Crystal Umbrella

So, now we know: the Chancellor’s Budget documents make it clear that IR35 is here to stay. However, there is also a clear commitment to improving its administration by HMRC, in accord with one of the options raised by the OTS small business tax review.

A dedicated helpline staffed by tax specialists is to be set up and new guidance will be published clarifying the cases which HMRC consider to be beyond the scope of IR35. Furthermore, target compliance activity will restrict reviews to high risk cases and HMRC’s new approach will be closely monitored by a new IR35 Forum. The government appears to have taken heed of warnings in the OTS review that suspension of IR35 would jeopardise substantial amounts in revenue.

IR35 was introduced by the previous Labour administration in 2000 to prevent “disguised employment” by workers who received payments from clients through their own limited companies. Treated as dividends, these payments were not subject to National Insurance Contributions (NICs). Further evasions could be secured by splitting ownership of limited companies between family members, a tactic designed to reduce tax due by placing the income into lower tax bands. It should be noted that few owners of limited companies took these questionable actions, but many became subject to suspicion when IR35 became law.

Commenting on the decision to retain IR35, Crystal Umbrella’s Director of Service Delivery, Scott Illingworth, said that outright abolition at this stage would have created a policy vacuum, with no regulation at all. “This would almost certainly have led to a significant rise in non-compliance”, he added, resulting in an “even worse predicament than is the case now with an unreformed IR35 in place”.

Contractors working for umbrella companies in the Manchester area will almost certainly endorse recommendations to the Chancellor from a leading industry body in the region, as well as supporting calls for IR35 reform.

George Osborne received a statement issued yesterday by the Greater Manchester Chambers of Commerce, calling on him to ensure that he produces a “robust and convincing” budget capable of generating much-needed economic growth.

In the Greater Manchester area, there is disturbing evidence from the Chamber’s own survey covering the last quarter that domestic economic recovery in the region has, in their terms, “markedly slowed down.” Chris Fletcher, the Chamber’s Chief Executive, urged the Government to do more than repeat rhetoric about delivering pro-growth strategies. The time for talking, he insisted, is over and “the budget must be clear, bold and decisive.”

Businesses have been hampered by uncertainty for too long and this has now seriously eroded confidence since last year’s election, he added, warning the Chancellor to “avoid any temptation to simply tinker with policy.”

Mr Osborne has also received similarly robust warnings on the vexed question of IR35 reform, this time from the Chartered Institute of Taxation (CIOT). CIOT’s President, Andrew Hubbard, urged him to take decisive action on this issue, too. Although Mr Osborne is widely expected to announce the implementation of a key recommendation from the recent OTS review of small business tax – the merger of income tax and national insurance contributions – this will only be achieved in the long term. In the meantime, he must decide whether to suspend or improve the administration of the IR35; to do nothing “is simply not acceptable,” Mr Hubbard added.

The Office of Tax Simplification’s recently published small business tax review was been warmly endorsed by a leading tax group, despite early criticism from some freelancers that it had appeared to dodge reform of IR35 legislation.  Describing the IR35 section of the report as ‘fair and balanced’, the Deputy President of the Chartered Institute of Taxation (CIOT), Anthony Thomas, praised the review’s ‘constructive suggestions’.

The issues surrounding IR35, he explained, amounted to an ‘almost intractable problem’ but the report rightly recognises that taxation is neither the main nor the only driver behind self-employment through personal services companies or other arrangements.  A tax-only solution would therefore not be the right answer, he added, although he believes the proposed new business test has much merit.  If it can be formulated properly, Mr Thomas continued, “it could act as a very effective filter which would mean that a whole swathe of people would not have the worry of whether IR35 would apply to them or not.”

Amongst other proposals welcomed by Mr Thomas was the simplified tax scheme for small businesses.  In the past, Governments have resorted to a ‘sticking plaster’ approach to the issue, whereas a thorough review was necessary.  ‘Hasty and ephemeral changes’ to tax policy have driven many small firms to make distorted commercial decisions and the simplified tax scheme for small businesses will do much to redress this problem, leading to much better relations between them and HMRC.

Workers and engagers should, in a modern flexible labour market, be free to form the contractual relationships of their choice, without having them ‘second-guessed’ because the tax consequences differ from those of another possible arrangement, he added.

Although immediate reactions to the OTS review of small business taxation have been negative in some quarters of the UK’s self-employed workforce, especially in relation to IR35 legislation, the report repays a closer reading. It is far from a fudge or a missed opportunity, as some have suggested, and the recommendations have met with a cautious welcome from organisations such as the PCG.

