IR35 is a “sticking plaster” on the structural problems of the UK’s tax system. This is according to engineering firm Amey’s tax director Robert Fort, giving evidence during the fourth session of the House of Lords Select Committee on Personal Service Companies (PSCs).
Fort warns that transferring the burden of IR35’s enforcement onto clients would “clobber the recruitment market”, and could lead to firms like Amey deserting the UK’s supply chain of contractor small to medium sized enterprises (SMEs) in favour of lower risk large consultancies.
The public sector witnesses representing the NHS and local government defended their use of limited company interim management contractors, even at senior levels. But the NHS maintains that as a result of the 2012 Treasury review into public sector off-payroll workers, NHS managers are receiving the assurance they need that those workers off the payroll are meeting their tax and National Insurance (NI) obligations.
PSC contractors are not used by clients to disguise employment
Fort emphasised that Amey uses limited company contractors for very specific purposes and not to disguise employment: “Their primary use is in specialist and professional roles to cope with specialist or temporary skills shortages or gaps in the employee base.”
He emphasised that contractors are not a structural aspect of the business adding people over the long-term, explaining that the business profiled those roles requiring full time permanent employees. Because of the heavily regulated nature of much of Amey’s work, such roles had to be filled by employees.
However, Fort acknowledged that when a contract tender requires financial modelling and legal reviews overseen by a bid manager, then people may join that team for three, six or twelve months, “typically on a temp basis and typically on a PSC”.
Three key drivers for PSC use
Fort believes that there are three key drivers for the extensive use of PSCs within the engineering and construction sectors. Operational flexibility is one: “We need access to specialist skills at short notice for a short period of time. To have that resource on the books permanently is expensive and inefficient. For peaks and troughs we depend heavily on that temp market.”
One of the other things to consider, continued Fort, is the “structural drivers of the UK tax system, which encourage people to use such structures”.
He highlighted how there is a significant difference between the tax paid by employees and that paid by freelancers using PSCs. And from an employer’s perspective, there is the issue of the cost of employers’ National Insurance Contributions (NICs).
If a tax system imposes a high tax penalty on employing people then it is hardly surprising that there are drivers for people to avoid them
Robert Fort, Amey
“If a tax system imposes a high tax penalty on employing people then it is hardly surprising that there are drivers for people to avoid them,” he added.
“Disproportionate employment rights entitlement”
The third driver is the wider issue of employment law, and what Fort labelled as “disproportionate employment rights entitlement”. He explains: “If we want someone for three to six months and give them an employment contract…that raises a whole host of issues disproportionate to the length of the relationship.”
Fort notes that employee benefits such as pensions, incentives schemes and so on require a considerable administrative structure to be built around employment, which is just not appropriate for a worker who will only be in the business for three to six months.
There is also the tax risk. If the worker is hired on a self-employed sole trader basis, but circumstances subsequently find that the worker was in fact employed, then the hirer bears the risk of paying unpaid tax. Using a PSC removes this risk.
Substitution called into question
In response to a question put by the committee about HMRC’s businesses entity tests and whether substitution clauses are commonly used by those engaged through PSCs, both private sector witnesses believed that such clauses are not genuine.
Dr Alix Thom, employment and skills policy manager for Oil and Gas UK, said that in her experience, oil and gas contractors are “engaged to work as themselves and clients would monitor this”.
Fort highlighted that Amey’s standard contracts do not explicitly refer to substitution and are contracts between two companies, although in the case of PSCs the underlying relationship would be with the individual. “Even if it [substitution] was allowed, then it would not be appropriate because we want that engineer and that bid manager,” notes Fort.
This is of great concern, particularly as greater representation of private sectors clients may have revealed that genuine substitutions are more commonplace in core contracting sectors other than engineering and oil and gas.
PSC use in the public sector not a cause for concern
Representatives from the public sector were also questioned during this evidence session, and included a team of three representing the NHS, as well as Michael Coughlin, executive director of the Local Government Association (LGA), who represented local government.
The Lords’ efforts to seek clarity on the use of PSCs in the NHS and local government were hampered by a lack of data. Coughlin highlighted that local authorities were excluded from the Treasury review and subsequent off-payroll rules introduced in September 2012. The data he presented about contractor and PSC use was provided voluntarily by LGA members, and incomplete.
The NHS is in a similar situation. Tim Sands, deputy director for NHS Pay, Pensions and Employment Services, explained that oversight organisations like his simply “don’t get involved in the level of detail” to monitor the use of PSCs. He also noted that about half of the NHS is overseen by other bodies, such as NHS England.
PSC use in the public sector robustly defended at professional and senior levels
At one point Lord Myners asked: “Am I correct in saying that in most cases of senior level workers the use of PSCs by the employer is designed to obtain the output of a product at a lower cost than if the person had been employed?”
He went on to say that in such circumstances the worker would pay a lower rate of tax than had he been employed, adding that local government and the NHS are funded by the Exchequer and it is getting lower tax receipts as a result of pursuing these policies.
Sand said that at a senior level IR35 would apply so there would be no tax advantage, but the worker would be able to secure a higher rate than if they were on the payroll. Lord Myners then asked if it “costs more to employ someone through a PSC?”
Sands and Lord Myners traded several comments on this point, but it was Coughlin who highlighted that the situation is not as simple as costing more: “It is better value for the employer/client by using a fixed-term arrangement and provides the access to specialist skills.”
Coughlin continued by stating that the payment made to a PSC may not reflect the full costs of terms and conditions of the equivalent permanent employee, when pensions, NICs and full costs of employment are added in. “The total costs [of a PSC] may not be as high as you are suggesting.”
Limited company contractor use well justified, except for substitution
In conclusion, the session did present considerable evidence to suggest that not only were PSC arrangements justified, in some cases they were essential for the continued operation of both private and public sector organisations.
The two client representatives’ treatment of the substitution issue was not helpful to contracting’s cause, particularly when there were no witnesses from other private sector industries which heavily use PSC contractors and freelancers to contradict it.
The next session is a private meeting being held on Monday 13 January 2014, and no further public evidence sessions have yet been announced. ContractorCalculator will provide news and analysis as the inquiry continues.