Employment Status & IR35 expert Re Legal Consulting Ltd
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IR35: The employee vs self-employed tax conundrum

Rebecca Seeley Harris reviews the Office of Tax Simplification literature on the taxation of personal service companies and the self-employed. Is the time now right for the government to grasp the nettle of this most prickly of problems?  

11th Aug 2020
Employment Status & IR35 expert Re Legal Consulting Ltd
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Will the UK government grasp the IR35 tax nettle?
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On 26 March 2020, following his announcement on the Covid-19 support package the for self-employed, Chancellor Rishi Sunak noted with regard to NIC: “It is now much harder to justify the inconsistent contributions between people of different employment statuses. If we all want to benefit equally from state support, we must all pay in equally in future.”

This may have prompted the Office of Tax Simplification (OTS) to released its evaluation update and stock take of the work it has carried out on corporation tax, personal service companies and self-employed people’s taxation. As a previous a Senior Policy Adviser to the OTS, I was personally involved with some of this earlier work.

Peronal Service Companies (PSCs)

Working through a PSC makes it possible to share, or defer, the distribution of income received by the company as dividends, so that it is taxed at a lower rate. If the owner is in a position to significantly defer the distribution of income, then it may be realised in capital form when the company is sold or wound up.

The OTS noted that PSCs were also commonplace because agencies and other engagers will only engage those who have incorporated. This is on the basis that this will help safeguard engagers from employment rights obligations, the costs of employers’ NIC and the risk of later finding themselves liable for PAYE.  This was the premise of the IR35 legislation, which provided that engagers did not need to consider status where the contractual service provider was a company

Previous OTS work

The OTS considered a variety of approaches to simplifying the experience of those operating through PSCs, not least in the Small Company Taxation review published in 2016. Much of the focus of the work was on reducing the greater administrative burdens that come with being incorporated as compared with being a sole trader.

One idea that the OTS explored was for a sole trader to be able to register as a ‘Sole-Enterprise with Protected Asset’ (SEPA). This would be to give the owner of the business a limited level of main asset protection, without otherwise changing their legal or tax status. This was subject to a further review in 2016.  I was the lead on this particular piece of work and would still recommend it as an alternative so people could disincorporate, but still have protected assets.

The OTS also considered the potential for PSCs to be taxed on a “look through” basis but, the OTS concluded that this would not be simplification overall.

Possible future work

In the OTS’s 2016 small company tax review, other possible legal forms which small businesses could take were considered. One of these possibilities would be the potential for legislative changes to enable the formation of single-member limited liability partnerships; or another approach would be the renewed consideration of the S-Corporations in the USA.

S-Corporations

The aim would be to provide small personal service type businesses with a fully recognisable form of limited liability, removing them from corporation tax (but accounts would be filed at Companies House), together with the relative ease of a self-employment style tax calculation.

A key question would be whether any of the alternatives would be elective or not. Making it mandatory would involve significant changes in defining the companies to which it applied. The OTS is presuming that the off-payroll rules would still apply, so any alternatives would still have to consider that legislation, which seems counter-productive.

The OTS will continue considering these issues and would welcome contributions from others to this discussion.

Self-employed individuals

In the Tax reporting and payments arrangements report in 2019, the OTS said a good deal could be done to improve tax administration for the self-employed. In particular, the report recommended HMRC explore the potential of offering a fully integrated Individual Tax Account, providing an end-to-end tax reporting and payment service.

The OTS did not comment on whether it would be pursuing this idea any further.

Employment status

There are issues with the different categories of employment status for employment rights and for tax purposes. There are three categories for employment rights: employed, self-employed and “worker”. But for tax purposes, there are only two categories: employed and self-employed. 

In December 2018, the government’s good work plan committed to improving the clarity of the employment status tests. This followed on from the Taylor review which recommended that the employment and tax frameworks should be aligned as much as possible and maybe set in law. However, this government has yet to respond formerly to the employment status consultation published in February 2018.

The OTS is interested in going further down this path, in particular in relation to the possibility of a statutory definition of employment for tax purposes, and whether it would be practicable or desirable for this also to apply for employment law purposes.

