ICAEW slams HMRC for IR35 failings

office block
istock_bm_noskowski_aw
Share this content
Tags

Organisations including the ICAEW have called into question several key aspects of the off-payroll reforms for the public sector, before an expected move to roll them out to the private sector in the Autumn Budget.

In a letter to the Financial Secretary to the Treasury, the ICAEW stated that HMRC’s check employment status tool (CEST) was not suitable for use in the private sector.

This follows up an admission from HMRC that it has no detailed proof to demonstrate that the tool is accurate following a series of Freedom of Information (FOI) requests as part of a five-month investigation by contractor website ContractorCalculator.

In a separate letter, the ICAEW has also written to HMRC to call for clarity on the accounting treatment of IR35.

Tool ‘does not cover all scenarios’

Following the introduction in Finance Act 2017 of new rules for taxing workers’ services provided to public sector bodies (PSB) through intermediaries, where IR35 applies, the responsibility for deducting and paying PAYE and class 1 national insurance contributions (NIC) rests with the PSB.

The Check Employment Status of Tax (CEST tool) forms a key part of the procedure public sector bodies should follow to determine whether IR35 applies to an engagement.

However, after a number of FOIs HMRC stated that it holds no detailed test data on which the tool is based. “The CEST tool testing was done by a workshop,” an HMRC spokesperson told ContractorCalculator, “the only documented output of the workshops is the set of rules used by the tool.

“Our records show that HMRC has used the CEST tool to test all the cases cited in your request, but we do not have a record of how each question was answered as part of the testing, only the end determination.”

In a letter to Financial Secretary to the Treasury Mel Stride, the ICAEW stated that following the changes to the off payrolling regime for the public sector made in April 2017, the body has identified a number of problems which need to be resolved before any similar change can be considered for the private sector.

These include the CEST tool, which the accounting body believes is currently “not suitable for use in the private sector”.

“HMRC has stated that CEST does not cover all scenarios, including the mutuality of obligations master and servant test, and that the tool was designed based on public sector contracts,” the letter continued. “Further, there are also no rights of appeal for individual workers who disagree with the CEST status decision.”

HMRC has previously argued that the public sector changes have seen a rise in compliance, and are doing the job that the FA 2017 legislation set out to do in clamping down on disguised self-employment.

Last October a Revenue spokesperson told AccountingWEB: “We do not oblige anyone to use the tool but we stand by its results where correct information has been inputted in line with the guidance. If incorrect information is inputted, the results will be skewed but that has nothing to do with the reliability of the tool.”

Accounting treatment

In a separate letter, the ICAEW wrote to HMRC to call for clarity on the accounting treatment of IR35 applied to public sector contracts, before the predicted consultation on rolling out the off-payroll reforms to the private sector at the Autumn Budget.

The accounting body’s letter included questions about the accounting treatment of the contract fee in the personal service company (PSC)’s accounts, and also the treatment of corporation tax and VAT.

“At the moment there is uncertainty around how to account for the [contract] fee that is invoiced to the public sector body (PSB) because we’ve got FRS 102 and the Companies Act to comply with,” Sarah Ghaffari, the ICAEW’s technical manager (SME business tax) told AccountingWEB.

“Currently, it doesn’t seem there’s an agreed way forward in terms of whether revenue should be shown as gross or net of PAYE and employee’s national insurance, that the PSB is now liable to pay on behalf of the PSC.”

The lack of clarity around this matter is particularly concerning, according to the ICAEW’s letter, given that the government is rumoured to be consulting on the extension of the off-payroll rules to the private sector, where the numbers affected will be increased significantly.

PSCs with April year ends will also soon begin the process of preparing their accounts and may struggle with the current ambiguities of the system.

Corporation tax

Even if the accounting issue is rectified, according to Ghaffari the way the tax legislation is written means that tax relief can only be given for the amount of deemed payment in the PSC.

“This will result in a notional profit hanging around in the PSC,” said Ghaffari, “because if they’re showing turnover of, for example, £10,000 being  the gross figure they’ve invoiced the PSB, the PSC must show revenue of £10,000 but it doesn’t actually receive that because the PSB has deducted PAYE and NI.

“So let’s say the PSC receives cash of £7,500. Assuming there are no other costs, the owner takes that £7,500 out of the company as their remuneration. However, the PSC shows revenue of £10,000 there will be £2,500 hanging around in the accounts. That was never an amount received, as that is the tax paid on behalf of the individual, but that sum of £2,500 will be a notional profit in the company and CT will be due on the gross figure. And, of course, there will be no cash available in the company to pay that corporation tax.”

