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IR35 Reform: compliance must be shared by contractors and clients

Contractors are stuck with IR35, as HMRC has made it clear in its Intermediaries Legislation (IR35) discussion document that the legislation won’t be abolished, despite the fact that many think it is now irrelevant and unenforceable.

So, in order to make it work, perhaps both contractors and clients should be made responsible for compliance. A reworked set of rules that shared the compliance burden between the two key stakeholder groups would meet HMRC’s policy objectives, insofar as this would be fair to both contractors and clients.

Before embarking on any new compliance regime, HMRC must do much more to understand the flexible workforce in general and the contracting sector specifically, so that its goals are realistic and any new rules are fair.

In this third and final in a series of three articles summarising ContractorCalculator’s response to HMRC’s IR35 discussion document, we offer a possible framework within which IR35 might be more effectively implemented in the future.

Making engagers alone responsible for IR35 compliance won’t work

In its discussion document, HMRC has suggested that making engagers, or clients, responsible for IR35 compliance could result in more effective implementation.

Interestingly, when IR35 was first consulted upon back in 1999, the original idea was for engagers to be responsible for compliance. Lobbying by big business got that provision removed before it became law. Under the existing legislation, all IR35 risk is with the contractor, including the taxes, in the form of employers’ National Insurance Contributions (NICs) that would normally be paid for by the employer.

In practice when large companies become responsible they are either risk averse and over-regulate, or are results-focused and under-regulate.

Furthermore, mid- and top-end contractors typically hold the power in the relationship, not the engager. These contractors have hard-to-source skills, so if a client tells them they must go on the payroll to avoid risk, the contractor will simply move on and find a less risk-averse client.

And clients are unlikely to have sufficient numbers of employment law specialists to properly evaluate each individual contractor’s engagement and make a judgement using IR35’s existing tests for employment. Like contractors and most of HMRC, IR35 in its current form is just too complex for most engagers to apply.

Could sharing the compliance burden be the solution?

If HMRC and its Treasury masters are determined that IR35 will remain, despite the projected extra tax yield of £430m being effectively a fantasy figure, then a possible solution could be to share compliance between contractors and clients.

A framework could be developed where contractors require independent certification and clients must request and check a contractor’ accreditation before engaging them. Other service providers and membership organisations in the contracting sector have previously suggested a similar approach.

The Construction Industry Scheme (CIS) operates in a similar fashion for the construction sector. The CIS is far from perfect and has many critics, but it mostly works and only legitimate single person or labour only businesses qualify for the register and can be paid gross by their client.

How could a new contractor/client compliance scheme look?

To work, a contractor/client framework must have certain core features, not least of which is that HMRC should be as far away from delivery as possible, and only act in a specification and audit role. The sort of essential features the scheme must have include:

  1. Straightforward and accessible categorisation of contractors
  2. Fair, transparent and affordable accreditation by third party experts
  3. Ongoing and updated accreditation of contractors
  4. Low administrative burden for clients and contractors
  5. Proportionate sanctions.

Contractors would apply for accreditation via an independent third party, which itself has been granted the right to accredit contractors, using a range of tests, by HMRC. Once accredited, contractors enter an online register managed by an independent third party that clients can quickly and inexpensively check.

HMRC would be responsible for setting the requirements for accreditation, accrediting the independent third parties, most likely IR35 consultancies or contractor accountants, for appointing the third part that manages the register and for audit.

This removes HMRC from operations, as the CIS experience shows the taxman lacks the resources and capabilities to run such schemes effectively.

In addition to sharing the compliance burden between stakeholders, the sanctions for misclassification should also be shared. Currently, the contractor bears the entire cost of all tax underpayment if IR35 applies to their contract. But with the Dividend Tax changes coming into force in April 2016, contractors will effectively be covering employee’s NICs through their higher income tax.

The tax that would be missing is employers’ NICs, so under a new scheme sharing responsibilities it is fair that clients should be liable for unpaid NICs in the event that a worker is misclassified. Without any sanctions, engagers would disregard a new IR35 in the same way they disregard IR35 now.

HMRC must conduct much more research

Before considering any changes to IR35, HMRC must complete much more research into contractors, contracting and the flexible workforce. This research will inform HMRC of the latest market conditions and form the basis for more realistic tax revenue objectives.

HMRC must have compelling evidence that any new burden placed on businesses – both contracting companies and engagers – will actually generate additional tax. The reality is that mid- and top-end contractors are not controlled and are not disguised employees.

They would have nothing to fear from an accreditation scheme, and HMRC is unlikely to see an increase in tax yield from this demographic, whatever changes it eventually decides to make.

The research will show that the tax revenue-based policy objectives – the additional £430m a year that the taxman believes is the cost of IR35 avoidance - will never be achieved because there just aren’t that many disguised employees out there anymore. HMRC would need to catch at least 60,000 contractors on £500 a day inside IR35 to generate £430m a year.

HMRC believes that there is considerable disguised employment at the bottom end of the contracting market. In that case, HMRC would need to catch around 145,000 low-end agency workers/contractors on about £15 per hour / £120 a day inside IR35 to generate £430m. Are either of these scenarios realistic?

IR35 reform – another sticking plaster

Whatever measures are devised and adopted following the responses to HMRC’s discussion document, they will only be a sticking plaster over the UK’s incredibly complex and barely functioning tax system.

Whilst genuine contractors should have nothing to fear either from IR35 as it stands, or a new framework requiring accreditation, IR35 remains an unnecessary cost and administrative burden. Because the problems it was designed to address are no longer there.

A compliance framework shared between clients and contractors is not designed to be the complete solution, and there are challenges that require much more research and thinking through.

However, this presents an alternative to the current situation that may help to meet HMRC’s desire to tackle the challenge of disguised employment, such as it is in the modern workplace, at the same time as not imposing an unnecessary burden on business.

Published: 19 October 2015

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