Bearing in mind that the OTS was charged with finding “revenue neutral” solutions, it is impossible to overlook the fact that straightforward abolition of IR35 would cost the Treasury and estimated £200 million a year, the report suggests. It would also “condone the significant underpayment of tax/national insurance contributions (NICs) by some individual,” a move which the report says will be seen as “unfair” by employees.

Either of the two lead options set out in the report – suspension or reform – should be tied to a timetable for integrating income tax and NICs. Unless this structural reform occurs, the OTS insists that “the issues underlying IR35 will continue to exist, and enforcement of legislation to combat this will continue to place burdens on both tax payers and HMRC.”

Using Treasury calculations, the OTS says that aligning income tax with NICs would cost £200 million. However, it would also save HMRC £300 million a year and employers £759 million. Perverse incentives under the current system to seek spurious self-employed status amongst some individuals, who do so in largely in order to evade NICs would also be removed.

This fundamental reform, which of course is bound to take time in order to be fully tested and properly implemented, should result in much greater clarity for individuals over their tax status than exists presently.

The Office of Tax Simplification’s Small Business Tax Review is published today and contains two key recommendations for reform, which have relevance for contractors working for either umbrella companies or limited companies.

Acknowledging that IR35 legislation proved to be the “thorniest issue” raised by small business representatives across the UK during the OTS roadshows, the review also notes that “no one method of reform currently commands universal support.” Outright abolition would also require “underpinning by a much better quality of data than presently seems to be available.”

The two central pillars of the review are structural reform of the current tax system by integrating National Insurance Contributions and Income Tax, and the introduction of a radical new approach to taxation for the smallest unincorporated businesses.

Prior to structural reform of taxation, which the OTS believes will remove the need for IR35, the review recommends two alternative approaches: suspending the legislation with a view to permanent abolition (using the suspension period to investigate behaviours and costs) and preserving it unchanged but improving its administration by HMRC.  But there is also a third alternative, which may interest the Chancellor – the introduction of a new “business test” aimed at radically reducing the size of the population currently caught by IR35 legislation. The effect would be to exempt large numbers of individual contractors from the worry of an IR35 investigation.

Other areas for reform include simplifying the VAT system for small businesses undertaking international activities, improving the capital allowances regime and improving HMRC administration.

We’ll bring further details of the review in subsequent news reports.

PAYE umbrella contractors may feel relieved that they decided against working through their own limited companies in the light of breaking news concerning the Office of Tax Simplification’s proposals for IR35 reform.  According to a report in the Daily Telegraph, the OTS is likely to argue on Thursday that the Treasury should integrate National Insurance Contributions (NICs) and income tax rather than replace IR35 legislation.

The OTS has been examining a range of small business tax policies, prominent amongst which has been the previous administration’s IR35 rules, which police approximately 1.4 freelance contractors.  The upshot of this process appears to be the view that the UK’s tax legislation is so complex because the Treasury is intent on preventing people using their employment status to dodge NIC payments.

Commenting on the ‘road shows’ which informed the OTS’ review across the country, the organisation’s tax director, John Whiting, said that a recurring major difficulty expressed by small businesses stems from NICs – the very issue which drove IR35 legislation in the first place.

There is, however, likely to be a good deal of anger and disappointment amongst small firms and individual contractors affected by IR35.  The OTS is thought to favour preserving the legislation but improving its administration by HMRC, even though an option to scrap the rules and replace them with an alternative ‘business test’ will also be put forward.  The latter would exclude individual contractors from having to comply with the system.

According to the British Chambers of Commerce, IR35 has cost businesses £73 million but appears to have raised little to no additional revenue.

One of the major issues influencing whether prospective contractors chose to operate through umbrella companies or their own limited companies is the thorny issue of IR35 legislation. Introduced by the previous Labour administration in 1999, it was created in an attempt to prevent tax avoidance. In reality, because of the complex and ambiguous ways in which the distinction between employed and self-employed statuses are cast in the legislation, many freelancers have been subject to distressing and time-consuming IR35 investigations by HMRC, with the prospect of facing heavy penalties if deemed to be in disguised employment.

PAYE umbrella contractors have largely been spared these ordeals, with their status clear and their tax calculations handled by the agency. As is well known, however, the Office of Tax Simplification (OTS) was set up by the incoming Coalition government last year to consider reform of all areas of tax pertaining to UK businesses. Reform of IR35 was, from the outset, one of its principal targets.

