HMRC has suggested three ways to improve compliance with IR35 in the private sector, none of which will be easy for contractors or their clients to comply with, writes Rebecca Cave.
The consultation is titled: Off-payroll working in the private sector. I feel the term “off-payroll working” implies that the correct tax treatment is to always pay the freelance worker through the payroll, which is certainly not true. Is this a case of unconscious bias by HMRC?
HMRC has also provided an IR35 factsheet which seeks to debunk some of the rumours about the IR35 rules which have applied for public sector contracts since April 2017. One of those “facts” is that its check employment status tool (CEST) has been rigorously tested in conjunction with HMRC lawyers against live and settled cases, and reflects employment status case law.
This is a half-truth at best, as independent checking of CEST by Chartergates legal services and ContractorCalculator has found that the tool does not take account of the test of mutuality of obligation (MOO). This is a vital test of self-employment, as was demonstrated by a recent IR35 win for an IT contractor over HMRC.
HMRC justifies changing the way in which the IR35 rules are applied in the private sector because it is time-consuming and expensive for it to investigate IR35 disputes. This, HMRC claims, is largely because every personal service company (PSC) must be investigated independently.
I have always believed that every taxpayer has the right to be considered individually by HMRC, and is thus required to pay tax based on their own circumstances, not according to some blanket categorisation.
HMRC also whinges that the complex supply chains involving multiple agencies means that it finds it hard to collect information from every organisation involved in the contract, and some of those agencies are not always cooperative.
Finally, HMRC complains that when it does win a case and demands back taxes plus interest and penalties, the PSC simply closes down, and the individual worker starts trading through another company. The consultation omits to explain that HMRC has the power to collect the unpaid PAYE, NIC and penalties from the directors in cases where the PSC is forced into liquidation due to deliberate errors or misstatements provided by the directors.
What’s off the table
The consultation is very clear that the underlying rules for establishing employment status will not be changed, and although the Taylor Review has made some suggestions in this area, those are not taken account of in this consultation.
In addition, the following ideas which have been put forward in the past as potential solutions to the IR35 “problem”, are dismissed as being outside the scope of the consultation:
- Employment status tied to a minimum length of the engagement – with short-term engagements (not specified how short) never classified as employments.
- A new structure called freelancer limited company – this was suggested by IPSE in 2014 and considered by the OTS in its small company taxation review in 2016.
- Client tests the employment status of the worker, and if the relationship is employment pays the employer NIC (as under current public sector rules), but the worker would not be subject to PAYE (contrary to current public sector rules).
- Client withholds tax from the contractor in a similar fashion to CIS deductions – this is a particularly bad idea, as Howard Royse has argued.
Extending public sector rules
This appears to be the favoured option for HMRC, as it believes the tweaked IR35 rules have worked well so far in the public sector.
Moving responsibility for assessing employment status onto the end client means the client will have to rely on CEST to provide an answer in the majority of cases. The consultation is asking for suggestions on how the public sector IR35 rules should be adjusted to work in the private sector.
David Kirk, an expert on IR35 and employment status, made the following points on the extension of the public sector IR35 rules to private sector contracts:
- There is a distinct lack of public confidence in CEST, which will continue as long as it produces results visibly at variance with what case law would suggest. The most recent case that HMRC have lost (Jensal Technology) was lost on this issue – and in the public sector too.
- All parties to the contract will have to rely on HMRC guidance on how to account for the tax payments by the client on behalf of the PSC under PAYE. The current HMRC guidance on the public sector rules appears to contravene both the Companies Act 2006 definition of turnover and the FRS 102 definition of revenue. Correcting these points will require a change in the law, which needs to accompany any other changes to IR35.
- There is also serious lack of public confidence in HMRC’s policing of IR35, which will not be restored as long as they keep on losing cases in the tax tribunal. So far they have lost two cases out of three this year, six cases out of eight since the new tribunal system arrived in 2009, and 12 out of 24 since IR35 came into being in 2000. A record like this suggests that some of the increased compliance that HMRC has noted in the public sector is likely to have come from incorrect categorisation, resulting from misunderstanding of the legal tests.
- In the private sector, this poor record will encourage those engaging workers to challenge HMRC aggressively in the courts. Less knowledgeable businesses will simply do what they have done in the public sector, which is to shift non-compliance to offshore umbrella companies that HMRC does not have the resources or the legislation to tackle properly.
Secure labour supply chains
An alternative approach suggested by HMRC is to require businesses to audit their labour supply chains, to ensure that all freelancers are complying with the IR35 rules correctly. There is already HMRC guidance on how to undertake due diligence checking on labour supply chains, and HMRC believe that some of these checks could be adapted to the IR35 rules, for example:
- checking the agency rules have been applied, if appropriate; and
- ensuring the agency has made the required quarterly reports under the employment intermediary reporting rules.
David Kirk commented: “These audit requirements would add a complex layer of bureaucracy and would be very unlikely to work in an environment where non-compliance is endemic.”
Additional record keeping
A third alternative approach is to require engagers to keep more records about the contractors they engage, such as copies of contracts, shift rotas, and line management reporting relating to the engagement. If this information was retained, HMRC would be able to quickly gather what it needs directly from the engager should it later open an enquiry into one or more contractors or PSCs.
David Kirk also believes that this level of record keeping simply would not happen in a business that has no other need to keep the information, and where the people who would need to collate it are far removed from the accounting/ tax function. He commented, “compliance officers will never be able to keep up with this, even assuming that they are themselves aware of the issue in the first place.”
This is a stage 1 consultation, and as such it focuses on policy design rather than practical aspects of regulation. The “how to” stage will be fleshed out with draft legislation, likely to be released this Autumn, with a view to passing the law in time for implementation from 6 April 2019.
However, if enough respondents emphasis that a longer lead time is needed in order for businesses to properly prepare, and for systems to be changed and tested, the implementation could be pushed back to 2020.
How to respond
HMRC will be conducting roundtable discussions on the issues raises in this consultation with representative bodies, so if your professional body has not been invited to such a discussion ask them why.
You can respond individually by email to: email@example.com
Written by: Rebecca Cave