Contractors are likely to be unfairly targeted by HMRC for IR35 reviews because the P35 Employer Annual Return Question 6 has lacked focus since its introduction in 2000. That is the inevitable conclusion to be drawn from the P35 Question 6 data revealed by HMRC following a ContractorCalculator Freedom of Information (FOI) request.
The FOI request reveals :
- IR35 and the Managed Services Company (MSC) legislation directly affected 0.5% of businesses in 2009-2010
- Over ten years there were between 4,000 and 145,000 'Yes' responses to Question 6 Part A
- Between 2,000 and 29,000 said 'yes' to Part B, and making 'deemed payments' or paying employment income.
- A potential hole in HMRC's reported figures of tax collected due to IR35 of around £200m
HMRC’s response shows how the P35’s Question 6 has evolved over the last decade. It also reveals that the question’s ambiguity in past years may have led to contractor limited companies being incorrectly designated as businesses at high risk of IR35.
The responses by businesses to the P35’s Question 6 have led to wildly variable results from year to year, even when the question has remained the same. This suggests that the questions have been widely misinterpreted. Therefore, HMRC basing an IR35 and Managed Service Company (MSC) legislation compliance strategy on the responses will almost certainly have led to compliant contractors having to suffer full-blown IR35 investigations.
And from this further piece of the IR35 jigsaw, there appears to be a large hole in HMRC’s accounting for additional tax revenues generated by the legislation. IR35 tax take totals published by PCG in response to FOI requests fail to correlate even crudely with the number of contractors making deemed payments or paying employment income because they have ‘self-certified’ themselves as being inside IR35.
IR35 and MSC legislation directly affected 0.5% of businesses in 2009-2010
Of the 1.7m businesses submitting a P35 return in the 09-10 tax year, the most recent results HMRC has in its database said that 97,000 firms answered ‘yes’ to Question 6 part A, “Are you a service company?”.
A further 10,000 answered ‘yes’ to part B. This asks contractors whether sufficient amounts of employment income have been paid to reduce the deemed payment to nil, or whether a deemed payment has been made in accordance with the Managed Service Company (MSC) legislation or IR35. Saying ‘yes’ to this question basically means a contractor is caught by IR35 or the MSC legislation, and is paying the additional income tax and National Insurance Contributions (NICs) accordingly.
This latest data therefore suggests that 0.5% of businesses were directly affected by the MSC legislation and IR35 in 09-10. The same percentage of businesses claimed to be making deemed payments. That means they were caught by IR35/MSC in 08-09, yet in 07-08 the percentage of businesses saying ‘yes’ to part B and admitting they were caught by IR35/MSC was more than three times the 08/09 and 09/10 total, at 1.6%
What has caused the wide variation in responses?
The spike in contractor businesses answering ‘yes’ to the deemed payment question in 07-08 is most likely to have been caused by contractor confusion immediately following the implementation of the MSC legislation.
The subsequent steep fall in contractors making deemed payments and paying employment a year later may have been due to better advice from professional advisors and guidance from HMRC. It is also possible that there was a ‘mass-disincorporation’ of former composite company contractors deciding that other trading solutions, such as umbrella companies, were more attractive.
The full response from HMRC shows that the variation in headline figures in the ten years that Question 6 has formed part of the P35 to have been huge:
- Total P35 returns submitted: 1.7m (04-05, 08-09 and 09-10) to 2.6m (03-04)
- Those responding ‘yes’ to Question 6 Part A: 4,000 (03-04) to 145,000 (05-06)
- Those responding ‘yes’ to Question 6 Part B: 2,000 (03-04) to 29,000 (07-08)
A range of issues has caused these responses to fluctuate so widely, not least the fact that the questions have not only been highly ambiguous, but also that they have changed regularly over the last decade. Part A has only been the same for the last three years.
It has taken HMRC about seven years to get the P35 question 6 to be something approaching the right wording
This wide fluctuation also suggests that it has taken HMRC about seven years to get the question to be something approaching the right wording. But how many contractors have been unfairly targeted because they ticked the wrong box due to poorly worded questions? This would have led to limited company contractors being unfairly targeted and HMRC wasting resources chasing compliant contractors.
Where has all the tax gone?
According to PCG’s FOI data from HMRC, between 02-03 and 07-08 a total of £9.2m in tax has been directly attributed to IR35. This fails to correlate even crudely with the fluctuations in the numbers of contractors caught by IR35 according to the data HMRC supplied in response to ContractorCalculator’s recent FOI request.
A contractor on a modest £35 per hour will pay approximately £10,000 more in income tax and National Insurance Contributions if caught by IR35. Between 06-07 and 07-08, the number of contractors caught by IR35 and making deemed payments increased from 6,000 to 29,000.
If each of those 23,000 ‘caught’ contractors paid £10,000 extra in tax each year, that would total £230m, which is greater than the original £200m Treasury estimate that IR35 would raise in additional tax each year and orders of magnitude more than what PCG's FOI request indicates. It also does not include any additional income tax and NICs generated by contractor choosing to trade through umbrella companies. Where has all this extra tax gone?