IR35 - the next instalment

Justine Riccomini wonders why HMRC is pressing ahead with IR35 consultations for the private sector whilst in the middle of an employment status consultation.

The ink is barely dry on the submissions made to BEIS, HM Treasury and HMRC on the employment status consultation (see ICAS’ submission) and the next task is for us to respond to a consultation on IR35 (Private Sector) which closes on 10 August 2018.

This latest consultation follows the consultation of 26 May 2016 regarding IR35 in the public sector, the new rules for which became effective from 6 April 2017.

Background

The public sector regime places a new deductions and reporting responsibility on the public sector body which engages an individual providing services through an intermediary. The body must deduct PAYE and NICs from the amounts paid to the intermediary where it establishes that the individual would have been classified as an employee were it not for the existence of the intermediary.

The public body is supposed to utilise the HMRC Check Employment Status Tool (CEST) to determine employment status. Previously, the onus was on the individual to determine whether the intermedaries’ legislation (IR35) applied to their situation on a case by case basis.

According to HMRC, around £1.2bn per annum is lost in tax revenues because it estimates only around 10% of the businesses which are supposed to be accounting for their income using the IR35 Intermediaries rules are actually doing so.

They have concluded this largely because of the exponential rise in new companies via Companies House which only have one director, compared to the small amount of companies who have registered with HMRC as falling under IR35.

This tax gap is created because HMRC perceives that most service providers operating through an intermediary such as a limited company are paying themselves a salary roughly equivalent to the personal allowance, which enables them to pay just enough NICs to qualify for state pension and benefits entitlements, little or no income tax, whilst taking the rest of their income by way of dividend.

This represents a perceived loss to the exchequer of Class 1 NICs on gross taxable income from the employee, employer’s NICs and any differential payable by way of dividend tax when compared to income tax.

Meanwhile, in Scotland, Scottish income tax is levied on NSND income (such as earnings) whilst dividend taxes remain reserved to the UK Government so, from a Scottish Government perspective, it is in Scotland’s interests to maximise those paying income tax whilst minimising the tax receipts on savings and dividends income.

This has been the subject of a Scottish Parliament Finance and Constitution Committee inquiry ‘The Scottish approach to Taxation’. Wales commences its devolved income tax programme from April 2019, so a similar issue will apply there then.

IR35 in the public sector – one year on

HMRC issued the private sector consultation document on the same day as it released the findings of a report by IFF research, which was undertaken on HMRC’s behalf. The findings go against some of the existing commentary on the public sector IR35 reform, stating that the new regulations had merely a “minimal impact on how public bodies recruit”.

According to the report, an almost unanimous (97%) confidence exists amongst the public bodies surveyed that they were compliant with all aspects of the reforms by July 2017, whilst half declared they had experienced very few problems in complying.

Compare this to the study by the CIPD and IPSE which concluded that just over half of public sector hiring managers perceived skills shortages had arisen because of the IR35 (Public Sector) rules changes, and almost three quarters (71%) were facing retention issues.

The CIPD / IPSE study, which surveyed 867 contractors and 115 managers, also found the admin burden may have been adversely affected, with 80% having witnessed a rise on workloads relating to the hiring and payment of contractors.

In addition, evidence of large-scale projects being stalled or cancelled including Transport for London and the NHS was found.

To CEST or not to CEST?

The HMRC report noted the main problem was down to the difficulties in using HMRC’s “Check Employment Status for Tax” tool (CEST). Another problem revolved around disputes with agencies and the individuals themselves over what status should apply – some agencies reportedly deliberately not operating PAYE where the public authority had advised them they needed to do so.

However, some commentators have openly criticised the public sector reform, stating that the flexibility and confidence within the labour market was being compromised.

It is too early to analyse the actual impact on recruitment and retention, continuity of service and overall agility within the public sector because the vast majority of self-assessment returns have not yet been submitted for the 2017-18 tax year – the deadline being 31 January 2019.

It is also not clear whether the right decisions on status are being made by public authorities, who may simply see the whole thing as a tick-box exercise which is impeding their day to day business and productivity.

Not all freelancers and individuals invoicing through personal service companies are pseudo-employees, but public authorities may simply be making blanket decisions as an administrative easement, although the HMRC report insists that around 90% of decisions are made on a case by case basis.

HMRC maintains that 85% of the time the CEST tool gives a clear answer as to whether someone is employed or self-employed, and in the remaining 15% of cases, there is more detailed guidance and a helpline. HMRC also maintains that around 60% of the time a self-employed verdict is given based on data available from February 2018.

However, the main complaint raised by professional advisers and other bodies is that the CEST tool does not take adequate account of, or fully examine, the principle of Mutuality of Obligation (MOO) because HMRC deems this already to be present in every contract according to the HMRC solicitors, who quote the Ready Mixed Concrete case; a case which HMRC places a lot of faith in.

Despite this, HMRC has lost a number of IR35 cases in the courts and has been let down by the MOO point and other aspects of the CEST tool. In 2018 alone, HMRC has lost two out of five cases, and since IR35 was introduced in 2000, it has lost half of the 24 cases which have come to court.

Conclusion

The debate on employment status rages on and, for employers, the waters seem to be getting muddier rather than clearer. ICAS will submit its response to the latest consultation by 10 August – although it seems that moves on the operation of the intermediaries’ legislation are being made before the wider debate on employment status has even been resolved. Time will tell whether a sensible solution can be brought about.