If the enforcement of the IR35 tax legislation were outsourced to the private sector in its current form and with its existing enforcement strategy, then without a hefty public subsidy it would be thrown out by the financial director (FD) of any business as presenting a dreadful, or even negative, return on investment.
Why? Well, let’s first look at the numbers. Contractors earning under £12 an hour are unlikely to be using a limited company because there are virtually no tax advantages. They’ll be using umbrella companies or working as a sole trader, and therefore not an IR35 target.
As we move up the earnings food chain, a limited company contractor outside IR35 and earning £20 an hour will save around £5,000 in tax. That means if the contractor is investigated and deemed to be inside IR35, then the return will be around £5,000, plus interest and penalties, plus up to five times as much again if HMRC think the contractor’s been at it for the last five years of trading.
Moving up the food chain, the approximate tax savings of trading through a limited company and paying a low salary and high dividends, gives:
- At £30 an hour – £8,000 a year
- At £40 an hour – £10,000 a year
- At £50 an hour – £11,500 a year
- At £75 an hour – £15,000 a year.
You can almost see the pound signs in a hungry tax-inspector’s eyes, or the eyes of our notional FD. A high-end contractor found to be in IR35 over five years could net £75,000 plus interest and penalties. Not a bad return for a little investigation.
But then let’s look at the realities of the marketplace. The higher up the fee-food-chain you go, the more expert the contractor and the harder it will be to prove basic tests of employment, such as control. Is a client really going to pay a highly qualified specialist £500 a day just to tell them how to do their job? Not likely.
You can then add the fact that such high-end contractors are, by and large, very savvy when it comes to IR35. They’ll know all the best practice, can afford IR35 contract reviews and will almost certainly have investigation insurance and, even if they don’t, can afford to employ experts to defend them.
Suddenly, contractors on £75 an hour look a lot less attractive as IR35 targets. And, when you work out the likely success rate across a population of tens of thousands of such contractors, the return on investment (ROI) is likely to be very low indeed. Add to that ‘market evidence’ from PCG, which claims that of the approximately fifteen hundred PCG members who have contested IR35 rulings, all but a dozen have won their cases. A good investment? No, the FD is certainly going to shoot this one down.
But let’s get the marketing director working with the FD, and chances are the two of them would try to segment the market in a slightly different way, to see if it could become a more profitable prospect.
Contractors in the Friday-to-Monday category are highly likely to be disguised employees, and if HMRC catch them quickly, that’s like getting your money up-front, because they either go back to what they should be doing – being employed – or pay tax like an employee under the deemed payment rules.
Then there are permtractors, those contractors who have been with their client for so long they are ‘part and parcel’ and likely to be easy to target, just by looking at their client invoices for the last few years. Targeting them would offer great ROI, particularly as many are likely to have been inside IR35 for up to five years. The FD will like this idea, and might even grudgingly accept that there’s a point to having a marketing team!
But the current IR35 strategy, if HMRC can be said to have a strategy at all, is much less targeted and a whole lot less effective than it could be. The recent MBF Design Services ruling is a case in point, when clearly the contractor should not have been targeted for an IR35 ruling in the first place, yet it took years and goodness knows how much wasted public money to get to the point that should have been obvious from the start.
The current situation is bad for the Exchequer, bad for HMRC, bad for taxpayers and particularly bad for genuine contractors.
Right now, IR35 enforcement presents a poor case for return on investment.