A report by a House of Lords committee has called on the government to address the ‘inherent flaws and unfairnesses’ in the IR35 regime and has recommended it reviews its entire approach to its plans to extend off-payroll working to the private sector from next year.
This was one of the overarching recommendations contained in the Lords Economic Affairs Committee’s Finance Bill Sub-Committee report Off-payroll working: treating people fairly published on Monday (27 April 2020).
Witnesses from CIOT and the Institute’s Low Incomes Tax Reform Group (LITRG) were questioned by the committee and their evidence is cited in a number of places in the report.
The peers are dismissive of the government’s resistance to alternative approaches and have recommended it rethink its proposed off-payroll working rules which, although delayed to April 2021, they say have already caused significant disruption.
They suggest the government adopts a short-term means of raising revenue from contractors working in the private sector as business emerges from the COVID-19 pandemic.
In the longer-term, they advocate an alternative approach from the government’s current plans that is easy to administer, supports economic growth and provides contractors and clients with certainty, simplicity, fairness and enforceability. The 2017 Taylor Review of Modern Practices is highlighted as a model to follow.
The challenges of off-payroll working
The report notes that the growth in off-payroll working – in particular the gig economy – has increased self-employment, but at the expense of employment protections for some (especially low-paid) workers.
Although the committee supports the original policy aims of IR35 (of ensuring greater fairness in the tax system and preventing contractors and businesses from gaining unfair tax advantages), the rules have been ‘ineffective’ over time. Government inaction in the face of problems with, and following reviews of, the IR35 regime was also highlighted as a concern.
The report says that it is ‘unacceptable’ for distinctions to be made between employment status for tax purposes and for employment law. This has helped to create a class of ‘zero-rights employees’ that denies contractors the rights that they would normally expect in return for paying taxes if they were employees.
They also chide the rules for off-payroll working for building on the ‘flawed’ IR35 system and say that it is not appropriate for contractors to have to ‘bear all the risk for providing the workforce flexibility from which both parties (contractors and clients) benefit’.
The peers warn that if the government accepts this divide, the off-payroll rules could ‘eliminate by stealth contractor flexible working’.
The extension of IR35 rules to the public sector has led to recruitment and retention problems. The peers are concerned that these problems will extend to the private sector when the rules take effect next year.
They cite evidence in their report of firms that have started to refuse engagements with freelance contractors without having properly assessing whether they would fall within the boundaries of the proposed off-payroll working rules.
Other concerns with the proposed off-payroll working rules considered by the committee include business preparedness in light of the challenges of the COVID-19 pandemic.
They also considered the role played by Personal Service Companies, some of which may act unscrupulously.
The report quotes comments from Meredith McCammond, who appeared as a witness before the committee representing LITRG, suggesting that there was a ‘blind spot’ within HMRC in understanding the ‘dark arrangements and engagements’ that can emerge with umbrella companies and low paid workers.
The report notes LITRG’s concerns that this can result in the ‘potential for workers to find themselves in a non-compliant umbrella arrangement’.
The peers also said that changing employment status could result in some contractors having absorb the higher costs to service companies of employer tax and national insurance costs, a situation the committee’s report describes as ‘unfair’.
The evidence provided by LITRG and others assisted the committee in recommending that HMRC engage with business and tax professional bodies to understand the risks posed by PSCs.
The report accuses the government of ‘privatising tax compliance’ by asking businesses to bear the costs and burden of determining the employment status of contractors.
Improved compliance could generate as much as £4.1 billion for the Treasury by 2024/25.
The committee says that the value of this potential tax take requires compliance measures that work for contractors, clients and HMRC.
In evidence cited in the report Colin Ben-Nathan, chair of the CIOT Employment Taxes Committee, outlined to peers that many companies in the private sector were keen to ensure that they fulfil their IR35 obligations.
However, at present, the support provided by HMRC to help businesses determine employment status, ‘falls well short of what is required’, the peers conclude.
Their comments reflect those made by Colin Ben-Nathan for CIOT in oral evidence when he described the Check employment status for tax (CEST) tool as being ‘not fit for purpose’.
The report also references concerns raised by the CIOT in July 2019 warning of the need to significantly improve CEST.
It is particularly critical of CEST, saying it falls short of what is required to determine the employment status of contractors and has left businesses facing significant financial and time burdens.
The peers cite concerns raised with the committee by Colin Ben-Nathan around the challenges involved in creating a tool that could deal ‘with a whole variety of sectors across UK plc’ and the failure to properly address concerns around mutuality of obligation.
The report welcomes an HMRC commitment to review the methodology used to model the costs to businesses and suggests that the government also uses the one-year delay to April 2021 to ‘tackle the ongoing deficiencies of CEST’.
While it expresses some optimism that compliance with off-payroll rules should improve and boost the government’s tax take, there remains a risk that some contractors will be wrongly included in the rules.
Colin Ben-Nathan, in oral evidence, noted support for the concept of a statutory employment test to provide individuals, employers and clients with certainty and ensure employment rights fairness. The committee in turn notes that such a test could provide the government with an alternative approach to its present policy.
Towards an alternative approach
The committee believes the government needs to rethink its plans for extending off-payroll working to the private sector.
Although they recommend an alternative approach, the peers also recommend that the government should confirm no later than October 2020 whether it plans to proceed with its April 2021 implementation date.
It also recommends that the government commission an independent review of the implementation of off-payroll rules in the public sector, and an assessment of how the extension of IR35 would impact the private sector.
The peers recommend that the review should consider alternatives to the government’s proposals. It should also present Parliament with a clear strategy that addresses fairness in the tax system and helps to foster a flexible workforce.
It believes that these alternatives should be ‘fairer and less risky’ and should ‘not treat individuals as employees for tax purposes’ when they do not enjoy the same employment rights.
In recommending that the government adopts an alternative to its current plans, the committee suggests that the 2017 Taylor Review of Modern Working Practices offers ‘the best long-term solution (and) opportunity to consider tax, rights and risk together’.
It cites LITRG’s disappointment that the rules for off-payroll working were being introduced before any of Taylor’s recommendations.
Meredith McCammond described this as a ‘sticking plaster’ approach that wouldn’t work. The report highlights her comments in the main body of its report that ‘a better way of dealing with all this would be to have a wholesale, comprehensive review of the system that underpins the labour market’.
The committee notes that a number of alternative proposals have been suggested over the course of the inquiry that could be simpler and less burdensome. It says that these should be considered as an interim measure.
The principles of a new approach
In recommending that government consider alternatives to the off-payroll working rules, the committee recommends that any alternative should provide:
- Certainty – So that clients and contractors are clear on the tax treatment that will apply
- Simplicity – The current rules are too complicated
- Fairness – Treatment as an employee for tax purposes should only apply when employment rights are present and the contractor and employer share the associated risks
- Support for economic growth – By respecting and preserving the flexibility that exists in the UK labour market
- Administrative ease – The rules should be straightforward to operate and not excessively burdensome to administer
- Enforceability – It should be manageable for HMRC to enforce
A link to the oral evidence provided by the Chartered Institute of Taxation and Low Incomes Tax Reform Group on Monday 10 February 2020 can be found here.
You can also access video of the evidence session on the Parliament website here.