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HMRC’s business entity tests for contractors may already be unravelling

Before HMRC has even published its much anticipated business entity tests, they appear to be coming under fire from many of the very organisations enlisted as part of the IR35 Forum to help devise them.

The trouble appears to lie not so much in the concept of having tests that indicate whether or not a limited company contractor’s business is ‘genuine’, but in how HMRC has chosen to score and weight the tests. In essence, it seems that HMRC’s weightings could lead to virtually every limited company contractor who takes the test being told that their business is at ‘medium’ or ‘high’ risk of being found not to be genuine.

Unsurprisingly, this has resulted in strong opposition. PCG managing director John Brazier says: “Along with the vast majority of other non-HMRC members of the Forum, PCG is locked in disagreement with the Revenue over the scoring.” Despite this, several sources have indicated to ContractorCalculator that HMRC is determined to introduce the new tests in April, and see how they develop over a 12-month ‘test and learn’ phase.

Tests agreed by the IR35 Forum are still “insufficient”, says PCG

The specific questions to be used in the test have been agreed by all members of the IR35 Forum, according to PCG managing director John Brazier, but he still has concerns. “We believe the tests are insufficient, so PCG has tabled additional tests that would be effective risk indicators and give genuine businesses greater opportunity to demonstrate their low-risk status. However, for now, these have been rejected by HMRC.”

There are believed to be 12 questions, each attracting different weightings of positive or negative points. Contractors scoring 10 and under are at high risk, 11 to 20 at medium risk, and 21 and above low risk. But how those scores are come to is at the heart of the concerns being expressed by IR35 Forum members. As PCG’s Brazier puts it: “The scoring is crucial to the success of the tests, as the accumulated points will determine the risk faced by each business.”

Business tests don’t accurately indicate IR35 risks

But whenever business entity tests are introduced, and however they are weighted, many outside the IR35 Forum struggle to understand how they will add to the simplification of IR35 administration, and how they could add clarity to contractors’ tax affairs.

“Business entity tests aren’t IR35 tests,” says ContractorCalculator CEO Dave Chaplin. “So even if a business ‘fails’ the test by being shown as a risk, the contractor could still pass IR35 tests, with their contracts easily being outside IR35.

“In other words, the new tests could be entirely meaningless and add nothing,” continues Chaplin. “Considering they are being introduced as a result of the IR35 Forum’s stated aim to simplify the administration of IR35, they would seem to be a ‘non starter’. But PCG and other members of the IR35 Forum are to be congratulated for their efforts to make sure that responsible contractors aren’t caught by the new business entity tests.”

Why push ahead with badly weighted tests that provide inaccurate answers?

So why might HMRC want to press ahead with potentially pointless tests? Chaplin notes: “Whilst IR35 is generally seen as failed legislation by many contractors and their professional advisers, it has actually proven highly successful in generating additional tax revenue.”

He points out that although a PCG freedom of information request to HMRC shows that between the 02-03 and 07-08 tax years a total of only £9.2m in tax has been directly attributed to IR35, that doesn’t account for other factors that have led to increased tax takes – estimated via a ContractorCalculator FOI request to potentially be in the region of about £230m each year.

“IR35 has indirectly increased HMRC’s revenues by driving huge numbers of contractors into PAYE employment through umbrella companies. It has arguably also persuaded many genuine limited company contractors to pay tax as employees. Contractors have been scared into effectively over-paying what they owe and providing HMRC with easy-to-collect revenue streams.”

Chaplin continues: “The new tests could continue that unhappy ‘tradition’ and prove a very useful weapon in HMRC’s armoury, by persuading even larger numbers of genuine contractors to ‘self-certify’ as being inside IR35 when they’re not.”

A long way still to go, and PCG needs feedback

However, other industry and IR35 Forum sources are urging caution, and saying that contractors should not be too concerned at present, because nothing is set in stone. The contested weightings of the new business tests are certainly a troubling start, they say, but this is just the beginning of the process.

The IR35 Forum is said to be still debating the precise wording of the questions and the weightings. However, the Forum is not due to meet again until 10th May 2012, by which time the questions and the weightings may have been ‘live’ for a few weeks.

Along with the vast majority of other non-HMRC members of the Forum, PCG is locked in disagreement with the Revenue over the scoring.

John Brazier, Managing Director, PCG

PCG is working closely with its members, including encouraging them to complete the draft questions on its site. It wishes to monitor not only how the tests work in practice, but also how HMRC deals with contracting firms found to be at medium or high risk. John Brazier says: “As part of the better administration of IR35, we must have a better-trained team at HMRC that deals consistently with contractor businesses in similar situations.

“That’s why PCG is looking beyond its membership to all contractors, freelancers, consultants and industry suppliers who may be affected to provide feedback on how HMRC is approaching and dealing with individual cases.”

Published: 04 April 2012

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