IR35 and personal service companies (PSCs) were put under the spotlight by a House of Lords committee on 25 November 2013, which discovered just how unsuccessful the strengthened IR35 enforcement has been in generating revenue for the Exchequer. HMRC also revealed that just 122 IR35 cases have been opened to date in the 2013-14 tax year
Contractor limited companies underwent their first committee examination by the Select Committee on Personal Services Companies, during which representatives from HMRC and the Office of Tax Simplification (OTS) were questioned by peers.
Despite the title and stated aim of the committee to focus on personal service companies, the questioning and evidence was dominated by IR35 and the new enforcement framework introduced by HMRC in May 2012.
According to HMRC deputy director Rowena Fletcher, IR35 has only generated about £1m in recent years and there is no estimate of the cost of enforcing IR35.
OTS director John Whiting described the legislation as “a burden” and said the direct tax yields over the life of IR35 was “derisory”. However, he does consider the additional tax yield generated as a result of the deterrent effect far outweighs the costs of implementing IR35.
Fletcher claimed that the tax legislation is still meeting its stated aim of generating an estimated £475m a year in tax, mainly as a result of the deterrent effect. But she was not able to confirm that IR35 has actually delivered the amount of tax that it was expected to.
Fletcher was supported by HMRC colleague, Robin Wythes, team leader of the Employment Status Team, who highlighted that HMRC’s specialist IR35 team of 40 inspectors and support staff created in May 2012 is targeting 250 inquiries each year.
Wythes went on to say that during 2012-13, following the introduction of the new regime, 256 cases were opened and 122 have been opened to date in the 2013-14 tax year. He also said that the average time from opening an inquiry to closing it has fallen from averages of 140 weeks to 28 weeks, and that five of the open cases are expected to go to tribunal.
HMRC currently estimates that there are 200,000 personal service companies in the UK, but admits that this is only an estimate because there is no statutory definition of PSCs. This has grown from an estimated 90,000 in 2000, when IR35 was first introduced. When asked, Fletcher confirmed that HMRC has yet to research the level of IR35 awareness among the self-employed and small businesses.
Whiting believes that HMRC’s estimates of numbers are “plausible”, but noted that when IR35 was first designed, it did not factor in what he described as the “push/pull” effect. He said that the pull is the potential for tax saving, but there are other pulls such as a genuine desire to freelance.
The push is that many clients insist that workers will only be hired if they incorporate, and that the deterrent effect of IR35 does not allow for this.
The assumption was that if someone was inside IR35, they would just get put back on the payroll, which clearly does not happen. But Whiting acknowledged that no one really knows what would happen if IR35 was not there.