Contractors and other contracting sector stakeholders are eagerly awaiting the outcome of the Office of Tax Simplification’s (OTS) Employment status review due to be published at the end of February 2015.
As part of the review, the OTS asked key stakeholders, including those in the contracting sector, to submit evidence for the review, by 31 December 2014 if possible, and it suggested structuring responses around a series of key questions.
ContractorCalculator’s response, delivered by CEO Dave Chaplin, highlights that:
- The existing employment legislation case law should be kept for now
- However, using employment case law for tax purposes does not ultimately work
- A statutory employment test cannot be defined, as it is mathematically flawed.
The solutions are either to:
- Not challenge employment status and give workers freedom to contract, or
- Remove the different tax treatment of earnings from employment and capital by merging income tax and National Insurance Contributions (NICs).
Although the review specifically excludes coverage of IR35, as the tax legislation is underpinned by employment status legislation then of course any actions arising from the OTS review will impact on IR35.
HMRC and employment status
The OTS is keen to understand HMRC’s views and actions on employment status, covered by questions one and five. Chaplin’s initial response is that: “HMRC’s default position is that if a worker’s employment status is being questioned, then they must be an employee.”
HMRC's default position is that if a worker's employment status is being questioned, then they must be an employee
Dave Chaplin, ContractorCalculator
In employment status matters, HMRC likes to use employment status as a “blunt instrument”. Evidence from service providers confirms that HMRC often bullies contractors and other workers into accepting the taxman’s assessment of their status.
Furthermore, the quality and consistency of HMRC’s guidance can be highly variable. Finding the right information has always been tough, and that has been compounded by the transition to the gov.uk platform. Plus the IR35 helpline and contract review service are deeply distrusted by contractors.
Changing work patterns, and how they drive engagement strategies
Chaplin believes that the changes to the world of work have had a profound impact on employment status (OTS question two). Those changes have happened for reasons that are not grounded in taxation: they have been driven by business imperatives. The impact on tax is a byproduct.
Businesses and other organisations that require highly skilled workers increasingly recognise the benefits of using flexible workers. It’s a no-brainer – why employ an expensive expert when you only actually need them for a project lasting two months?
The nature of the engagement is largely driven by the workers. Most choose a limited company or umbrella company model largely because it suits them, not because their clients are forcing them.
Tax is not the main driver (OTS question 4). Engagers typically have a fixed budget for a project and don’t care how the deliverables are provided. Even HMRC’s own business surveys have concluded that aspects such as branding and liability trump tax efficiency as reasons for workers to incorporate.
Employment status uncertainties and the current tax system
When contractors and their clients engage, there is no uncertainty (OTS question 3). According to Chaplin each party understands the nature of the agreement – there is no employment by the client, the contractor is employed by their limited company or umbrella company.
Uncertainty arises when HMRC starts using employment legislation case law to determine employment status for tax purposes. Case law is inherently subjective, leading to uncertainty. Case law is used for IR35, and fifteen years of experience of IR35 also shows that it is inherently uncertain and subjective.
Chaplin provided the OTS with the results of ContractorCalculator’s free online IR35 test, which highlights that, from the 50,000 contractors who have taken the test, 45% are borderline according to classic employment status case law as applied to IR35.
Contractors manage this uncertainty and risk through IR35 best practice. The current tax system does not manage these uncertainties well (OTS question 4). That’s because tax and employment law don’t mix well. However, it is the best solution currently available, and it has been fine tuned over decades through evolving case law.
The solution is not a statutory test – that’s mathematically impossible
The OTS specifically asked for stakeholders’ opinions on a “possible statutory employment test” (OTS question six). Chaplin is adamant that, given the continuum between employment and self-employment and the lack of a clear dividing line, a statutory test is mathematically impossible.
Similarly, a statutory test based on the existing framework that uses case law would also not work, because case law is subjective. Many of the proposed criteria for statutory tests that have been debated in the past, such as in ContractorCalculator’s white papers published in 2011 to support the OTS IR35 Review, are inherently unfair and arbitrary.
Australia’s statutory tests for contractors are a good example both of how such tests are unfair and arbitrary (OTS question 7). And a statutory test employment for tax purposes would have to align with both tax and employment law. But a statutory employment test can’t align with subjective case law.
A brand new test could be created that does not depend on employment law, but then there would be two tests, and a bewildering array of outcomes. A contractor could be paying tax like an employee under the tax test but unable to claim employee rights under the employment legislation.
In five years time – freedom to contract
In response to the OTS question eight – where should this issue be in five years’ time – Chaplin’s response is straightforward: “Workers should be given the freedom to contract and the basis of their relationship with their engager should be one of mutual choice.”
He continues: “In five years time, the disparity between taxation of the employed and self-employed should be removed so the difference between employment and self-employment becomes irrelevant. Taxpayers need to be educated now about how much tax they really pay so that when fundamental reform takes place, there are no surprises.”
The OTS is planning to report on the issue by the end of February. This is so that any recommendations can be incorporated into the March 2015 Budget, if the Chancellor so wishes. ContractorCalculator will continue to report on the OTS’s findings as they are published.