Further meddling with IR35 won’t have a positive outcome. The Treasury and HMRC’s IR35 thinking is flawed and their assumptions are wrong. Any changes to IR35 will decrease – not grow – the tax yield.
It will reduce the size and scope of the UK’s flexible workforce of highly skilled knowledge workers, reducing global competitiveness and the attractiveness of the UK for inward investment.
In our three-part response to HMRC’s IR35 discussion document, we highlight how IR35 is no longer relevant or fit for purpose. It was created for a problem that no longer exists. Furthermore, HMRC’s policy objectives for the tax are flawed. It is targeting a population of disguised employees that just does not exist anymore.
What’s needed it a solution that is fair and workable, and tackles the elephant in the room, which is employer’s National Insurance Contributions (NICs). Right now, IR35 is none of these things.
Wrong thinking: HMRC does not understand its ‘market’
From the outset, in its Intermediaries Legislation (IR35) discussion document, the taxman’s assumptions about contractors and contracting show a woeful lack of knowledge about how the market actually works.
For example, HMRC provides examples of two lawyers, one employed and one a contractor, in order that it can compare how much tax each one pays. In the example, the employee’s annual salary and the contractor’s gross fees are the same.
Assuming equal pay is a schoolboy error that should shame a first-year on HMRC’s graduate programme, let alone the policy team that created the discussion document. Contractors are paid much more than employees in a similar role – that’s just basic market forces. HMRC just doesn’t understand its market.
Flawed assumptions: contractors will actually pay IR35 taxes – they won’t
HMRC has made great fuss of the £430m in extra tax yield it believes will be generated if IR35 were to be properly implemented. The taxman also reckons that £520m of tax is currently ‘protected’ because IR35 scares lots of workers away from incorporating.
The taxman assumes that contractors caught by IR35 would simply roll over and pay lots more tax, including subsidising clients by also paying for employer’s NICs. They won’t. Contractors will just go onto the payroll on a fixed-term contract, or return to employment. Either way, they will end up on Pay As You Earn (PAYE).
HMRC would then have successfully taken highly paid contractors who pay more tax than equivalent employees out of being in business and into employment. Meaning they pay less tax into the Exchequer.
We also know that IR35 has nothing to do with highly paid employees not incorporating. Most are completely unaware of the legislation. It is their employers that prevent highly paid employees from incorporating, not IR35.
The skills shortages of the late 1990’s that caused a huge spike in the ‘Friday to Monday’ phenomenon no longer exists, so employers don’t have to skills hoard by allowing their top people to incorporate. The £520m of tax revenue ‘protected’ by the deterrent effect of IR35 has no basis in reality.
Sums don’t add up: 65,000 disguised employees don’t exist
To generate £430m of additional IR35 tax revenue would require HMRC to catch around 65,000 high-end contractors on £500 a day inside IR35. Alternatively, they would need to catch 145,000 lower-end contractors on £120 a day inside IR35.
Aside from the fact that HMRC only has 40 IR35 experts and an annual case capacity of 250 inquiries, 65,000-145,000 disguised employees just don’t exist. Surely if the market was that target rich even HMRC would have caught more disguised employees by now?
The fact is that, whilst it is believed that disguised employment is a problem at the lower paid lower skill end of the contracting sector, you can’t control experts. And contractors are typically experts at what they do.
Why would clients hire a contractor and then tell them what to do? Genuine contractors will almost always fail the control test, which is one of the three key pillars of being an employee (substitution and mutuality of obligation being the other two).
What is the purpose or IR35?
IR35 was created to tackle what used to be the very real challenge of false self-employment, or disguised employment. It was created to prevent workers who really should have been employed from trading via a limited company and making tax savings when compared to being employed.
But disguised employees just don’t exist in the numbers HMRC believes, and with the Dividend Tax changes being introduced in April 2016, much of the tax advantage of working via a limited company will be removed.
IR35 is not stopping highly paid workers who genuinely want to set up in business from doing so, and employers quite reasonably want to employ, and keep employing, their top talent, so won’t let them continue in the same role but as a ‘consultant’.
So, what is the purpose of IR35? It seems that the only outcome of improved implementation of IR35 will be to reduce the size and scope of the UK’s flexible knowledge-based labour force. It will also reduce and not increase tax yields.
This will put a brake on the flexible workforce’s growth and erode the UK’s competitiveness in global markets and attractiveness as an inward investment destination.