Income tax and NICs alignment

One of the key problem areas is the long-standing structural difference between the treatment of the self-employed and employees for income tax and NICs. The OTS considered this in two reports in 2016: one on  the closer alignment of income tax and NICs, and the implications of the possibility of employee’s NICs operating in the same way as PAYE for the self-employed. Neither report considered the very substantial difference in the treatment of pension contributions for NIC purposes.

The key areas for future consideration in relation to people whose work can realistically be done either in a self-employed capacity, through a personal service company or as an employee, are:

  • aligning self-employed people’s NICs and benefits more closely with those for employees
  • moving to an annual, cumulative and aggregate basis for employee NICs
  • bringing taxable benefits in kind into Class 1 NICs
  • aligning the definition of earnings and expenses for income tax and NICs.

The Chancellor’s response to the OTS reports was that progressing this agenda would involve a range of challenges. For example, bringing employee NICs onto an annual, cumulative and aggregate basis was estimated to involve 5.5m people paying more NICs and 7.6m people paying less NICs.

In the March 2017 Budget, the government attempted to increase the level of Class 4 NICs paid by the self-employed. The Chancellor then had to U-turn on the issue after a backlash involving the Conservative Party’s manifesto.

However, the government’s view at the time was stated as: “The current differences in benefit entitlement no longer justify the scale of difference in the level of total national insurance contributions paid in respect of employees and the self-employed. Most notably, the introduction of the new state pension in April 2016 is worth an additional £1,800 to a self-employed person for each year of retirement.”

That 2017 statement also re-affirmed the government’s commitment to abolishing Class 2 NIC but again, for various reasons, that hasn’t happened. The government needs to find a broader approach to resolve these issues and develop and communicate a package of changes that can be implemented in a more coordinated way.

The OTS continues to consider and to discuss these issues with government with a view to moving debate forward.

Conclusion

Despite numerous reports from the OTS on a wide range of issues affecting the self-employed, PSCs, micro- and nano-companies, we do not appear to be much further forward.

Alongside the OTS reports, the government commissioned the Taylor review and has issued various consultations, most notably the Employment Status consultation, which has yet to be answered. The Department of Business, Energy and Industrial Strategy also published various reports on the subject of employment status.

Various private individuals and organsiations have contributed to the debate on tax and employment status. Most recently in July 2020 professor Judith Freedman, who is now on the board of the OTS, published Tax and employment status: myths that are endangering sensible tax reform. The Institute for Fiscal Studies (IFS), meanwhile, issued Employment Status, Tax and the Gig Economy—Improving the Fit or Making the Break?

The Supreme Court is currently considering the employment status of Uber drivers, but the judgement isn’t expected for many months to come. Will it clarfy or mystify this very complex area of tax and employment law? 

Replies (9)

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By mydoghasfleas
12th Aug 2020 09:46

If there was a real desire to reform the logical step would be to abolish NICs altogether and raise the rate for income tax. Current age exemptions could be overcome by a fixed level of age allowance. Ignore the screams of, "unfair to x,y znd z" the only people who think tax is fair are those who do not have to pay it. It would leave the thorny issue of employer's NIC but look at the simplification on the individuals' side, no need to discriminate between employed, self employed, non-employed, no parallel collection structures for tax and NIC, no distinction between earnings for tax and earning for NIC.

It will not happen because no Government is going to grasp the nettle and call NICs a tax.

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By johnjenkins
12th Aug 2020 09:48

Blah blah blah blah blah. Same old, different day. The OTS said years ago that IR35 wasn't fit for purpose. It never has been and never will. It should be abandoned immediately. HMRC should not and never should get involved with employment status. it is a commercial decision. Hasn't anybody with the power yet realised all our taxation problems (lack of money in the coffers) is due to either Government or HMRC trying to screw more out of those that work hardest. Take a step back, let's get rid of all these taxes that try and cover up other problems. So let's just have a basic rate of tax, no NI, on earnings. that way if Government need more money they can put the rate up. Trouble is the electorate will then know which Government gives value for money. But isn't that what they are there for - to serve us, not for us to serve them.

