As part of its brief to review IR35, the Office of Tax Simplification (OTS) has been instructed to ensure any measures it recommends are revenue neutral. In other words, whatever amendments to IR35 the OTS comes up with, they must generate at least as much tax as IR35 does currently.
Now, exactly how much tax IR35 generates is a matter of debate, with some claiming it costs more to enforce than it generates. Others point to the PAYE and National Insurance Contributions (NICs) that are so efficiently gathered by umbrella companies, and claim the estimated half a billion tax revenues umbrellas pay into the Exchequer every year means IR35 is doing its job very well, thank you.
Whichever side of the argument you choose, no one is disputing that IR35 is difficult to administer, is highly ambiguous and leaves taxpayers, mainly contractors, in an uncertain and unenviable position regarding their tax liabilities. Under the current system, you can be definitely not caught by IR35, work your way through a massive grey area, and then be definitely caught... all on the same contract!
So, the OTS’s challenge is to come up with a revenue-neutral solution to removing the grey area with a simple set of new employment status tests.
Reviewing what other common law nations with significant contractor populations do, such as the USA, Canada and Australia, does not bode well. No other government or tax authority has managed to come up with a simple set of tests to accurately define employment status. The complexity is largely down to the use of employment law and case law, which allow for huge grey areas.
Perhaps the solution is to create simple employment status tests to identify those strongly outside IR35 who are genuinely self-employed, and those strongly inside IR35 who are really disguised employees, with a general rule that says if in doubt, you are considered to be employed. So anyone who is in the grey area is automatically deemed to be an employee and must pay tax accordingly.
Alternatively, you could say that if according to these simple tests you are not definitely an employee, then you are automatically assumed to be genuinely self-employed and are taxed accordingly.
Either of these alternatives would eliminate most of the shades of grey and leave contractors with an assured employment status on which to plan their tax affairs. But they could cause other problems.
So let’s follow the money. The first option, assuming everyone in the grey area is an employee, will certainly generate more cash to begin with, but over time will reduce the flexibility of the workforce and result in lower tax receipts. The second option is likely to mean a lower tax yield, so is unlikely to even be seriously considered, let alone adopted.
Because the tax books must be balanced, a set of simple employment status tests is likely to end up making entry to the ‘not employed’ club harder than it is now under the existing IR35 legislation.
That means amendments to IR35 could actually increase the number of contractors deemed to be disguised employees, making things worse than they already are under IR35. The irony is that, by removing the shades of grey that are currently such a nightmare of IR35, there would be no room for manoeuvre for genuine contractors wanting to make a case in their defence.