The ICAEW’s letter states that the body believes the tax legislation needs to be amended to allow a corporation tax offset for the full amount recorded as turnover.

VAT treatment

The ICAEW’s correspondence also calls for the ambiguity around the VAT treatment of the contract fee to be resolved.

Currently, the PSC is liable for VAT on the gross figure reported as its turnover, despite only the net amount (after PAYE deductions) being received. The PSB claims input VAT on the gross figure as this represents its cost. As a result, many small businesses are left with a VAT underpayment on their VAT account due to an anomaly in the tax and accounting rules.

Issues need to be ironed out

The inconsistencies outlined above have been raised with HMRC in a two-hour meeting between the ICAEW’s tax faculty and the Revenue before the letter was sent, with the various scenarios outlined.

According to Ghaffari HMRC is already in conversation with the Financial Reporting Council on the matter, but at the moment have not resolved the issue.

About Tom Herbert

Tom is editor at AccountingWEB, responsible for all editorial content on the site. If you have any comments or suggestions for us get in touch.

Replies

Please login or register to join the discussion.

18th Apr 2018 09:52

Thanks for this update Tom, good article.

Thanks (2)
avatar
By mkowl
18th Apr 2018 10:21

Yes thanks only got one client with a PSC contract. Just to keep it easy it is a genuine husband and wife earners ltd co, with the former on the PSC and the other on a private sector arrangement. When I read the "guidance" I saw it that both sides of the equation turnover and payments out were a disregard for corp tax purposes. The floating debit in debtors we were just going to w/o to P & L as an effective bad debt and include as a disregard. Saying that I thought worry about this after the year end - which bad news was 31st March so clarity would be useful now

Thanks (1)
avatar
18th Apr 2018 10:31

It does seem that we are doomed to see another triumph of HMRC dogma over common sense and economic benefit.

IR35 has created a whole industry providing "solutions" and the various tinkering and shifting of responsibility for testing has done nothing to curtail that.

At its heart is HMRC refusing to understand that in the modern economy, the ability of a new company to hire some specialist expertise for a short period and to have some flexibility as to whether that expertise is then retained or not, is a vital tool in the entrepreneur's box.

Equally, contractors like this way of working. They are content that the risks of no holiday pay, no training, no sick pay, perhaps no job, are matched with the choice of a (slightly) more generous tax regime.

HMRC dogma though says - not acceptable.

Why? Nobody knows.

HMRC has recently claimed that "increased compliance" is not a measure they use in determining the "success" of IR35 reform (which has seen a flight of skills from the PSBs, abandoned projects and increased costs) but every time they are asked, we get the same answers that increased compliance is worth the complication and uncertainty.

If only we had a set of MPs who cared enough to put a stop on all new reforms and instead forced HMRC to actually explain their true motives and plans and then made the rules fair and workable.

Oh wait - we have - the Treasury Select Committee is looking at HMRC performance. Given the usual pat answers and deflecting commentary we witnessed yesterday however, I'm not holding my breath.

Thanks (8)
By cfield
18th Apr 2018 11:13

I don't know why people are getting so confused about the accounting treatment of so-called IR35 pay. It seems pretty straightforward to me.

Firstly, you recognise the gross figure before deductions as turnover. You credit Turnover and debit Trade Debtors.

Secondly, unless the director wishes to challenge his deemed tax status, you treat that gross figure as salary. That avoids it suffering both income tax and corporation tax. So debit Salaries and credit Director's Loan a/c.

It is important not to actually put it through the payroll though, as the director will already be getting a P60 from the fee payer. You don't want one from the PSC as well.

You should still report it in Field 58A on your payroll software (which HMRC have finally got round to adding to Basic Tools) but this should be just a flag field. It shouldn't affect the payroll numbers or appear on the director's earnings record.

Then the cash comes in, net of deductions, so you debit Bank with the net figure, credit Trade Debtors with the gross and put the balancing debit for the deductions on the Director's Loan a/c, so he ends up with the net pay figure, just as he would if it had gone through his own payroll.

Simples. Why HMRC and ICAEW are getting so confused about this I just don't know.

Of course, the HMRC Guidance note last year proposed a totally different treatment. It said you should treat the net figure as turnover and basically ignore the IR35 deductions. This is hogwash and should be completely ignored. It flies in the face of all accounting principles and has no legal status as it is not in legislation or been endorsed by the professional bodies.

