IR35 and Off-Payroll Explained

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Lords slam IR35: benefits are unproven and HMRC needs to review them

IR35’s benefit to the Exchequer as a tax-raising tool is in doubt, and HMRC has been called on to assess the costs and impacts of the legislation. If IR35 is retained following the review, the Lords recommend that HMRC provides improved guidance.

This is one of the lead conclusions of the House of Lords Select Committee on Personal Service Companies, which also says that HMRC “should consult on revising the Business Entity tests”.

And there was a big stamp of approval for contractors and the UK’s flexible knowledge-based workforce, with the committee’s final report acknowledging that: “Serial contracting is a feature of the British workforce and is supported by both businesses and contractors.”

No proof that IR35 acts as deterrent

“HMRC failed to demonstrate that that they had a sound basis for the £550m of tax and national insurance that they cited as being at risk if IR35 were to be abolished or suspended,” highlights committee chairman Baroness Noakes.

“The deterrent nature of the IR35 legislation is its main rationale. We recommend that HMRC publish a detailed assessment of this figure and we also call for an assessment to be made of the cost to the taxpayers affected by the rules.”

Chris Bryce, CEO of PCG, points out that the contractor and freelancer body has repeatedly asked the taxman to justify the £550m figure and the deterrent effect of IR35. “The simple fact is, HMRC cannot do so,” he says, adding that, “the effectiveness of this legislation and the justification for its continued existence is built on smoke and mirrors.”

As a result, PCG is calling for the suspension and eventual abolition of IR35.

Lack of government cooperation slammed

Another notable observation by the committee was the government’s refusal to cooperate with the inquiry. The Exchequer Secretary to the Treasury David Gauke refused to give evidence, nor allow any Treasury officials to do the same, claiming that the inquiry was to do with HMRC’s application of IR35.

However, the Lords felt that: “The legal framework within which HMRC operates clearly affects the tax collection process and much of the evidence we received was concerned with the problems created by the IR35 legislation itself, not simply issues associated with its implementation.

“It was unfortunate that we were not able to discuss these issues with a Minister before making recommendations.”

Main findings of the committee

In its report, the committee’s main findings and recommendations that impact on contractors are that:

  • The use of personal services companies by the UK’s flexible contracting workforce is increasing, but there are many reasons why limited companies are chosen as a trading vehicle, and it is not simply about avoiding tax. “The motivation to incorporate is not driven solely by financial incentives,” confirm the Lords
  • HMRC has failed to substantiate its claim that the deterrence effect of IR35 generates £550m for the Exchequer, and the taxman has been asked to publish an assessment of this figure and the costs to taxpayers of maintaining IR35
  • Should IR35 remain in force following HMRC’s review, then its guidance to contractors must be improved, and this includes undertaking a full review of the Business Entity Test. The membership of the IR35 Forum should also be reviewed
  • There is not enough solid data about the use of personal service companies. The Lords suggest this could be rectified by including additional compulsory questions on contractors’ personal tax returns and making questions on PSCs compulsory, rather than voluntary
  • The off-payroll rules also received a mention, with the committee calling for consistent application across all government departments, led by the Treasury. There was also strong support from the committee for the use of contractors in the public sector.

Low paid workers were singled out as a group that may be unwittingly, or unwillingly, being forced into using PSCs. The report recognised the distinction between this type of worker and highly skilled, highly paid contractors.

HMRC told to “carry out and publish a detailed assessment”

The focus of the Lords on IR35 was because the “primary focus of the Committee’s investigation was on the use of personal service companies and the associated consequences for tax collection”.

The report says that IR35 is “especially cumbersome”, and there was little evidence of the ‘Friday to Monday’ phenomenon which the committee understood to be one of the primary drivers behind IR35.

There were also the questions over HMRC’s justifying IR35 “on the basis of significant risk to the Exchequer of the loss of tax and National Insurance Revenue”, which was originally estimated by HMRC to be £475m and then revised up to £550m. “It was not clear to us that these figures were reliable,” was the committee’s carefully worded conclusion.

As a result, a key recommendation is to conduct and publish an assessment of these figures, which the Lords believe will “enable a better assessment of whether the legislation is having the intended effect and is proportionate”.

The long-term future of IR35 – merging income tax and NI

Despite acknowledging IR35’s obvious flaws, the committee has not gone so far to recommend that IR35 is abolished. Quite the opposite, in fact, suggesting it would be unwise to abolish IR35 even if the threat to tax yield was not as high as HMRC estimates.

However, it is also acknowledged that there is a structural tax problem to be addressed, because some trading structures allow income tax and NI benefits, so merging income tax and NI could be the solution.

“Whilst we recognise the complexities in merging income tax and National Insurance and the effect that this may have on the contributory principle, we recommend that the government re-examine the longer term case for combining taxes on income and National Insurance.”

Responsibility for enforcing IR35 – compulsory tax return questions?

The committee’s next major recommendations came under the banner of who should be responsible for enforcing IR35. Significantly, they note that it should not be contractors’ clients.

To help with determining whether IR35 applies, the committee recommends that HMRC re-examines the need to secure complete and accurate responses from contractor tax returns and the RTI employer year end declaration (which replaces the P35).

If HMRC decides that it needs that data, then the taxman should be allowed to legislate for those questions to become compulsory. And if this happens, then HMRC should provide clear guidance as to who should complete these questions and how they should be answered.

But if HMRC’s review determines that the data from these questions adds no value, then they should be removed from tax returns and declarations.

Enforcing IR35 – does HMRC have sufficient resources?

The final report notes that the evidence presented to the committee demonstrates clearly that HMRC has not allocated sufficient resources to the enforcement of IR35, saying: “HMRC did not convince us that the resources currently allocated were sufficient to ensure compliance with the IR35 legislation.”

As a result, HMRC has been asked to: “articulate with greater clarity the costs they incur from IR35 compliance efforts and administration, and the relationship between those costs and the overall yield gained from the legislation.”

HMRC has been traditionally reluctant to publish the results of its IR35 activity in any meaningful form to allow comparison and performance appraisal. This recommendation – as with many others – may find itself being quietly filed, with no action taken.

In light of the report and the PCG’s subsequent call for suspension and then abolition of IR35, the organisation’s Chris Bryce is optimistic: “The government has refused to listen to the cries for help from the hundreds of thousands of contractors, freelancers and independent professionals blighted by IR35, but they cannot ignore the findings of the Committee."

Published: 07 April 2014

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IR35 and Off-Payroll Explained