HMRC, through the implementation of IR35 and their invention of the "deemed employee", is to blame for the proliferation of tax avoidance in the UK that it has ironically dedicated so many resources to tackle. If the taxman doesn’t take a look in the mirror and acknowledge this, instead of pressing ahead with plans to extend their new off-payroll tax rules into the private sector, the problem is only going to worsen.
HMRC announced recently that more than 20,000 contractors have admitted to using tax avoidance schemes over the last 20 years, as the deadline for the April 2019 loan charge draws nearer.
It estimates that these contractors collectively owe roughly £1bn, and maintains that the hefty sums owed after these schemes were tackled retrospectively are just a means of ensuring that contractors pay the tax that is due.
And, while it’s fair to say that many contractors should have known better than to engage in dubious tax schemes, most would never have done so if HMRC hadn’t imposed the punitive and unfair IR35 tax.
Tax avoidance: why IR35 is a counter-intuitive regime
As The Times’ article acknowledges, the avoidance schemes in question began to emerge in 1999, following the introduction of IR35. At the time, contractors had a favourable tax regime, largely because National Insurance (NI) wasn’t due on dividends.
However, the bulk of HMRC’s perceived tax shortfall comes from non-payment by their "deemed employer" of their employer’s NI 13.8% tax bill, which IR35 inexplicably requires contractors to pay out of their own earnings. This demand is akin to an employee having their salary cut by roughly 13% to pay their employer’s tax bill, and having their employment rights taken away at the same time.
While it’s difficult to condone the use of tax avoidance schemes, they were technically legal at the time and still are, and it’s not hard to see why many saw them as a suitable means of escaping a draconian tax regime.
Now that the tax paid by limited company contractors is roughly the same as employees when outside of IR35, and substantially more when inside, some may feel even more vindicated using these schemes.
Off-Payroll rules intensifies tax avoidance issue
HMRC has, to a degree, finally acknowledged that a tax regime which has been in force for almost two decades is entirely unfair. The new Off-Payroll tax, which is chapter 10 of ITEPA is different to the original IR35 legislation, which is chapter 8 of ITEPA. The new tax requires that employer’s NI is borne by the hirer, or ‘fee payer’ – yet, absurdly, the taxman’s rhetoric surrounding the new tax still centres on tax avoidance among contractors.
Nonetheless, you might have thought that the new Off-Payroll tax would create some parity and ease the adoption of tax avoidance schemes. Sadly, you would have been mistaken. Non-compliance with the rules among hirers, and non-existent enforcement of the rules by HMRC, means we are back where we started.
Post-April 2017, public sector hirers and agencies are advertising ‘inside IR35’ contracts with rates which are inclusive of their own employer’s NI, which the contractors are being forced or coerced to pay. Consequently, it is estimated that some 10,000 contingent workers have signed up to avoidance schemes since the new Off-Payroll tax came into effect just over a year ago.
Why some contractors are driven to avoidance schemes
If Government wants to extract more tax from the relationship between contractors and corporations, then it is free to do so. But, it needs to target the corporations and do so in a manner that doesn’t provide them with a way to pass their tax obligations onto the contractors.
This injustice fuels tax avoidance, often among contingent workers with a mortgage to pay and mouths to feed; responsibilities that they struggle to cope with when presented with a massive effective pay cut.
HMRC would have you believe that the profile of a typical scheme user is a highly paid contractor who is well aware of the illegality of their doings. In truth, a more accurate case study comes from the uptick in scheme adoption among relatively low-paid NHS nurses who are being exploited by their hirers.
The loan charge rules: an inordinate punishment for some
Contractors are often warned of the ‘too good to be true’ arrangements which promise that they can take home 85% of their income, after tax. Because these arrangements are well documented, HMRC has created the misconception that any individual caught in an avoidance scheme was foolish and must face their just deserts.
In truth, many of the schemes bought into after April 2017 result in contractors paying roughly the same amount of tax as they would on an employee salary - so alarm bells won’t ring at all.
I’ve seen tons of these schemes, and they are very convincing and to the uninitiated they appear entirely credible. Many providers even produce misleading pay slips to hoodwink the contractor. It is easy for contractors to enter into what they perceive to be a legitimate arrangement, only to unwittingly become a tax cheat in the eyes of HMRC, and subject to punitive penalties and interest payments which leave them bankrupt years down the line.
Those who are unable to pay within 30 days are criminalised, which is an outrageously inordinate punishment for those unaware of their wrongdoing. Are we really going to start locking up nurses who have been duped?
HMRC hurting its own tax yield with IR35 and Off-Payroll
HMRC has been keen to blow its own trumpet and hail its efforts in clamping down on tax avoidance. This latest £1bn figure might sound impressive, but it hardly scratches the surface. So far, 20,000 contractors have notified HMRC of their arrangements, while there are estimated to be more than 100,000 who have engaged in schemes.
If HMRC only catches 20% of avoidance scheme users, it will miss out on £4bn in tax to which it believes it is entitled. HMRC would never admit it, but it is actively hampering its own tax yield. Had the taxman never introduced IR35, marginalising the entire contract sector in the process, tax avoidance as we know it wouldn’t be such a problem.
Perversely, HMRC believes the solution lies in introducing more of the same. The new Off-Payroll tax rules always looked as though they would intensify the problem further, and in the public sector that has very much been the case. Before making its next move, Government and HMRC need to take a long, hard look in the mirror and reapportion the finger of blame.