Having identified that small business taxes act as an incentive for incorporation, the House of Lords personal services companies (PSC) committee said the government should consider combining income tax and national insurance contributions. Andrew Goodall reports.
The IR35 rules are intended to ensure that people providing services through intermediaries pay the same income tax and NICs as someone employed directly, if their arrangements amount to “disguised employment”.
But IR35 raises its own problems, said committee chairman Baroness Noakes at the end of an inquiry that began with a leading expert describing the regime’s contract-by-contract approach as “innately clumsy”. That approach can make the rules “especially cumbersome”, the committee said, and compliance requires “a sound understanding of case law”.
Many individuals “simply take a risk” that HMRC will not examine their employment status – an attitude that was “fostered” by a decreasing number of compliance investigations. Guidance for those affected “must be improved” if IR35 is to be maintained, the committee said.
Concluding a four-month investigation, today’s report found “considerable hostility” to the regime among contractors, and called on HMRC to do more to show that revenue protection provided by IR35 outweighs the cost of the legislation.
The report also recommended changes to the business entity tests, improvements to HMRC’s contract review service and a review of the membership of HMRC’s IR35 forum.
PCG, representing freelancers and contractors, called for the suspension of IR35 “while proper consideration is given to its abolition”.
CEO Chris Bryce, responding to the report, said removing the “unnecessary” legislation would allow the UK’s flexible workforce to “do what they do best – boost British business”. Bryce had told the committee that 84% of PCG members incorporate for non-tax reasons, including “limited liability, credibility in some industries and the ability to negotiate contracts”.
The committee raised concerns about lower paid workers engaged through structures that avoid a direct employment relationship. “The impetus for operating through a company can come from the engager, rather than the individual,” it noted.
The engager is not liable to pay employers’ NICs and does not have to provide employment rights. The ICAEW cited the broadening scope of employment law and new entitlements for employees as “driving the growth of PSCs”.
Responding to the report, an HMRC spokesperson said: “Many PSCs are used for genuine commercial purposes, supporting labour market flexibility, but the report also recognises that some are used for tax and NIC avoidance, underscoring the continued importance of the IR35 rules. We will continue to work closely with stakeholders such as the IR35 forum, to make the rules easier to operate in the interests of the majority of taxpayers who play by the rules.”
The committee concluded that serial contracting is “a feature of the modern British workforce” and is supported by both businesses and contractors. “We heard that although IR35 is not a significant issue for businesses, it can arouse considerable hostility from contractors.”
Several witnesses regarded the legislation as ineffective. Contractor Calculator said: “It does seem somewhat wasteful having industry experts and HMRC standing around a dead horse discussing how they can make it win the race. It’s a non-runner, and has been since inception.”
In contrast, G4S plc, Amey plc and Oil and Gas UK were supportive. “Various parties from the business sector” told the committee “very clearly” that the status quo should be maintained. But it was less clear, the committee observed, “whether this was an objective assessment of the situation or simply an appraisal of how the current rules are beneficial for their current business models”.
Amey plc told the committee that “a lot of administrative structures are built around permanent employment that are simply not appropriate for somebody who is only going to be in the business for three or six months”.
The committee recommended that HMRC:
- articulate with greater clarity the cost of IR35 compliance work and administration, and the relationship between those costs and the overall yield
- publicise the contract review service to greater effect and consider how to increase confidence in its “independence and impartiality”
- consult on improving the business entity tests to provide greater certainty
- review the breadth of membership of the IR35 forum and “go to greater lengths” to demonstrate that HMRC is “receptive to the feedback that is provided through this group”.
The committee said abolition or suspension of IR35, whilst attractive, would be “unwise if the legislation has the exchequer protection effect claimed for it by HMRC”. But it cast doubt on HMRC’s estimates and called for “more robust work”.
A second article will examine the committee’s call for “more robust work” in assessing the revenue protection offered by IR35. In the meantime, do you think peers have made a useful contribution to the IR35 debate? Please share your thoughts below.