A leading tax expert called for clarity over the rationale behind IR35 yesterday, as a Lords committee’s call to re-examine the “longer term case” for combining taxes on income and NICs was backed by AccountingWEB members. Andrew Goodall reports.
Patrick Stevens, tax policy director at the Chartered Institute of Taxation, told AccountingWEB: “At the moment it seems to be that if the relationship between the person doing the work and the end user would be employment if there were no entities in the way, then the total amount of tax and NICs to be paid should be the same as if there were no entities in the way. That is what IR35 aims to achieve. If this policy is to remain the same the only question is how to enforce it better.”
He added: “If the intention is to change the policy so that inserting a company in this situation will change the basis of taxation as though someone were effectively self-employed, then everyone should be entitled to that and all employees who set up such a structure can have a more favourable tax position.”
Commenting on yesterday’s report on AccountingWEB, Tonyleigh said the real purpose of IR35 was to stop contractors paying themselves dividends free of NICs. Rather than do this by changing the NIC rules, he suggested, the government had introduced “the cack-handed employment status tests we have today”.
GazCol said IR35 had been “manipulated into something far above and beyond what it was ever intended to resolve”, but Ringi argued that removing it would “send a signal that anybody could avoid having to pay NIC by using a company”. The only sensible option was to combine income tax and NICs.
Peers called on HMRC to do “more robust work” to show that revenue protection provided by the IR35 regime outweighs the cost of the legislation.
‘Service company’ questions
Committee chairman Baroness Noakes said a general lack of information on the use of PSCs was due in no small part to an absence of reliable information collected by HMRC. “This could be rectified by amending the personal tax return and employer year-end declaration and making the questions on service companies compulsory, rather than optional,” she said.
HMRC had told the committee that 1,000 individuals had completed the tax return question for 2011/12 but 120,000 employers answered “yes” to the P35 question, indicating that they were a service company. This was “some way” from HMRC’s 200,000 estimate for the overall PSC population, the committee observed, although HMRC had suggested a number of reasons for non-completion.
The committee noted the absence of a detailed articulation of what “service company” means, adding that HMRC – which did not insist that taxpayers answered the questions – had missed an opportunity to raise awareness of the tax consequences of operating through a PSC.
HMRC had failed to substantiate its estimate of £550m tax and NICs at risk in the event that IR35 was abolished or suspended, Noakes said. Yet the deterrent nature of IR35 was its main rationale.
Based on 2010/11 data, HMRC put the “total estimated fiscal risk” at £550m, comprising an exchequer yield of £30m and exchequer protection of £520m.
Giving evidence on behalf of HMRC’s direct business tax team in February, Peter Lumb said HMRC considered that if IR35 were removed about 220,000 directors would take more of their income as dividends, reducing their tax and NIC bills by about £500 each. In addition, about 55,000 people who are now directly employed would provide their services through a PSC, reducing their liabilities by about £8,000 each.
Asked whether HMRC was engaging in anything more than guesswork, Lumb cited limited research conducted by the Office of Tax Simplification (OTS) and HMRC’s own evidence on tax-motivated incorporation.
But Lumb added that “there is quite a lot of uncertainty in the evidence base for this costing”.
Yesterday’s report called on HMRC to publish a detailed assessment of the exchequer protection figure and of the costs that taxpayers incur in dealing with IR35, to enable “a better assessment of whether the legislation is having the intended effect and is proportionate”.
The committee said it was not clear how the figure of £500 per director had been calculated: “In respect of the 55,000 employees who would move to incorporate in the absence of IR35, we were told that this represented 4% of employees who earn over £50,000. We were also told that the OTS had estimated that 1.8% of individuals with an employment income of between £50,000 and £150,000 might incorporate in the absence of IR35.
“HMRC made it clear repeatedly that these overall figures were only estimates based on the available evidence. Given the critical importance of these calculations in justifying the existence of the IR35 legislation, we were of the opinion that more robust work was needed in this area.”
Suspension would be ‘unwise’
Suspension of IR35 with a view to permanent abolition, alongside a commitment to integrate income tax and NICs to reduce the tax motivation for incorporation, was one of three options suggested by the OTS in its March 2011 interim report on small business tax. Budget 2011 announced that IR35 would be retained, but the government undertook to improve administration of the regime.
The Lords committee stressed that the structure of the tax system for small businesses provides “an incentive for taxpayers to arrange their financial affairs in order to minimise the amount of tax and NICs paid”.
It concluded that abolition or suspension of IR35, whilst attractive, would be “unwise if the legislation has the exchequer protection effect claimed for it by HMRC”.
OTS director John Whiting had suggested that any suspension could be lifted in the event of a “marked move up in behaviour that would blatantly be caught by IR35”.
The committee added: “Whilst we recognise the complexities in merging income tax and NICs, 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 NICs.”
Does the Lords committee report strengthen the argument for suspension or abolition of IR35, or is an overhaul of small business tax and NICs the only solution? Please share your thoughts below.