Thanks (10)
to cfield
18th Apr 2018 11:16

Surely the reason people are getting confused is because, as you say, "The HMRC Guidance note last year proposed a totally different treatment."

It's all very well saying it should be ignored, but it's a intolerable & lamentable state of affairs that the official guidance is so wrong.

Thanks (2)
By cfield
18th Apr 2018 11:27

Well, that's what happens when bureaucrats think they know our jobs better than us.

Thanks (1)
to cfield
25th Apr 2018 12:36

That is very helpful and clear. So the amount left in the director's loan account is paid out to the director as a deemed salary, outside the payroll?
How does one account for other expenses of the PSC?

Thanks (0)
By cfield
to Rebecca Cave
25th Apr 2018 13:10

It's not a deemed salary. It's actual salary. It's just that it's been taxed in someone else's payroll.

The fact that it didn't go through your own payroll doesn't affect its status as a deductible trading expense for corporation tax purposes. Nor does it make the net pay element a Deemed Payment under IR35. That only applies to turnover which is caught by IR35 but wasn't matched by salary taxed under PAYE.

The other expenses like eligible travel, mobile phone bills and accountancy fees are also treated as deductible trading expenses in the normal way.

If all or most of the PSC's turnover for the year is taxed at source under the public sector IR35 rules, that will create a loss both for accounting and tax purposes, as there will be little, if any, remaining turnover to offset the other overheads against. If the PSC paid corporation tax the previous year, then it can carry the loss back and claim a tax rebate.

Thanks (1)
18th Apr 2018 11:23

The main outcome of the change in legislation to put the onus on the public sector to enforce IR35 has been, from my own experience, the public sector, particularly the NHS, applying it incorrectly.

My clients who were caught by IR35 were already operating in IR35, there have been a number of others who are legitimately contractors outside IR35 who, due to a knee-jerk response, have had massive deductions of income tax and NI on project earnings for a fixed term, partially subcontracted, completely outside IR35 engagement.

If that is HMRC's definition of a rise in compliance then it points to them being more concerned with maximising revenue than maximising accuracy. Hands up anyone who's surprised.

Thanks (1)
By cfield
to Duggimon
18th Apr 2018 11:38

Your clients should have either suspended all further work under their contracts until the NHS Trust agreed to treat them as outside the scope of IR35, or found jobs in the private sector.

If the Trust was the fee payer, your clients could have sued them for breach of contract due to making illegal deductions not required by the legislation (which by the way obligates them to assess each person individually, not impose blanket policies).

In practice, however, most locums and other NHS contractors were herded en-masse into umbrella companies, where you sign up to being an employee, so that option wasn't open.

Thanks (2)
avatar
to cfield
18th Apr 2018 11:52

That's a sound theory but in practice, a nurse who finishes her 10 hour (employee) shift and then needs to do 2 or 4 more hours as an agency/bank nurse to ensure that she/he has an adequate income, is not in a position to refuse to work or sue the hand that feeds them.

And that's another problem at the heart of HMRC's flawed world view. They think, like you, that contractors are all highly paid people with choices and access to advisers and lawyers for when things go wrong.

The reality is that many are lower paid and have no choices, no advisers and are susceptible to being "herded" into umbrellas. If they are, then that's a tick in the box for HMRC's "increased compliance measure (that they claim not to use) and more profits for umbrella owners.

It suits HMRC to say that "tax dodgers" are well heeled people who know what they are risking. It does not suit them to show that they are hard working, necessary workers who need to contract to earn a decent wage. HMRC is prepared to throw them under the bus so long as they can show an MP that they answer the phone more than 1 time in 2.

Thanks (5)
By cfield
to G Webber CTA
18th Apr 2018 12:59

To be honest, an agency nurse shouldn't have to work through either an umbrella company or her own PSC as she is clearly an NHS employee in all but name. I believe they all have the option of working through the "bank" but the pay rates are lower so many choose the agency option instead.

No doubt this is due to the employer NI burden being dumped on the employee, but the hourly rate should still be higher than it works out for a salaried employee. It would be a whole lot simpler and cheaper for the NHS if they paid their nurses decent overtime instead of requiring them to work through agencies or the bank, simply to avoid budget constraints.

I certainly don't think all contractors are highly paid professionals. I've seen many that aren't, and I suspect these people are the real target of the IR35 reforms. A lot of them probably are disguised employees if push comes to shove, although in the NHS many locums would pass the control test given the chance.

