ContractorCalculator assesses IR35’s objectives and looks at why contractors and the contracting sector IR35 affects – not to mention the government, HMRC and taxpayers – deserve to see it better administered. This is the first in a series of articles analysing the options available to the IR35 Forum as it determines how HMRC might administer IR35.
Contractors must now accept that, following the 2011 Budget, IR35 will not be abolished for the foreseeable future. Indeed, as the flexible workforce (and potential ‘disguised employees) increases as a percentage of the UK’s economically active population, the scope for abuse of the system and for tax avoidance is increasing. In other words, there is an argument, particularly amongst those responsible for the UK’s revenue, that retaining IR35 is not only necessary, but even desirable.
Now that HMRC and the Treasury accept that there is a case for a reform of IR35’s administration, and the IR35 Forum has been tasked to offer solutions to do just that, there is a slim possibility that IR35 could become fairer and more workable.
IR35 stands accused of systemically failing contractors
IR35 appears to fail on two key points: it doesn’t work as it should, and it might even be entirely the wrong solution.
Certainly, following the work of the Office of Tax Simplification and the subsequent Budget in early 2011, there can be no doubt that IR35 fails systemically to perform as it should. Due to its in-built failures of process and application, it fails dismally at its most basic task – to tackle the avoidance of disguised employment.
And, more seriously, it fails on a more strategic level, in that it takes no account of the fact that the world has moved on considerably since IR35’s inception over ten years ago. Indeed, even when it was first mooted in 1999, IR35 was already trying to use industrial age concepts to tackle knowledge economy issues.
The only certainty IR35 offers is uncertainty, at every level
The principles of workable taxation require that tax law should contain certainty and leave no room for ambiguity, as a result being clearly understood and enforceable. Unfortunately, IR35 fails on all those counts, as HMRC has demonstrated time and again through over a decade of inconsistent targeting and application.
Because IR35 was so badly designed at the outset, HMRC has struggled to enforce it, repeatedly applying the rules to contractors who were clearly never meant to be within scope, and losing the majority of its cases as a result. Perhaps more seriously, it has also lost the ‘hearts and minds’ of contractors. That’s because, in order to avoid HMRC’s erratic approach, many contractors have opted to use trading vehicles that mean they must pay far more tax than they have to, whilst simultaneously watching obvious disguised employees getting away with it.
The reasons for IR35’s systemic failure to fulfil the criteria as ‘good tax law’ are many, but largely come down to the fact that no tax can be workable if it is:
- Misunderstood by taxpayers
- Misunderstood by HMRC, the very organisation responsible for its enforcement
- Ambiguous and lacking in certainty
- So complex it can only be ‘understood’ by experts with conflicting interpretations
- Only enforceable piecemeal, one taxpayer at a time
- Inconsistently applied
- Easy to evade and where breaking the rules cannot be easily detected and investigated
- Dependent on the taxpayer to decide whether it should apply.
Clearly, the objectives for better administration of IR35 should start at the very least with resolving the above issues. However, these are largely systemic issues; should the IR35 Forum dig deeper when considering how to better administer IR35, and question the whole basis of the rationale on which IR35 is founded?
Industrial age concepts applied to tax avoidance in the knowledge economy
False contractors (or disguised employees) typically avoid the full taxes that should arise from employment by using an intermediary such as a limited company. That’s an accepted fact, and there is therefore a strong argument there should be legislation to address such workers. It could effectively distinguish genuine contractors from disguised employees, by dealing once and for all with the ‘Friday to Monday’, ‘perm-tractor’ and other false contractors who are, in effect, employees who should be taxed as such.
But, as has been repeatedly demonstrated by HMRC’s attempts to apply IR35 to genuine contractors, at times it is very difficult to tell the genuine contractors from the disguised employees. Should an engineering consultant genuinely in business be penalised because things like airports and chemical plants take a long time to build? Equally, leaving work on Friday, only to start on Monday doing exactly the same job, at the same desk and for the same ‘boss’, but as a consultant, looks highly suspicious and, in many cases, really is a case of disguised employment.
When determining to whom anti-avoidance legislation should apply, this brings us back to the question: what was the original intention of IR35? Who did the Treasury and HMRC wish to target? And what is the situation now; is the intention to target any and all flexible workers because:
- Many more workers are choosing flexible working
- Our economy is increasingly dependent on flexible workers to compete globally
- HMRC fears that more flexible workers will result in lower tax yields?
HMRC offered profiles of the kind of flexible workers that IR35 was intended to target – view ‘Gordon’, ‘Henry’ and ‘Charlotte’ for more details – and ten years later these highlight why IR35 has become such mess – the profiles are vague, don’t relate to current IR35 case law and appear to focus mainly on IT contractors.
A recipe for better administration of IR35
As did the Office of Tax Simplification before it, the IR35 Forum faces the challenges of trying to find a workable solution to the administration of IR35 without changes to the original legislation, and all whilst maintaining tax yields. In addition, any potential solutions the IR35 Forum puts forward and are accepted by government may face potential intransigence from an HMRC that is widely acknowledged to be under-staffed and under huge pressure.
Understanding who you are setting out to catch makes the creation of a set of guidance and rules about how you will catch them so much simpler.
The first step for the IR35 Forum will be to determine the type of avoidance, and therefore the profile of the individuals that the legislation was and should be designed to target. Understanding who you are setting out to catch makes the creation of a set of guidance and rules about how you will catch them so much simpler.
The next step will be to create clear rules and definitive guidance on whom to target and how. These rules and the guidance must also remain within the boundaries of the source legislation, which will be no mean feat if they are to make sense when applied to flexible workers in the 21st Century’s challenging, fast-moving and global knowledge economy.
Part 2 of ContractorCalculator’s IR35 Forum series will take a contracting industry insiders’ view of how HMRC might be able to target and catch those disguised employees who taint the rest of the contracting community.