In this first item in our ir35 solutions series analysing potential solutions to IR35, and the challenges facing the Office of Tax Simplification (OTS) as it reviews the IR35 legislation with a view to recommending an alternative, the objectives of IR35 and its potential replacements are examined.
Contractors could be forgiven for mistaking the original intention of IR35 as being a deliberate attack on the livelihoods of flexible workers. Depending on your point of view when it was introduced in March 1999, it could be seen as a ‘greed-tax’ to redistribute wealth, or a mechanism whereby all workers contributed their fair share of tax.
The official line from the then Inland Revenue in March 1999 was that IR35 was an attempt to crack down on perceived tax avoidance by what was termed 'disguised employees'. In particular, it was targeted at those leaving employment on Friday to start contracting for their previous employer on Monday, and doing exactly the same work, in the same circumstances, but contributing considerably less through taxations.
The footnotes from the time show that the new measures were intended to be designed to encourage enterprise and not stifle. In fact, the Inland Revenue claimed that without the changes IR35 would bring about, “it would be very difficult to target support at genuine entrepreneurial activity”.
Create a plan with some objectives, and stick to it
The original rules proposed by the Inland Revenue were clear, unambiguous and well reasoned. They postulated that a certification scheme might be the solution that removed the burden of compliance from clients and enabled legitimate contractors in business on their own account to self-certify, with understandably draconian sanctions for those caught lying or bending the truth.
But whatever the then Chancellor Gordon Brown’s and the Treasury’s original objectives, the IR35 legislation soon came to undermine genuine entrepreneurialism, not support it. The Inland Revenue, which became HM Revenue and Customs (HMRC) in 2004, appeared to implement the legislation without any clear strategy or objectives, lashing out at disparate contractor targets, seemingly at random.
Added to the confusion over exactly why IR35 was needed was the dreadful legislation that ultimately became law. But is ‘dreadful’ too strong a word? Well, tax, accountancy and employment law professionals, and a good few ex-tax inspectors themselves, have labelled IR35 variously as badly drafted, poorly thought through and lacking the key component of granting workers caught by the legislation with the employment rights it was originally intended to provide.
The original rules proposed by the Inland Revenue were clear, unambiguous and well reasoned
Anecdotal evidence to confirm these harsh criticisms abounds, much of it based on interviews, undertaken by ContractorCalculator journalists, with contracting sector experts operating during that time. Other stark evidence came to light during the research conducted in October 2009 to create the ContractorCalculator IR35 Special: 10 years that shook and shaped the world of UK contractors. Taken together, the feedback suggests that the consultation process completed by HMRC was largely ignored by the Treasury, which proceeded to draft the legislation in the shape it thought best, rather than what was needed or recommended.
IR35’s objectives – what’s the point of it?
Because of the wide range of consultants, contractors, interims and freelancers that have been targeted by HMRC, it is difficult to determine what the true objective of the tax actually was. Examining both IR35’s original stated purpose and how it has since been applied, the objectives of IR35 appear to have been to:
- Tax disguised employees, like permtractors
- Prevent employees ‘doing the Monday-Friday thing’
- Tax high-earning contractors who pay themselves with a combination of low salaries and relatively high dividends
- Protect vulnerable lower-paid and low-skilled workers from exploitation (ie not the type of professional ‘contractor’ or ‘freelancer’ who reads ContractorCalculator and uses its calculators and information services)
- Place a tax premium on being a high-earning, flexible knowledge worker choosing a limited company, or partnership, as a trading model for their contracting.
Whilst the first two objectives have the potential to protect tax revenues being lost through tax avoidance, clearly IR35 has become a victim of the ‘law of unintended consequences’. A combination of poor objective setting, drafting and implementation has resulted in IR35’s ‘police force’, HMRC, losing sight of what was originally intended. This has led to inconsistent implementation and the scatter-gun punishment of a broad stakeholder group of entrepreneurial small businesses.
Lessons on setting objectives for IR35’s successor
What can be learned from the history of IR35 that can assist the OTS in creating a set of recommendations for Treasury officials and ministers as part of its review of small business taxation in general, and IR35 in particular?
The first IR35 challenge for the OTS is likely to be to create a set of clear objectives that set out exactly what the new tax is supposed to achieve. Also needed is a forceful footnote in the recommendations suggesting that this time around considerably more care is spent ensuring the stated objectives are allowed for by law. In particular:
- The widest possible consultation should take place before any recommendations are put forward; fortunately, OTS appears to be very proactive in seeking out and inviting the involvement of numerous experts
- IR35’s replacement should set out in clear and unambiguous terms exactly what type of avoidance it is targeting, who will be affected, why and how
- Any IR35 successor legislation should be thoroughly and carefully drafted, with its implementation tested on industry professionals as well as other stakeholders; it must also re-establish the certainty in the tax system that contractors have lost since the introduction of IR35
- A post-implementation evaluation and refinement process should be undertaken, to ensure that adjustments can be made for any unforeseen consequences of the legislation.
The final lesson of IR35 is that any successor to it must be unambiguous in purpose; it should be clear to everyone subject to, as well as to those enforcing it, exactly what the law is for and how it will be implemented. IR35 introduced an unacceptable level of uncertainty to the tax affairs of those clearly within its scope, and it also affected many workers and small businesses that found themselves unintentionally caught. Such uncertainty has no place in IR35’s replacement.
Part 2 of ContractorCalculator’s IR35 Solutions series considers how the context has changed since 1999, when IR35 was created in a very different economic, market, legislative and political landscape.