The problem is in how the reforms were communicated and implemented. In theory all contractors should be individually assessed, either with the much criticised CEST tool or some other way, but not enough was done to stop the public sector bodies imposing blanket policies branding everyone as caught by IR35.

That was inevitable without anything in the legislation to stop it, as managers simply don't have the time, the knowledge or the inclination to sort the sheep from the goats. Also, they more or less ambushed them with these new rules, which were rushed in with undue haste.

Consequently, they have caused untold damage to the public sector by driving skilled workers away, and now they want to do the same to the private sector, all in the name of so-called fairness. I think they will find the private sector a much tougher nut to crack though.

Thanks (3)
to cfield
19th Apr 2018 08:59

You can work solely for the NHS and still be outside IR35, this could mean giving up all revenue. Even using your plan successfully could mean souring relationships with your sole or main client.

The issue for several of my clients is that the NHS did not inform them what was happening, they only asked them for their National Insurance number. The first they knew about IR35 was when they had large chunks of their earnings withheld.

There should have been a simple guide or tool for these public sector bodies to follow that gives a legally sound answer as to whether someone is inside IR35, before these laws were enacted. This clearly has not happened and the plan to roll the laws out to the private sector while still doing nothing to help the contracting bodies determine how to apply this poorly documented legislation is stupid and will result in far more people being wrongly deducted tax that simply isn't owed.

The HMRC CEST tool is neither legally binding nor fit for purpose and if it's not possible to create a better tool than that then the fault is in the poorly defined legislation.

Thanks (0)
By cfield
to Duggimon
19th Apr 2018 12:27

Duggimon wrote:

You can work solely for the NHS and still be outside IR35, this could mean giving up all revenue. Even using your plan successfully could mean souring relationships with your sole or main client.

The best solution was for locums and others unfairly affected by the blanket policies to band together and confront the NHS managers as a group demanding to be individually assessed, as was their right, or they would walk away to the private sector. Unfortunately, without a union to represent them, it is very difficult to mobilise people like this, even when they are all up in arms about it.

Duggimon wrote:

The HMRC CEST tool is neither legally binding nor fit for purpose and if it's not possible to create a better tool than that then the fault is in the poorly defined legislation.

The CEST has 2 saving graces. Firstly, for all its faults, it is actually quite generous if you can honestly give it the right answers. Secondly, they pledge to stand by it if you answer correctly and it rules in your favour.

So if you can get the client to agree with your answers (and that's a big IF for most contractors) you are in the clear.

The main reason most public sector bodies fail to use it is not because it's unfit for purpose. It's because a) they don't know about it, and/or b) they don't care about it, and c) there is nothing in the legislation to make them use it (or an alternative method of appraisal).

Thanks (0)
avatar
By NeilW
18th Apr 2018 12:33

.

Thanks (0)
avatar
By NeilW
18th Apr 2018 12:32

This will never be solved until the issue is addressed on the employment law side of the fence.

It should be straightforward. No amount of intermediaries should stop an employment relationship coming into being. In other words there should be no employment businesses, only employment agencies.

The tax consequences then follow automatically.

Once hirers realise they will end up on the hook, they will sort their contracts out.

Thanks (0)
avatar
to NeilW
18th Apr 2018 17:38

Agreed, the tax system is meant to treat everyone equally so how a senior manager can be paid through a service company when their secretary is paid PAYE is beyond me. Whether they're paid £200 or £20K per week is immaterial and the tax system has to reflect this.

Thanks (0)
avatar
to NeilW
18th Apr 2018 17:50

We should not have to look to the tax system to determine the "status" of a worker.

That should be between engager and individual and whatever they are comfortable with.

If HMRC think individual or engager is unlikely to pay over tax due, then make PAYE the default but allow both parties to appeal.

Thanks (1)
avatar
to NeilW
18th Apr 2018 17:50

We should not have to look to the tax system to determine the "status" of a worker.

That should be between engager and individual and whatever they are comfortable with.

If HMRC think individual or engager is unlikely to pay over tax due, then make PAYE the default but allow both parties to appeal.

Thanks (0)
avatar
By IANTO
to NeilW
19th Apr 2018 15:11

"The tax consequences then follow automatically"

As a long term opponent of all the provisions of IR35, in my opinion the only way to resolve this issue permanently is to have a single court which determines employment status.

Individuals should be able to apply to such a court, without prejudice to their position, to have their employment status decided.

