Contractor organisations and other contracting stakeholders have issued responses to HMRC’s Intermediaries Legislation (IR35) discussion document, as the Treasury looks to clamp down on disguised employment and tax-motivated incorporation.
Contractors operating through Personal Service Companies (PSCs) may soon learn their fate, with an announcement over IR35 expected to be made when the Government issues its Autumn Statement on 25 November 2015.
The Association for Independent Professionals and the Self Employed (IPSE), the Association of Professional Staffing Companies (APSCo), the Institute of Chartered Accountants in England and Wales (ICAEW), the Chartered Institute of Taxation (CIOT) and contractor trade association PRISM have all submitted formal responses to the Government. ContractorCalculator has also submitted a response.
As well as highlighting numerous reasons for the failings of IR35 in its current form – including ambiguity and a lack of effective enforcement - the responses reveal many other areas of contention with HMRC’s proposals.
HMRC has a distorted view of PSCs
One of these concerns HMRC’s warped perception of PSCs, with the discussion document implying a very high level of non-compliance with IR35 without providing any evidence.
The document reads: “In 2011-12 around 10,000 people paid tax under IR35, an estimated 10% of those who should have paid tax on at least part of the income their PSC receives under the legislation.”
This estimate has been questioned by several organisations, with both IPSE and ICAEW calling for HMRC to explain these statistics and publish the basis upon which it reached this conclusion.
It also illustrates HMRC’s assumption that tax motivated incorporation is more widespread than it is. As ICAEW highlights, many self-employed workers operate through a limited company out of necessity as clients/engagers often insist upon it.
HMRC’s quest to “level the playing field”
Contracting stakeholder organisations appear unanimous in agreement that what HMRC has referred to as an attempt to “level the playing field” is severely miscalculated, having made several huge oversights which have contributed to the taxman’s distorted outlook.
One obvious omission concerns the fact that contractors do not enjoy access to employee benefits such as employment protection and holiday and sick pay. Whilst APSCo flags this up in its response, the Government fails to factor this into its argument within the discussion document.
Meanwhile, IPSE argues that HMRC’s willingness to compare tax paid by employees to tax paid by contractors emphasises its lack of understanding of the contingent workforce, as it fails to recognise that businesses are taxed at a lower rate to incentivise taking on the risk of going into business.
ContractorCalculator’s response highlights that employees and contractors are never paid the same gross amount. Market forces dictate that contractors are always paid significantly more for similar roles.
Worst possible timing for contractors
Further compromising the notion of a truly level playing field is HMRC’s oversight of the impact of other legislation that is due to come into effect in April 2016.
Several responses highlight the dividend tax changes that are set to significantly reduce the income of many contractors, suggesting that the Government should wait and see how much extra revenue is generated through this before considering reforms to IR35. The heavily opposed restrictions on tax relief for travel and subsistence expenses for contractors are another notable burden on contractor income which have been overlooked.
Meanwhile, ICAEW argues that these measures are likely to act as a deterrent from engaging in tax-motivated incorporation, as they would make operating as a PSC a markedly less attractive proposition. As a result, it suggests that any further changes to IR35 would be unnecessary.
More so, the discussion document itself is based on current tax figures which paint a brighter picture for contractors, as APSCo highlights, further distorting the Government’s outlook.
Ambiguity over ‘Supervision, Direction or Control’
Contractors and experts have questioned the vague nature of the ‘supervision, direction or control’ (SDC) test proposed by the discussion document as a potential replacement for the existing tests of employment. HMRC’s ideas for simplifying the test are rejected by all of the responses.
The SDC test is considered by many to be open to interpretation, rendering it extremely difficult to apply. It has been argued that an element of supervision, direction or control can be considered to apply to any form of contracting; that’s simply the nature of work.
IPSE believes that any form of simplification of the test would not help, highlighting that IR35 is already too ambiguous to enforce. This is supported by CIOT, which notes that there are currently 17 pages of HMRC guidance on SDC, confirming that the test is far from straightforward.
PRISM also dismisses SDC as vague and unsuitable, highlighting that the test has been applied within the construction sector and has resulted in companies taking a risk-averse approach. As a result, it claims genuinely self-employed individuals have been incorrectly entered onto a payroll.
Meanwhile, CIOT dismisses the viability of such a test in any circumstance, claiming: “Arrangements have to be considered on a contract-by-contract basis. There cannot be a substitute for considering each contractual arrangement on its own merits even if a simplified test for ‘status’ is introduced.”
Issuing engagers with responsibility isn’t a solution
One of the most prominent concerns amongst contractor organisations was HMRC’s proposal to shift responsibility for determining contractor tax liability over to contractor engagers – their clients.
APSCo asserts that this proposed change would lead to a reduction in the use of contractors, as clients would be reluctant to expose themselves to potential, unquantifiable tax liability: “Large organisations have a corporate responsibility to take a risk-averse approach, and would thus be unable to agree an absence of SDC without certainty that their risk is minimised.”
