IR35 and its application has been heavily criticised as being “an additional unnecessary complexity in an already unfriendly tax system” by the Association of Chartered Certified Accountants (ACCA).
This is only one of many broadsides at the tax by the forty contributors to the written evidence for the House of Lords Select Committee on Personal Service Companies (PSCs) inquiry. A minority believe that IR35 is fit for purpose if HMRC were to enforce it properly, but the overwhelming evidence comes down firmly against both IR35 itself and the taxman’s enforcement of it.
Numerous contributors highlight that it is the UK tax system that is at fault, because it treats employment and investment income differently. Many propose that a merger of income tax and National Insurance Contributions (NICs) would remove the underlying problem and make IR35 irrelevant.
Common themes in the responses to the inquiry relating to IR35 include:
- IR35 is ineffective at collecting tax, it is not fit for purpose and its enforcement is woefully under-resourced
- The root of the problem is the “structural inconsistency” of UK taxation, treating the rewards from labour and capital differently and maintaining separate income tax and National Insurance systems
- HMRC’s framework for better administration introduced in May 2012 has been a failure and, specifically, the business entity tests (BETs) do not work, are being abused by both clients and contractors and must be abolished.
A summary of the key contributions relating to IR35 and its enforcement by HMRC, which related to questions two, three, four, five and six of the Lords’ call for evidence, is as follows.
How effective is IR35 at facilitating tax collection?
“Not very,” according to the respondents to an Association of Accounting Technicians (AAT) and Chartered Institute of Payroll Professionals (CIPP) survey conducted to seek their members’ views.
The ACCA says: “Employment status, which is what IR35 seeks to establish, is not a simple binary test. In practice HMRC have tended to operate on the basis that if an individual cannot positively prove self-employment then IR35 applies, which is not strictly correct.”
“The IR35 legislation is largely ineffective,” asserts accountant Sam Corcoran. “It relies on a definition of employment that is notoriously complex and subjective. The entities required to make a judgement on whether IR35 applies are those who have most to gain if it does not apply.”
The result is that HMRC’s tax yield has steadily decreased since IR35’s introduction, as contractors have come to understand the legislation’s complexities.
Should IR35 be scrapped?
“Existing legislation needs to be scrapped and replaced with something simpler, designed to level out the rules so that there is parity between PSCs and other forms of trading,” suggests a CIPP member.
However, an AAT respondent called for all contractors working on contracts over 12 months to be put onto the payroll, and said IR35 should “put the onus back on the employing company rather than the intermediary”.
The ACCA draws attention to the negative impact of IR35, claiming that: “Significant numbers of contractors have changed remuneration patterns, or simply left the freelancing sector altogether.”
IR35 is a product of “structural inconsistencies” in UK tax law
Writing as a buyer of contractor services, Amey’s written contribution is in favour of IR35, as it “places the tax compliance risk where it belongs – with the contractor who has been paid the money”. The company continues: “Absent the PSC/IR35 structure, the ‘employer’ would have all the risk of deciding whether the engagement was one of service (employment subject to PAYE) or for services (self-employed).”
However, echoing a strong theme from many of those giving evidence, Amey also noted that, “A more radical response would be to eliminate the structural inconsistencies in UK tax law.”
An AAT member agreed, arguing that “IR35 legislation would not be necessary if NI and tax were combined. This would be the simplest way in which to cut the knot and save everyone's time and money.”
Differentiating between returns on labour and returns on capital
The ACCA echoes these statements: “The fundamental difficulty is that the UK tax system is set up so as to differentiate between employed and self-employed workers, and between returns on capital and returns on labour.”
And accountant Julius Hutson supports the need to address the fundamental problem: “If HMRC [is] not happy for individuals to set up companies and avoid paying NI by taking a small salary and dividends, then the legislation needs to be changed with regard to tax and NI on dividends.”
Office of Tax Simplification Tax Director John Whiting adds: “The ultimate solution…is to combine NICs and income tax and thus remove what is often the main tax-saving driver for using a PSC.”
The impact of IR35’s administrative and compliance burden
IR35 has a negative impact on many stakeholders, as the ACCA explains: “The danger in attempting to apply a uniform solution to unrelated problems is that neither will be fully or appropriately addressed, while incidental impacts on other users of the tax system create a net negative impact of the provisions.”
“The current law is subjective and it is unfair on our clients who believe they are dealing with their tax affairs correctly,” explains accountant Peter Disney. “The tests need to be more robust, more objective, but need to take into account the real changing way that business is transacted in the UK today and in the future.”
But the Freelancer and Contractor Services Association disagrees: “We believe that the compliance burden and administrative costs generated by the current legislation are acceptable and not inappropriate given this is part of the overall balance of costs and benefits of working on a self-employed basis running a business.”
Have HMRC’s attempts at better administration been a success?
According to the AAT/CIPP survey, the “avenues of consultation” are not working. “We have not seen any positive development since the IR35 mess was introduced despite many years of consultative work,” writes one CIPP member.
“I didn't know they had made any efforts!” wrote another CIPP member. And a respondent from the AAT adds: “From what I have seen, there has been no real improvement in administration.”
The Institute of Chartered Accountants in England and Wales (ICAEW), which is a member of the IR35 Forum created to help shape HMRC’s move towards better administration, notes that “the forum does not have policy making power and so has to work within the boundary of poor legislation”.
Widespread abuse of HMRC’s new IR35 framework introduced in May 2012
Kate Cottrell of Bauer and Cottrell, which specialises in providingIR35 and tax/NIC status advice, provides evidence of how the business entity tests (BETs) introduced by HMRC in May 2012 as part of its framework for improved administration have manifestly not worked. She says they have been manipulated and abused by both contractors and clients.
“It should be remembered that the BETs were created as a means to establish risk of a PSC being selected for an IR35 enquiry and not to establish whether IR35 applies to a particular contract.
“We now have a growing situation, not just in the public sector, where the BETs are being manipulated by PSCs, aided in some cases by organisations marketing contrived solutions, in order to achieve a low BET score in an attempt to avoid IR35.”
What are the alternatives to IR35 as it is now?
Management consultant Box Ten Ltd argued that contractors caught by IR35 should automatically receive employment rights. However, if this occurred contractors and their clients would most probably collude to ensure that there was no chance of being found inside IR35. It would be two against one and HMRC could never hope to win.
Highlighting how in his experience workers on short-term employment contracts via agency PAYE can be treated identically to limited company contractors, legal documentation contractor Mark Agombar calls for the Employment Agencies and Employment Businesses Regulations to be changed. This would “forbid” agencies supplying limited company contractors to clients who were also using PAYE contractors to reduce the scope for tax avoidance.
In conclusion, the contributors’ views in the body of written evidence are both diverse and at times contradictory. However, reading through the responses relating to IR53 leaves the reader with the overwhelming sense that IR35 is definitely not working, is unfairly penalising many genuine businesses, and HMRC’s lack of transparency is contributing to the legislation’s failure.
ContractorCalculator also submitted written evidence, and has published a summary of the contribution focusing on IR35.