IR35 enforcement, strengthened through better targeting and improved processes by HMRC, is never going to be top of most contractors’ wish lists. But when it’s offered among the potential IR35 alternatives in the Office of Tax Simplification’s interim report on Small Business Tax Simplification, it may be the only practical interim solution available. At least until structural reform merging income tax and National Insurance Contributions (NICs) renders IR35 irrelevant.
Don’t get me wrong, I’d love IR35 to be suspended or abolished by the Chancellor in June when the OTS publishes its final Small Business Tax Simplification report. But realistically, ‘option 1’ of the OTS’s three options for IR35 reform is highly unlikely to ever make it from the interim report stage to the statute book.
OTS, alongside expert commentators, has already highlighted the risks attached to the suspension/abolition route. It has also shown that significantly better data, and an improved understanding of the risks, is required before this route can be considered. Not least is the potential risk for wholesale incorporation of high-paid employees, agency payroll and umbrella company contractors. Not only could that result in less tax collected, but the tax that was collected would come a year or more later than that currently collected at source via employee, agency payroll and umbrella company Pay As You Earn (PAYE) schemes.
Similarly, even with the caveats about wide consultation and improved criteria, ‘option 3’, an objective ‘in-business’ test as an IR35 alternative is doomed to failure from the outset. Inventing such a business test is like trying to define night or day by looking at the colour of the sky. Day merges into night, in the same way employment status for an individual is a not a black/white issue. Searching for a business test is also like searching for the Holy Grail. It doesn’t exist, or, if it does, no one has ever found it after spending many years looking.
Inventing such a business test is like trying to define night or day by looking at the colour of the sky.
In addition, the whole history of legislation and taxation suggests that clever advisers will in no time create ways to circumvent any tests. And the worst possible scenario is that the in-business test would be adopted by lawyers seeking to prove a worker does/does not qualify for employment status, and, ironically, become absorbed into the case law used to determine IR35 status.
That leaves us with ‘option 2’: ‘better’ IR35 enforcement by a woefully under-resourced HMRC. Currently, IR35 is a bit like risking driving at speeds above the limit. If there was only one police car in every county, and no speed cameras, would you be tempted to risk breaking the speed limit? Of course you would!
HMRC must have initially hoped, or assumed, that people wouldn’t break the ‘IR35 speed limit’ and that the mere fact of there being legislation would ensure compliance was unnecessary. But when a large proportion of contractors didn’t comply and it came to IR35 enforcement, HMRC discovered that chasing people down was more expensive than the fines they could impose. A significant number of contractors got wind of the lack of people being caught, and decided to put their foot to the metal.
But IR35 compliance for contractors is virtually impossible. To continue with the speeding analogy, contractors are currently trying to keep to a speed limit that is not signposted and which changes regularly at the whim of local enforcers, and where the impact of case law means the rules of the road are constantly changing.
If contractors and their advisors better understood the process and exactly how HMRC applies the rules, it is likely that there would be much more self-certification and the majority of contractors would stay well within the rules. That is certainly not the case at present.
It is conceivably possible to run all three OTS options concurrently, which may well be the OTS’s intention. Whilst the data is being gathered to determine the risks of suspension and abolition, HMRC’s processes could be improved and made more transparent, resulting in improved enforcement.
However, the key determinant of the eventual solution from among the IR35 alternatives proposed is likely to be practicality. Better enforcement is highly practical. And, after all, this whole process the government has put in train is all about simplification.
It should also be borne in mind, of course, that whichever of the IR35 alternatives Chancellor George Osborne eventually chooses may well be only an interim solution until more wide-ranging structural reforms to the tax system are enacted.