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IR35 is highly complex and expensive for contractors: that’s official, says the OTS

IR35 is both highly complex and expensive to administer, being the joint fourth most complex tax for small businesses in the Office of Tax Simplifications’ (OTS) tax complexity index. It also has top scores for both the complexity of its guidance and the cost to the taxpayer and HMRC of compliance.

So, what we’ve all known for over fifteen years is now ‘official’ from a body that is highly respected by tax practitioners, the contracting community and also by policymakers. That IR35 is too complex and expensive to administer not just for taxpayers but also for HMRC's inspectors who are supposed to enforce it.

IR35 is not objective and status can only by determined through human intervention using complex and subjective criteria. Unlike many taxes, the taxman has no automated mechanism of detecting who is breaking the rules.

Contractors are difficult to detect automatically because their profiles is just like that of any other one person company – contractors are just another small business, after all. And even if they are investigated, most contractors are IR35 savvy and can put up a good defence.

The cost to HMRC of fighting and winning a case in a tribunal is more than the tax they get back, if any. Contractors don’t pay HMRC 's costs, have insurance themselves to cover the cost of an expert defence, and if their company has no cash they end up paying nothing anyway.

This is all great to confirm, but the analysis by the OTS also shows some slightly worrisome thinking. In addition to cost and complexity, the OTS has also classed the error, evasion and avoidance risk at 4,which means a potential loss to the exchequer of £250-£500m.

Now that is a worry. We've been told in the past by HMRC in its Estimating the Administrative Burden of IR35 and the cost of abolishing it report that the exchequer risk (ie the cost to the Exchequer of abolishing IR35) is £550m and we dismissed this for good reason. But the OTS, whose judgement we usually trust, is broadly agreeing with that

HMRC estimates that £405m of this risk is down to high earning employees who would incorporate but don’t because of IR35. Our survey data suggests that the main reason that employees don’t incorporate is much simpler – it is because their employers won’t let them.

There are reasons employers want employees. Employers want the master-servant relationship and being able to tell their employees exactly what to do and how to do it. They want to retain corporate knowledge and give employees security hopefully in return for loyalty.

Furthermore, in its complexity analysis, the OTS says that the number of taxpayers affected by IR35 is 10,000-100,000. That does not quite add up, as we know from P35 returns data that about 10,000 contractors operate IR35.

If the average contractor on £400 per day is inside IR35, then using our IR35 Calculator they could be paying an extra £12,000 per year. That does not give us anything near the amount of tax that the OTS believes IR35 generates, directly and indirectly.

So, what have we learnt from this exercise and the work by the OTS? That IR35 is complex and that its Exchequer risk value remains highly questionable. Nothing new then.

But what is notable about the tax complexity index is its source. It is not us or service providers or taxpayers saying IR35 is very complex and expensive to run. It is the OTS. Maybe, just maybe, policymakers might listen to them.

Published: 01 July 2015

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