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By North East Accountant
12th Aug 2020 10:17

Let's hope they don't come up with all self employed and close company directors must put themselves on the payroll for all drawings.

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7om
By Tom 7000
12th Aug 2020 11:34

OTS

How about make dividend tax 10% ie class 2 1% +class 4 nic 9% and just abolish IR35. So if you choose to work as a company, you get no employment rights, no pension etc and thats just a personal choice and let the market take its position. If you see lots of employees incorporating, double dividend tax....and close the door of the trap you just set....

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Replying to Tom 7000:
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By johnjenkins
12th Aug 2020 12:35

Yeh why not tax everybody up to the eyeballs and stifle any chance of the UK having the entrepreneurs to allow us to move forward next year.

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By matchmade
12th Aug 2020 11:59

I'm not sure NICs should be abolished: the concept of a National Insurance Scheme is still valid and it's useful to remind people of this as a major benefit and responsibility of being a UK citizen, even if it doesn't really cover the full cost of the NHS, State Pension, unemployment benefits etc. Just rolling NICs into one big income tax pot sounds tidy, but I think it's important that people understand National Insurance as a concept, as a contract between citizens and the state.

However, I think NICs should be disconnected from employment status completely and extended to everyone over 18, so they know it's a genuinely national scheme from which everyone benefits and everyone has to pay in, income permitting. The unemployed would be exempt from NICs, but students wouldn't, just as they should lose their arbitrary exemption from council tax (if they're capable of paying university fees and their living costs, they should pay to use council services just like everyone else).

The new National Insurance scheme would include a new obligation for retirees to pay in as well, at a reduced rate as they won't be contributing to pension or unemployment benefits. They will moan, but the point of this is to generate the funds to solve the social care crisis. In return for retirees paying NICs, they would all have a brand new entitlement to state-funded NHS care homes (or care-at-home services) as required by demonstrable medical and occupational health need. Care home residents or their families would of course be able to pay extra for top-up services and a better quality of accommodation if they wish.

This new system of care will mean that the mass of British citizens will be able for the first time at an affordable cost to insure themselves against developing dementia, Parkinson's, cancer, general frailty and other needs in their later years. Because everyone will be paying in, the cost per person for such insurance will be much less than buying it through a private provider (private insurance against developing dementia, for example, is extremely expensive at the moment, and only two insurers offer it). Retirees on small incomes would be protected from paying NICs by annual allowances, just as the low-paid are now.

If old people say they shouldn't have to pay, because they've "paid their fair share" etc in their working years, I simply say: no, you didn't! When they were young, there were far fewer old people than today, and a much higher young:old ratio. People also died younger, so were less of a "burden" on the state finances which working people were financing. And when they were paying in, there wasn't this new entitlement to care home funding either.

Finally, Employers' NICs will simply continue as a straight tax on employment. Some will argue the rate should be cut to make it cheaper to employ people, but there is a decent counter-argument that if you keep it the same or even make it more expensive, there will be greater incentive for employers to invest in innovation and improving productivity, which I believe has been shown to have a greater impact on long-term economic performance than keeping people employed in low-paid, low-productivity work.

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Replying to matchmade:
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By whitevanman
13th Aug 2020 19:10

I did wonder, when they recently banned Justin, where we would find the provocative, inaccurate, BS that we so loved. The wait is over!

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By andy sutcliffe
12th Aug 2020 13:07

spell check

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By Chris Pittock
18th Aug 2020 09:34

If the Class 4 (self-employed) rate of NIC was to increase to the same as Class 1 (employed) then the bulk of the IR35 problem would be removed and it would save everyone trouble and costs. The remaining issue is the ERNIC, (bear in mind the Government are already providing the Employment Allowance) and this needs to be removed for all. If you stop and consider... a Tax on employment?! Remove it and it may resolve the unemployment issue as well. We shouldn't be taxing employment, we should be encouraging it! The Government will have to balance it's books another way but don't tax employment. (ERNIC of course originally financed pensions, SSP and SMP, but pensions and SSP now have to be financed by the employer as well!)

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