Response to 'Off-payroll working: treating people fairly' report by the HOL - and why it won't make a difference to HMRC.

Some commentators have described the report into the implementation of IR35 reform as "scathing" and that it demonstrates the whole approach by the Treasury is flawed.

There is certainly an argument this is true but, without wishing to be the bearer of bad news, there is hardly anything groundbreaking in this report that HMRC & the Treasury weren't already aware of and yet are prepared to push forward with the reform regardless.

Let's dig into some of the detail in the report and try to understand how the government might react.

Disparity between employment and tax law

The report makes several references to the fact that IR35 creates a clear distinction between employment and tax law. This is absolutely correct, but its not limited to IR35 - as a whole a person's treatment for tax does not influence their employment rights.

The report recognises that it's currently very difficult to apply the correct tax treatment for those operating under Personal Service Companies (PSCs) and goes on to say, therefore, the most appropriate way to handle this would be to rely on a tribunal outcome.

It continues that, should the outcome of this tribunal identify that the PSC owner is operating as an employee, whilst they should pay the appropriate amount of tax, they should also receive employment benefits similar to that of permanent staff.

This would surely be completely unworkable for end clients as they would have the constant uncertainty of not only who they must provide benefits to on an on-going basis, but additionally for who they have to pay National Insurance Contributions (NICs).

This would likely produce a similar end result for many end clients who are currently carrying out blanket bans for PSC workers as they would simply be unwilling to carry this risk.

I can't see HMRC moving on this point, it would have far reaching consequences way beyond IR35, particularly in the gig-economy and will therefore be considered as out of scope.

More time to prepare

The report argues that, whilst it welcomes the delay from April 2020 to April 2021 due to Covid 19, businesses should be given even further time to prepare for the changes.

I think this argument is rather flawed and HMRC will simply comment that we are now effectively entering the third year that businesses have had to prepare for these changes and yet many have chosen to do nothing or very little about it.

Clearly more time is not what's required, in actual fact the government could solve much of this by providing clarity as to whether the new rules will indeed apply from April 2021 by either enshrining them in law by inclusion in the new Finance Bill or confirming a further delay or cancellation.

The currently halfway house makes it very hard for businesses to prepare when there is little certainty around whether the rules will actually come into force or not. Indeed, businesses who did use the time previously to prepare are now being punished where as those who were slower to react can carry on as normal.

I think it's unlikely, therefore, that HMRC will have any sympathy for the idea that businesses need even more time. They would also argue that end clients have had the advantage of not having had to enforce these rules for over 20 years by the time the reform does come into law.

CEST

An interesting statistic was that prior to its "upgrade" in November 2019, CEST produced a determination (inside or outside IR35) in 85% of cases, where as it now only produces one in 80% of outcomes.

Clearly this is still unworkable as a solution and has seemed to split how the market reacts; either they engage an external assessment company to carry out the tests more reliably, or they flat refuse to engage with PSCs.

Interestingly, few businesses seem to be relying on CEST wholly or at all.

It's widely been accepted that CEST still places far too much emphasis on substitution. In a large majority of cases, if answers to the questions indicate that the contractor has an unfettered right to substitution then the tool will produce an 'outside' determination.

The problem with this is that it simply does not reflect case law and in the case of NHS Digital, as an example, HMRC were able to prove that the questions on substitution had not been interpreted properly and the determinations therefore were incorrect.

This, the report says, undermines quite severely the promise of HMRC to stand by the outcome of CEST as the original inputs can be challenged anyway.

Umbrella Companies

The report describes a worrying lack of regulation in the Umbrella sector and the creation of "too good to be true" solutions.

Umbrellas provide many challenges for contractors, not least the fact that in the vast majority of cases, Employer NICs are deducted from the worker's gross pay. This seems to be at odds with tax legislation which makes it very clear that Employer NICs must be in addition to the gross salary.

If PSC owners are being taxed as an employee and the goal of the government is to drive tax fairness, then I think it's important that this changes. Currently it places all of the burden on the worker which isn't fair.

I think, and hope, that HMRC will address this with further legislation and enforcement.

The goal is to increase tax take

The committee states that its in agreement with industry that the main purpose of this change is to increase tax receipts. I don't think the government has ever denied this and states that by tax year 23/24 it should increase take by ￡1.3 billion.

This is important not least in the current environment, with the huge burden of Covid 19 on exchequer, they will look to increase take in all areas and, despite the fact that it will place extra load on companies trying to recover from the lockdown, the bottom line for the government will dictate policy.

HMRC have struggled to enforce the rules as they currently exist and the report agrees "it is likely that the changes will indeed bring greater compliance with the rules". I think this confirms why the government wishes to push forward with the reform and will continue to do so.

Not a new piece of legislation

The report talks about the fact that these changes will create a new form of employment where PSC owners will effectively pay tax as an employee but have none of the benefits.

HMRC will likely argue that nothing has changed here - it's not an issue of whether the legislation is correct but the enforcement of it.

They will argue that this change simply means it's easier and more effective to ensure wider compliance of the rules and the whilst it does place a burden on end-clients, there is a clear appetite to drive fairness when it comes to tax treatment.

Alternatives to IR35

Several alternatives to IR35 were mentioned in the report such as a flat-rate scheme where contractors deemed to be working as employees pay a flat tax rate on a quarterly basis on account.

Additionally there was the suggestion of a Freelancer Limited Company where contractors would self-certify each year as working as a freelancer and could be taxed accordingly. What incentive there would be for a freelancer to effectively volunteer to pay more tax, though, remains to be seen.

Finally there was a concept of a levy which end clients pay direct to the government if they use PSCs and would be directly linked to their output.

However, all of these approaches, as well as IR35 as it stands today suffer from the same issue. They all require a reliable test to determine one's tax status

Summary

I believe there is nothing in this report which HMRC has not already seen before. IR35 has been around for 20 years and during that time there have been multiple reviews and assessments of its effectiveness and there has only ever been two running themes.

Firstly, how does one reliably determine someone's tax status - CEST is currently the only solution government offers and clearly it's fraught with issues.

Secondly, compliance is not wide enough and must be addressed to ensure fairer taxation in the population.

I think, therefore, there is not a huge amount in the report that will cause HMRC to change direction. Hopefully they will provide businesses with enough notice to take time to prepare but I believe any hope that the government will set a new course on IR35 is, at this stage, rather futile.