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IR35 Forum – Part 4: ‘In-business’ tests are great idea in theory, not in practice

ContractorCalculator highlights that a set of objective ‘in-business’ tests might sound like the perfect solution to simplifying complex tests of employment. But in practice they won’t work in favour of contractors and could make things worse. This is the fourth in a series of articles analysing the options available to the IR35 Forum as it determines how HMRC might better administer IR35.

Contractors are complex animals whose varied working practices can’t be reduced to simple tick boxes on an ‘in-business’ test. Where such tests have been tried, the results have not been positive, as the Australian example proves.

But, as the minutes of the inaugural IR35 Forum meeting show, HMRC has been asked to create a “gateway test model” for discussion at the next meeting. This idea was originally included in the Office of Tax Simplification’s interim report on its Small Business Tax Review.

HMRC and Treasury chiefs must be delighted with that Forum decision. A set of simple ‘in-business’ tests that were defined by tax inspectors, and had the blessing of contracting sector representatives on the Forum, would be a perfect solution to better administer IR35.

But that’s unlikely to be a good thing for the contractor, as it would make it so much easier for the taxman to categorise vast swathes of contractors as disguised employees and tax them accordingly.

Fortunately, it seems some on the Forum have already flagged that such apparently simple “gateway tests” might not be quite so simple in practice. The minutes reported that “there were some concerns about how such a test would in fact operate in practice”.

If a simple test was workable, wouldn’t it be in place already?

The UK’s legal system has benefitted from centuries of fine legal minds being applied to create a code of laws that, by and large, work rather well. Leading judges have contributed to a body of legislation through case law that has been applied to determining employment status for decades.

So, if a simple set of ‘in-business’ tests could be made to work, wouldn’t it have been developed and be in place by now?

An objective test might look superficially to be a simple undertaking, but the contracting sector knows from hard-won experience that it’s just not possible. And the ContractorCalculator team has first-hand experience, having spent months to develop our IR35 Online Test.

We had a team, including former tax inspectors, employment law experts and masters level mathematicians, analysing case law and working on algorithms that could be used to determine a contractor’s IR35 status.

Could we achieve our aim of a ‘simple’ test? Well, it’s simple to take our online test, but such are the complexities of IR35 legislation and case law that it takes over 50 questions to determine a contractor’s IR35 status. Even then, it’s on an 11-point scale ranging from ‘fail’, to ‘borderline fail’, through ‘borderline’, to ‘borderline pass’ and then ‘pass’.

So believe this team of industry and IR35 experts when it assures you that there is no such thing as a simple ‘in-business’ test.

An objective test would catch too many innocent, genuine contractors

The elegance of the common law concept that underpins the UK’s legal system is that it is open to interpretation. Some might consider that flexibility to be a curse, but a set of rules that does not acknowledge that the real world is a complex place, with shades of grey, won’t remain in place for long.

Australia’s Personal Services Income (PSI) rules are a prime example of how such inflexible business tests have seriously backfired on the contracting community. There is no flexibility and the tests are quite arbitrary. For example, why should a contractor with 80% of their income from a single client in a given year be any less ‘in business’ than a contractor with 79% of their income from a single client?

If a simple set of 'in-business' tests could be made to work, wouldn't it have been developed and be in place by now?

In order to catch contractors who really are, and should be taxed as, employees, the line would have to be drawn so far back that a huge number of genuine contractors would cross it. This could happen, for example, just by virtue of a contractor having a client’s project overrun, meaning that ‘too large’ a percentage of their income in a financial year is from a single client.

Who watches the watchers?

By allowing HMRC to drive the development of ‘in-business’ tests, or to use HMRC’s terminology, ‘gateway’ tests, is akin to offering a child the keys to a sweet shop. Of course HMRC will come up with a set of rules that will be designed to catch as many contractors as possible – it would not be doing its job properly, and representing taxpayers’ interests, if it did not!

But what is particularly frightening about the current scenario is that HMRC will have created these ‘gateway’ tests with the contracting sector’s tacit approval, by virtue of the trade and membership bodies representing contractors on the IR35 Forum.

If the contracting sector is not careful, HMRC will be able to unleash its own gateway tests on contractors. And the contracting sector will have no come-back, as HMRC would be likely simply to point out that the tests were developed with (or even by) the contracting sector itself.

ContractorCalculator can only urge those non-HMRC members of the IR35 Forum to veto the idea of ‘in-business’ tests as unworkable now, before the idea gains too much momentum, and HMRC feels it has the mandate it requires.

The fifth part of ContractorCalculator’s series of articles on the IR35 Forum will focus on the need for HMRC to measure the results of its administration of IR35. Without measurement, it won’t be possible to determine whether changes to IR35’s administration are actually ‘better’.

Published: 28 June 2011

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