OTS Director John Whiting has just announced that his organisation will provide a report on its review of UK taxation ahead of the March 23^rd Budget. However, he warned that contractors seeking an immediate reform of IR35 will need to be patient – proposals for a successor to the widely disliked legislation will need “bottoming out” time after the budget to assess their implications.

The OTS final report is due in the summer, and Mr Whiting was clear that he wishes to come up with true improvements by then on what is broadly considered to be an excessively burdensome regime.

In a survey of small business owners, which include contractors owning Limited Companies, The Federation of Private Business (FPB) has discovered that over half of them (57 per cent) are prepared to pay more tax in exchange for a simpler and fairer tax system.

Of those polled, 50 per cent said that they would pay more under a simplified tax regime provided it prevented tax avoidance by their bigger competitors. The latter often have the resources to exploit tax loopholes geographically. Almost half of them said they would tolerate higher tax payments if legislative red tape were reduced.

The FPB’s Chief Executive Phil Orford noted that the cost of complying with the UK’s labyrinthine tax system is so high – in terms of time, money and the vagaries of IR35 legislation – that many small business leaders are of the view that a little more tax would be a “price worth paying” if the system were to be simplified. He added that if the government is serious about its commitment to stimulating small business growth, a streamlined tax administration should be a top priority.

Mr Orford was scathing about current tax loopholes, which hugely favour bigger firms. Larger retailers can, for instance, set up shop in places like the Channel Islands, where they proceed to deliberately undercut smaller shops and internet retailers, a practise which leads to flagrant tax abuses and distorts competition. The recent plans announced by HMRC to clamp down on tax avoidance fall short in several areas, including this one.

Reforms to incentivise small business growth are “desperately needed,” he went on; small firms need to invest their time and money in expansion and future planning rather than in an unwieldy and unfair tax system.

Contractors have been vocal for many years now regarding the IR35 tax rule and their wish for its abolition. Now the Institute of Directors have joined the campaign for the intermediaries legislation to be repealed.

Handing a paper to the Office for Tax Simplification (OTS), the IoD referred to IR35 as “a serious problem”. They pointed to investigations which find contractors to be inside IR35 and the subsequent effect on organisations who have hired them, when the taxman comes knocking for PAYE and NICs. It is the belief of the IoD that tIR35 should be replaced with a specific test for contractors based on their working practices. They also believe an initial screening test should be introduced.

Speaking to Contractor UK, Richard Baron, head of tax at IoD commented:
“We want to take as many businesses as possible out of the scope of the replacement for IR35 in order to minimise the hassle for businesses. If a large number of businesses could take one look at an initial screening test and know straight away that they do not need to worry [about the contractor’s IR35 status], that would be very helpful.”

Speaking about the introduction of a test for contractors, the group told OTS: “The test would however need to be one that would allow most contractors to be confident of their likely status for a tax year, or for an engagement, while the year was in progress or before starting the engagement. Otherwise they might not put enough money by to cover tax and national insurance (NI) liabilities.”

IoD concluded their submission by stating: “The managed service companies’ legislation, which was necessitated by the impracticality of applying IR35 on any large scale, has tackled the bulk incorporation of whole workforces. There is a case for some replacement for IR35… [but the legislation has] has turned out to be a bad solution to a problem that has shrunk”.

The investigation into the effectiveness of IR35 and possibilities for its replacement is still at the forefront of most contractors’ minds. During question time in the House of Commons last week, David Gauke, Treasury Minister, confirmed that the Office of Tax Simplification will have submitted its report to the Chancellor before the Budget next year. This means the future of IR35 will be included in next year’s Budget.

This confirmation came as Mike Freer MP questioned the steps being taken by the government to keep to their promise of simplifying the current taxation system. Mr Gauke responded: “The Government are committed to simplifying the tax system. To help to achieve that, the Government have established the independent Office of Tax Simplification. Business and tax professionals have also consistently pointed to the way in which tax policy is developed, legislated and implemented as a contributing factor to overall complexity. We published a discussion document alongside the June Budget setting out proposals for a new approach to tax policy making.”

Mr Freer then asked specifically about the progress of the OTS investigation into tax reliefs and IR35. Mr Gauke responded: The OTS is looking at two areas. One is reliefs and exemptions, and although the timing of the publication is to be finalised and that is a matter for the OTS, there will be an interim report, I believe in November, on this area. With regard to the reform of small businesses, including IR35, the OTS intends to report in time for the Chancellor to take into account its views in preparation for the Budget.”