In this fifth and final article in our IR35 solutions series analysing IR35 and possible routes forward for the Office of Tax Simplification (OTS) as it reviews IR35 and UK taxation with a view to simplifying it, conclusions are drawn about IR35’s future and the limited options that could actually work in practice.
What has become clear is that further ‘sticking-plasters’ in the form of amendments and adjustments to IR35 specifically, and tax legislation generally, will not provide contractors and other taxpayers with the fairness and certainty they require. Nor will they provide the government and citizens with the tax revenues they should rightly expect.
That UK taxation requires simplification is not disputed by taxation experts; indeed it is the OTS’s reason for existing. And such simplification could lead to a fairer taxation system that is likely to make contractors’ “employment status” and, by default, IR35 irrelevant. But this won’t happen quickly and IR35 is likely to be with contractors for at least the medium term, while the bigger problems are addressed.
So, when predicting the post-IR35 landscape, an interim stage should be considered in which IR35 will still be in force, but perhaps implemented differently and more effectively. In the longer term, fundamental changes to taxation should follow that will address root causes of tax avoidance, by changing how income is classified and taxed for all workers, regardless of their employment status or trading vehicle.
IR35: summary and current status
In the ten years since IR35 was first implemented, much has changed, and the first four articles in this series summarised IR35’s objectives, changing context, reasons for failure and potential solutions:
- In Part 1, it was established that IR35’s objectives from the outset were clear – to target disguised employees and tax them accordingly – but in the process of drafting the legislation, consultation and implementation, the Treasury and HMRC lost their way, and contractors bore the brunt of this, with many being unfairly targeted
- Part 2 examined the evolving context of IR35 ten years on, with a new government and a bleak economic landscape in which increased tax revenues are imperative, but contractors could provide UK PLC with the highly skilled knowledge-based flexible workforce it needs to remain competitive and drive economic growth
- According to Part 3, IR35’s enforcement was doomed to fail, given that the legislation applied incompatible employment law solutions to a taxation problem and failed to recognise the irrelevance of traditional employment tests to modern work patterns; a requirement for self-certification by those affected and lack of resources for HMRC has resulted in IR35 being widely ignored
- Part 4 highlights the three options open to the OTS: firstly, to do nothing; secondly, to repeal IR35 and not replace it; or thirdly, to amend IR35 or replace it with something new. Options 1 and 2 are probably politically and fiscally unacceptable, but the range of solutions to option 3 could be unpalatable to contractors, clients and government, leaving no-one satisfied.
IR35’s undeniable truths
This analysis and all the evidence from the contracting sector leads to the inescapable conclusions that:
- IR35 in its current form is not working
- IR35 in amended form or by a replacement will never work
- The underlying issue is the UK system of taxation and enforcement, which must be fixed by taxing people the same, regardless of how they earn an income
- The UK tax system won’t be fixed quickly, so any IR35 solutions must be in two stages; making the best of what’s in place in the medium term, and then addressing the underlying issues in the longer term.
The medium-term ‘sticking plaster’ for IR35
Complexity, failure to self-certify and poor enforcement through lack of targeting and resources were identified by Part 3 as the root causes of IR35’s lack of effectiveness so medium-term solutions could include:
- Identifying the scale of the problem and the amount of tax actually being avoided from the outset, by gathering more information, possibly via existing channels such as tax returns and P35s
- Having established the scale of the problem and likely return on investment, to properly resource enforcement and develop specialists at HMRC, using data gained from tax returns and P35s for focused targeting of ‘perm-tractors’
- Place a time deadline on IR35 investigations, so contractors are not left with up to five years backdated taxes, interest and penalties; this alleviates much uncertainty and could also result in increased self-certification, rather than an ‘I might as well be hung for a sheep as for a lamb’ mentality of avoidance
- Extend self-certification and the use of IR35 experts, in parallel with what happens in accountancy and with the concept of auditing. Use preparation of company accounts and tax returns by accountants as an opportunity to confirm IR35 status.
20th Century taxation can no longer meet 21st Century needs
Flexible workers, such as contractors, have always formed part of the UK’s workforce and contributed to the strength of UK Plc. Research by organisations such as the Confederation of British Industry and market research by PCG suggests that the UK’s highly skilled and flexible knowledge workforce has never been greater. And labour market statistics by the Office of National Statistics demonstrate that self-employment is at an all time high.
For the next few years at least, IR35 is here to stay and likely to remain either in its current form, or potentially changed into something even more draconian with greater levels of enforcement.
However, tax legislation has not kept pace with evolving workforce trends and, as highlighted in Part 4, the traditional tests of employment are simply not relevant to modern flexible knowledge workers. Nor is the concept of a ‘disguised employee’ valid in the 21st century workplace, where in reality the boundaries between the employee and self-employed are often as basic as a job title or as absurd as whether or not the worker has access to the canteen.
As the OTS and other tax reform organisations work towards overhauling the UK’s complex and inefficient tax system, creating an environment in which everyone is taxed on their income regardless of how it is earned, IR35 will no longer be needed.
But for the next few years at least, IR35 is here to stay and likely to remain either in its current form, or potentially changed into something even more draconian with greater levels of enforcement. Genuine contractors in business on their own account and adopting IR35-status management best practice should have nothing to fear, and can look forward to a time when UK taxation encourages the flexible workforce to prosper.
This last in the series of five articles has been written based on three assumptions:
- That the general consensus amongst most stakeholders that IR35 needs to be replaced will actually lead to government action to legislate for change;
- That any solution put through the legislative process – and therefore amended due to lobbying by vested interests, the inevitable compromises and a potential lack of foresight – won’t be just as unworkable as IR35 has proven
- That the current Conservative-Liberal Democrat coalition of two parties that failed to win the last general election will survive for long enough to complete its tax simplification project.