IR35 should be suspended or better enforced by HMRC, until it is made irrelevant by structural reform of the UK tax system, which could be done by merging income tax and National Insurance Contributions (NICs). Those are among the key initial recommendations from the Office of Tax Simplification (OTS) in its interim report on the Small Business Tax Review, which included a review of the IR35 legislation.
The report suggests that contractors may also have the option of taking a possible new ‘in business’ test. This might be designed to completely exclude “a large proportion of the population currently affected by IR35 from the legislation”. That would potentially leave genuine contractors with the certainty that they were outside IR35, whilst at the same time offering a target rich environment of borderline cases and ‘disguised employees’ for HMRC to investigate.
Alongside its recommendations for simplifying IR35 and structural reform of the tax system, OTS suggests a range of further measures designed to directly benefit small businesses. These include improving HMRC’s administration of tax collection, reforming employee expenses and examining capital allowances and VAT rules.
Suspend IR35 or better enforce it?
Tax Director for the OTS John Whiting captured the complexity of the problem posed by IR35, saying: “We’ve suggested ways forward on the thorny issue of IR35, though it’s clear there is no easy solution there.”
According to the OTS, abolishing IR35 outright would be the best alternative from “a simplification perspective”. The report says any ‘risk’ of increased incorporation by contractors to mitigate tax and avoid NICs would be outweighed by “a commitment from the Government to the integration of income tax and NICs”. It goes on to note: “...the longer term objective of integrating income tax and NICs is by far the most wide-reaching simplification that could be made.”
We've suggested ways forward on the thorny issue of IR35, though it's clear there is no easy solution there
John Whiting, Tax Director, OTS
A suspension of IR35 is the option favoured by PCG, the membership organisation for contractors and freelancers. This would be an effective interim measure, allowing the impact on tax revenues of employees and umbrella company workers incorporating to be assessed. If the loss of tax revenue was significant, it could trigger a resumption of IR35.
The second recommendation is to retain IR35 in its current form, but “with explicit commitments from HMRC to make specified changes to the enforcement of the legislation”. This would, the OTS says, reduce the inconsistency of enforcement and the time spent on investigations, while increasing the likelihood of contractors being able to self-certify with confidence.
Introduce a ‘genuine business test’ to clarify the inside/outside IR35 issue
A third option, in the event the Government decides against suspension or better enforcement, would be the introduction of a ‘genuine business test’ as an addition to the existing IR35 legislation.
Whilst the OTS acknowledges that by suggesting adding a further test it is hardly simplifying matters, its aim is that by applying such a test “the great majority (90%+) of … businesses would know they were outside IR35, and attention (of advisers, businesses and HMRC) could focus on the remainder”.
The review’s appendix includes a list of criteria that might be considered for setting such a test, varying from the diversity of paying customers, to salary or dividend allowances to having premises or employees.
The OTS recommends “rigorous analysis and consultation on the criteria to be used in a possible test prior to implementation”. It suggests that the tests must be “objective”, with different tiers similar to the system in place in Australia, meaning that for some contractors a single test would confirm their status, and for others multiple conditions might apply.
IR35 reform hampered by lack of data
Despite the intense and wide-ranging consultation performed by the OTS, there remain large gaps in the data, as OTS Chairman Michael Jack explains: “It is…evident that any future decision on, for example, abolishing IR35 altogether would require underpinning by a much better quality of data than presently seems to be available.”
The report confirms that “no reliable data is available as to the current numbers affected by IR35”, although it suggests that “the risk of an IR35 investigation by HMRC, in simple statistical terms, is minimal.” In its conclusion, the OTS confirms: “On IR35, without structural changes to the system of tax and NICs, the OTS is clear that the issues underlying IR35 will continue to exist.”
Dave Chaplin, ContractorCalculator CEO, acknowledges the lack of reliable data on IR35, but believes that OTS has made a solid start. “The team at OTS has clearly consulted very widely indeed. They’ve produced an impressive interim report that takes into account all the patchy evidence on IR35, and the conflicting views of so many interested parties, to come up with some solid, sensible solutions. It is pleasing to see that many of the key recommendations align with suggestions made in ContractorCalculator’s white paper on IR35 reform.”
It is evident that any future decision on, for example, abolishing IR35 altogether would require underpinning by a much better quality of data than presently seems to be available
Michael Jack, Chairman, OTS
Further consultation before final report goes to Chancellor
An OTS spokesperson was keen to make the point that these recommendations are far from the final word on the subject of IR35 and tax simplification. He told ContractorCalculator: “The review will continue from here. These are simply recommendations we want the Chancellor's view on before progressing further with the work and making final recommendations in the summer.”
Whiting agrees, stressing that the objective of the report is to encourage further debate and consultation. He makes the point that, particularly in the case of IR35, there is still a dearth of solid data and evidence on which to base any final decisions.
“We want to stimulate more debate on our findings,” continues Whiting, “so whether you agree with us or not, we are keen to hear your views to help us develop our final report to the Chancellor later in the year.”