The inclination of clients to take the safe way out would be further augmented by their likely minimal understanding of IR35 legislation, as IPSE highlight: “Engagers have no expertise of IR35 whatsoever. Saddling engagers with such a burden creates a huge additional responsibility and one which they will be ultimately unable to fulfil.”
ICAEW agrees that transferring such a responsibility will cause difficulties for the engager which is likely to lead to over-compliance. This, it claims, may have implications for fairness and the flexibility of the labour workforce.
The impact on the contracting sector
Increasing regulations within any sector is likely to act as a deterrent for many, and the contracting sector is no different. APSCo anticipates that further tightening of the IR35 legislation is likely to result in a rise in contractor costs, as contingent staff attempt to recoup income lost to additional taxes. Contractors may also be driven abroad in search of work, or out of the contractor market for good.
It already appears to be a financial burden in its current form, even to contractors who aren’t caught by it. IPSE cites research by ComRes from 2009 which estimated that investment in clarifying whether contracts fall within IR35 was costing contractors £853 per year on average.
HMRC’s approach, which PRISM claims implies “a lack of understanding of the changing shape of business”, appears intent on reducing the tax gap between limited company contractors and employees, which IPSE argues will inevitably cause conflict.
“If workers are taxed like employees, it is likely, and not unreasonable, for them to expect employment rights. This will cause tensions between the worker and engager, which in turn will give rise to legal challenges.”
The impact on the wider economy
Inevitably, altering regulations on contractors is ultimately going to influence the wider market. Without tax incentives, IPSE argues that the employment rights which contractors are likely to call for would lead clients to incur significant additional costs, the avoidance of which is a primary incentive for hiring contractors in the first place.
With increased tax liabilities forcing contractor rates up, businesses will have to bear the brunt, ultimately limiting the UK economy’s ability to source contractors, as APSCo highlights.
“[The proposed changes] will almost certainly bring about a marked increase in the cost of engaging contractors. This would have a devastating effect on British business’ ability to access flexible professional talent, which is one of the key factors in UK plc’s ability to stay competitive in the global marketplace.”
Disregard of other official findings
APSCo recently released a statement criticising HMRC for its wilful disregard for the recommendations outlined in a report published by a House of Lords Select Committee set up to review the use of PSCs in 2014, and it’s not the only organisation to flag this up.
In their responses, both APSCo and IPSE note that, whilst HMRC acknowledges the findings from the committee, none of the conclusions drawn are taken into account within the discussion document.
Notably, the committee acknowledged that “businesses would generally resist being made responsible for IR35 assessment, finding the additional administrative pressure and liability as overly burdensome.” Despite this, the discussion document proposes making engagers responsible for assessing tax liability.
IPSE also accuses the Treasury of ignoring recent findings from the Office of Tax Simplification, which calls for harmonised rules to apply to both tax and employment rights.
What else can be done?
While contractor organisations agree that HMRC’s proposals look set to prove ineffective, whilst putting contractors in a disadvantageous position, alternative solutions have been put forward, many of which offer protection from IR35 to genuine contractors.
Organisations seem to be in favour of engaging in an approach which grants more consideration to circumstance. APSCo proposes adopting a more sectoral approach, acknowledging that particular roles within different sectors require certain levels of SDC. Meanwhile, PRISM advocates a more segmented approach which it claims would be more in-tune with the modern workforce.
This would involve a statutory test that recognises ‘career contractors’ – those who market their skills to a wide range of companies and travel to where their skills are needed – which would allow those who qualify to operate in the same way as limited companies, whilst also freeing them from the risk of being trapped by IR35.
This, it claims, would further assist HMRC enforcement as the numbers of PSCs requiring monitoring would reduce as ‘career contractor’ numbers increase.
Use existing tools and data to better risk profile disguised employees
APSCo suggests that HMRC requests quarterly intermediary returns which would provide it with a wealth of information about the size and shape of the self-employed sector. This information, it claims, could be used to set up a profile for each PSC, which would assist in providing a more accurate assessment of their status.
CIOT proposes instead enforcing a reporting obligation on the part of the engager, which would be based on the PSC notifying the client whether it considers IR35 to apply, with the client then reporting this position to HMRC, along with whether or not it agrees with the PSC.
It justifies this stance by highlighting that an SDC test is inherently subjective and will require a decision to be made that will likely depend on the view of the decision maker, claiming: “Two decision makers could very well come to different conclusions on the same facts.”
Meanwhile, IPSE advises that exempting engagements of less than 12 months from IR35 investigations would lighten the administrative burden for HMRC, whilst businesses would be able to focus on delivering skills to their clients.
“This would deliver a genuine simplification and remove some engagements from the spectre of IR35 altogether,” it concludes. “However, it would also introduce an arbitrary deadline by when engagements would be artificially terminated.”
The full responses by those organisations that have chosen to publish them are as follows:
ContractorCalculator: IR35 discussion document response
ICAEW: Intermediaries Legislation (IR35): discussion document
IPSE: Intermediaries legislation (IR35): IPSE response to the IR35 discussion document
PRISM: Response to HMRC discussion document: intermediaries legislation (IR35)