, IR35 won’t be abolished any time soon and the legislation will continue to act as a brake on the entrepreneurial activities of contractors and their clients.
Here are the seven deadly truths that should really kill off IR35:
1. The original problem no longer exists
IR35 was originally introduced to tackle the problem of disguised employment during the late 1990s. This was when employees left their desks on a Friday only to return to the same desk and role as a limited company contractor on the Monday. Employers used this strategy to retain skills during a time of acute skills shortages, particularly in IT. This ‘Friday to Monday’ phenomenon no longer happens.
2. IR35 is unenforceable
IR35 is highly complex and based on employment legislation and case law. It can only be applied by experts, and there are only about 40 of these experts in the whole of HMRC’s 55,000 strong workforce. But there are hundreds of thousands of highly savvy contractors who know exactly how to reduce the risk that IR35 applies to them and who hire IR35 experts to kill off any investigation before it gets off the ground.
3. Market forces and the dividend tax changes make IR35 irrelevant
IR35 is designed to tackle ‘tax motivated incorporation’ and identify workers who trade via a limited company but who are really employees and should pay the same amount of tax as employees do. However, contractors performing in the same role as an employee are never paid the same – market forces mean they are always paid much more and so actually pay more tax than employees, although HMRC does not recognise this. Furthermore, the dividend tax changes virtually eliminate the income tax differential between contractors and employees. As a result of these two factors, IR35 is now actually irrelevant as a mechanism for equalising tax take between contractors and employees.
4. IR35 ‘deterrent effect’ tax yield based on false assumptions
HMRC claims that the deterrent effect of IR35 generates £520m in tax. But highly paid employees don’t incorporate because their employers won’t let them, and not because they are afraid of IR35. There is no market pressure driving skills shortages that encourage employers to hoard skills via the ‘Friday to Monday’ phenomenon (see truth 1 above). And even if highly paid employees know about IR35 – which few do – it is widely ignored as being ineffective and unenforceable.
5. IR35 forecasts just don’t add up
HMRC believes that if properly implemented, the legislation should raise an additional £430m in tax. But to generate £430m in tax would require finding 145,000 fulltime contractors earning £150 a day inside IR35 every year, or catching 65,000 contractors working fulltime on £500 a day. So, why hasn’t HMRC’s taskforces caught thousands of contractors, considering that the taxman believes it is such a target rich environment? Is it because that many disguised employees simply don’t exist? Furthermore, with a team of 40 and an annual case capacity of around 250, HMRC simply lacks the resources to catch this many workers, even if they are disguised employees. And self-assessment is virtually impossible because IR35 is too complex for mainstream HMRC inspectors, let alone ordinary taxpayers.
6. Engagers/employers make no contribution
The elephant in the room is employers’ National Insurance Contributions (NICs). If found within IR35 it is the intermediary, which is a contractor’s limited company, that pays the equivalent of employee income tax and NICs as well as employers’ NICs. The client pays nothing if a contractor is caught inside IR35. This unfairness is a contributing factor to why IR35 is widely ignored. For IR35 to have any chance of working, the engager must take some responsibility for compliance, a measure that existed in the original IR35 legislation but that was taken out following major lobbying by big business. But that would place a huge burden on small businesses – every company hiring a freelancer would have to determine their employment status. Would £430m justify placing such a huge burden on business?
7. The UK tax system is outdated
The UK’s tax framework is no longer fit for purpose as it does not align with modern ways of working. The UK has transitioned from the industrial age model of single long-term employment to the knowledge age model of portfolio working, multiple employments and contracting/freelancing. This means there has been a steady decline in employers’ NICs because flexible workers do not pay this. And why should employers hire only employees, when they can access knowledge workers on an as-needed basis? The flexible workforce is growing due to market drivers, not tax, but taxation has fallen behind new ways of working.
No matter how often HMRC decides to review IR35 to devise more effective strategies for implementation, these seven deadly truths confirm that the tax cannot work. It is a poorly thought through piece of legislation that was not fit for purpose when first announced, and it is designed to address a problem that no longer exists.