So if some UBER drivers feel that they are an employees, then they can take their case to this court and have their employment status determined. Those UBER drivers who were satisfied with their lot, could continue as normal. Taxes and benefits would accrue depending on the judgement.

On the other hand if a consultant is challenged by HMRC over their employment status under IR35, then they should also be able to appeal to the same court without prejudice to their position. Again the judgement would determine the taxation and benefits situation.

However, such a court will never materialise, because the reason we have IR35 is that HMRC wants individuals to be taxed as employees, without being entitled to the benefits. Additionally, there are many organisations whose income stream largely depends on the continued existence of IR35 who would not support such a recommendation.

Such a court would determine that an individual is either employed, and so it would be the employer who would be liable for the taxes, or alternatively, if the court determines an individual to be self employed, then no employee taxes are due. So IR35 would automatically become redundant.

Given that HMRC doesn't want such a situation, the whole idea is pie in the sky, even if I say so myself.

Thanks (1)
avatar
to IANTO
19th Apr 2018 15:26

I think I agree that such an independent process is desirable, that vested interests in continued confusion will do their best to prevent it, ultimately it will not happen because if even 10% of the self employed in the UK wanted to use it, that's 250 judges hearing 5 cases a day, every year.

What is clear is that extending an already unfit for purpose system into a private sector where there is a risk v reward algorithm, (unlike public sector who spend our money regardless), is almost certainly going to be to the benefit of the vested interests.

Thanks (0)
avatar
By IANTO
to G Webber CTA
19th Apr 2018 16:22

"that's 250 judges hearing 5 cases a day, every year"
I can see how that figure might be derived, but why in essence should the numbers be substantially different from now?

An UBER driver or the like would only want to use this court if they were unhappy about a situation and conversely, a contractor would only want to use this court if they were challenged by HMRC under IR35. The 1st tier Tribunal and the ET are already open to such claims.

The crux would be that only one court would decide the status and so there could be no possible opposite judgement as there could theoretically be now.

However, I've always maintained that if someone caught by IR35 were to take their case to the ET, then the ET would be unlikely to come to a different conclusion, if only to save face. We can't have two courts of law disagreeing with each other!

Thanks (0)
avatar
19th Apr 2018 11:42

my understanding is that the public bodies are not legally obliged to use the CEST tool so if an individual using a PSC clearly stated in their initial discussions with a PB that they were not prepared to be engaged if the PB used the CEST tool then at the outset one key indicator (control) would help both parties establish that the contract was self-employed. this approach could only be used where there were genuine grounds for believing the contract to outside IR35.

Thanks (0)
avatar
By Mikolaj
24th Apr 2018 17:29

IR35 in the Public Sector has done more to harm the NHS than anything else, even more than Jeremy Hunt. The locum hours worked/paid in 2017/18 have dropped by a staggering percentage as doctors and senior clinicians quite rightly say "no" to umbrella companies or direct agency work and would rather stay at home than see over half their earnings spliced off to HMRC. Salaried doctor numbers/hours have not risen but remained stable throughout the UK thus these locum hours have been lost to the NHS meaning a significantly lesser service has been provided, longer waiting times for pastients and more stressed out staff. The ramifications of idiotic tax policies are now comming home to roost. HMRC have wet the bed for the NHS to put it politely. The cleaning up process is just starting. Oh if HMRC could learn from their mistakes? but that might be asking for a miracle.

Thanks (1)
By cfield
to Mikolaj
24th Apr 2018 17:46

Mikolaj wrote:

IR35 in the Public Sector has done more to harm the NHS than anything else, even more than Jeremy Hunt. The locum hours worked/paid in 2017/18 have dropped by a staggering percentage as doctors and senior clinicians quite rightly say "no" to umbrella companies or direct agency work and would rather stay at home than see over half their earnings spliced off to HMRC.

Have you got any official sources/statistics for this?
It would be political dynamite if true.

Thanks (1)
avatar
By Mikolaj
to cfield
02nd May 2018 14:43

Other than solid feedback (personal testimony) from the 50+ NHS consultants I have as clients (also locums, mainly now ex-locums), we shall have to wait on the official figures from NHS England and the National Audit Office publish an annual report on NHS staffing, but this is always up to 2 years our of date. I think an FOI request could really stir things up; the BBC's 'Inside Out' programme may well be some use on this one. Not exactly political dynamite, but laying out the realities and effects of errant tax policies.

Thanks (0)