IR35 and Off-Payroll Explained

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IR35 could become irrelevant if OTS Employment Status Review solutions are adopted

IR35 may become irrelevant if the recommendations made by the Office of Tax Simplification (OTS) in its Employment Status Review are implemented. For a report that claimed IR35 was outside of its terms of reference, the OTS still managed to mention it 57 times (excluding footnotes).

The OTS also highlighted that: “Personal service companies (PSCs) may be affected by any outcomes from this review, if taken forward by the government.”

ContractorCalculator CEO Dave Chaplin agrees that not only will limited company contractors be affected, but IR35 could become irrelevant as a result: “IR35 focuses on disguised employment, so any debate over employment status is going to have a profound impact on the legislation.”

IR35 could become irrelevant

Chaplin continues: “One of the proposed solutions is to devise a statutory employment test. Should such a test be created and come into force, then it is likely to become the de facto standard for determining employment status for the purpose of taxation. IR35 would no longer be relevant.”

Furthermore, the report’s evidence confirms that countries without a large differential in taxation of the employed and self-employed, there is much less movement between the two populations and the self-employed community is smaller than in the UK.

“The only workable solution is to reduce the differential between the taxes paid by the employed versus the self-employed,” continues Chaplin. “That would require root and branch reform of the UK’s tax system and a merger of income tax and National Insurance Contributions (NICs).

“However, that is not likely to happen any time soon, so if any future government chooses to act on this report, even with all its flaws, a statutory test will be high on the list of priority solutions.”

The OTS is no fan of IR35

In the report, the OTS acknowledges that: “A particular tax regime (IR35) applies to [PSCs]. Although that regime is outside the scope of this report personal service companies cannot be ignored in any discussion of employment status.”

And it is clear that the report’s authors do not feel positive towards the legislation, as ClearSky Contractor Account’s legal and technical director Juliet Byrne explains: “Despite the careful and diplomatic language that is used, reading between the lines it is clear that the OTS is no fan of IR35. The most pertinent comment comes on page 108, with this observation:

‘It is difficult for us to say more on IR35 other than to reiterate that it needs a solution in terms of a less burdensome way of working.’

IR35 applies complex employment case law tests of employment

“Employment status is a complex area of law,” says the OTS. “In order to determine employment status, it is necessary to refer to the tests and factors found in case law and the body of case law that contains the tests and factors goes back many years.

It continues: “Over the years, various tests have been proposed and many factors considered, but despite many attempts by the judiciary, there is no one single test.”

“My concern is that, if the finest legal minds in this and other common law countries have failed to devise a workable statutory employment test, why do you think we will succeed this time?” suggests Chaplin.

“A whole section of the OTS report is devoted to examining the very legal principles that underpin the application of IR35. So it is perhaps with no surprise that many contributors to the evidence used in the report want a statutory test to deliver greater certainty.

“This could be a classic example of ‘be careful what you wish for’. Everyone wants a statutory test that would replace IR35 in its current form, but only if the test delivers the outcome people want, ie that they are not employed for tax purposes. The reality could be very different.”

Employment legislation case law ‘lags behind modern working practices’

The OTS points out that “much of the case law and guidance is considered to lag behind modern working practices and the scenarios that businesses currently see in practice”.

It goes on to say that: “The way in which people work nowadays is often very different from the way in which they worked at the time that cases were decided and/or HMRC guidance published.

“The lack of certainty in this area means that a business can never be absolutely confident that HMRC will not seek to review the arrangements in the future, and possibly reach a different conclusion.”

“This is exactly why IR35 has become such a nonsense and effectively unenforceable,” continues Chaplin. “Savvy contractors who adopt IR35 best practice have very little risk of being found inside IR35, but they still have to spend considerable amounts of time and money to ensure that IR35 does not apply to their contracts.”

HMRC and the IR35 Forum Administration Review

The OTS explains that one of the reasons IR35 is not considered it its Employment Status Review is because: “HMRC’s IR35 Forum has just released its report of the administration of IR35.”

Chaplin is dismayed about this point, saying: “It is very worrying if the OTS takes anything from the IR35 Forum’s review of IR35. The IR35 Forum Administration Review proved that there has been no progress in better administering IR35, despite all the work of the forum and new measures introduced by HMRC since May 2012.”

Freelancer limited company could lead “straight back into IR35”

As an alternative to a statutory employment test, the OTS mooted the possibility of what it labelled as a ‘third way’, rather than forcing everyone into the two alternatives of either being employed or self-employed.

And that third way could itself take two forms: a new kind of legal entity or simply a status like being employed or self-employed that everyone simply accepts.

“The concept of a freelancer limited company is not new but it complicates an already complex situation even further, rather than simplifying,” says Chaplin. “The OTS itself highlights that a new entity adds another level of bureaucracy.”

It seems the OTS may be proposing the third way simply to cover all the bases rather than as a serious alternative, as it says: “If the freelancer limited company route is followed, then there is a risk we are straight back into IR35.

“IR35 has already been mentioned,” continues the OTS. “Its abolition would no doubt be seen as an important and worthwhile result of a ‘third way’. In fact, the issue might be better phrased as: the route is only worthwhile if IR35 can be abolished.”

But Byrne believes this will not be the outcome, adding: “The OTS goes on to observe that pursuit of the ‘third way’ concept would only be worthwhile if IR35 can be abolished. Leaving aside the fact that the OTS seems to be placing IR35 firmly within its terms of reference, we believe that the tax consequences of the third way risk exacerbating the existing concerns about a hugely complicated and outdated tax system.”

Chaplin concludes: “Employment status will continue to be an issue until the differential between employment tax and self-employment tax is narrowed. A statutory test would remove the need for IR35 and the uncertainties that come with it.

“But a statutory test runs the risk of being too draconian and dragging too many genuinely self-employed contractors into the employee category.”

Published: 25 March 2015

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IR35 and Off-Payroll Explained