Crystal Umbrella

Recent comments from the Prime Minister and Deputy Prime Minister have renewed hopes that IR35 may be destined for an earlier dispatch to the knacker’s yard than many contractors had supposed.

There’s a certain amount of ‘reading the runes’ involved here but, while talking to a group of small business entrepreneurs last Thursday, David Cameron mentioned three critically important words: general anti-avoidance powers. This is what he actually said while addressing the issue of tax avoidance:

“I think we need a tougher approach, one of the things we’re going to be looking at this year is whether there should be a more general anti-avoidance power that HMRC can use.”

The significance of this remark lies in the fact that, if he were serious, the implementation of a General Anti-Avoidance Rule (GAAR) – which New Zealand and Canada have already achieved – would render IR35 wholly superfluous. Many pundits consider this to be a vastly more preferable alternative to the UK’s IR35 regulations, not least because GAAR hinges on a set of principles rather than on hard-edged rules.

Contractors working through their own limited companies tend to favour the GAAR approach because it allows fresh case law to be set down around disguised employment rather than, as now, recycling inflexible definitions. Such a move could assist HMRC to avoid making the abundant mistakes they have accumulated in the past over their policing of IR35.

Nick Clegg, speaking on Radio 4’s Today show on the same day, said:

“There should be a general rule that you cannot play the system. We have received a report from an expert, Graham Aaronson, which says an anti-abuse rule is feasible.”

Contractors are divided between optimists, pessimists and stoics vis-à-vis business prospects for 2012, according to a recent PCG poll amongst its members.

23% of respondents appeared quite bullish about business in 2012, declaring that they expected prospects to improve. However, the confirmed optimists were a relative minority: the rest were split right down the middle. 38% believe that things would be much the same as in 2011 (the stoics) and 39% believe that things can only get worse. It remains to be seen, of course, which of these three turns out to be the realists.

The PCG claims that 2011 was a “tumultuous year” for PAYE umbrella contactors and other freelancers. They have had to contend with the implementation of the Agency Workers Regulations, which generated a good deal of uncertainty amongst many industry commentators who feared that it may have unintended, destructive effects on skilled temporary contractors. It was designed to protect vulnerable, low-skilled workers from exploitation, but some feared it would deter employers from using the services of high-end temporary professionals as well.

Not only that, but for contractors working through limited companies particularly, there has been ongoing uncertainty about the effects of IR35, which the Chancellor decided to retain with improved administration by HMRC earlier in the year. The reform process is underway, but the decision to keep the controversial rules means that uncertainties continue for those affected by them.

However, a number of recent polls (including the REC/KPMG’s latest Report on Jobs) suggest that demand for experts in IT contracting is rising healthily, a trend that is expected to continue into 2012.

Minutes from the last IR35 Forum on 9^th November have just been published on the HMRC website. They reveal that the Revenue intends to switch its compliance investigating priorities away from IR35 cases it considers low risk to those it believes are at the higher end of the risk scale.

The Forum was originally set up after the March Budget this year and charged with devising better ways of administering IR35 regulations. In addition to representatives from HMRC, it includes experts from a range of industry bodies, including the PCG, the REC and CIOT.

At the latest meeting, HMRC announced that it plans to publish its general risk criteria to help contractors determine whether they fall into low or high risk categories for IR35 review.

Although the proposal was generally welcomed, some concern was expressed that the published criteria may be insufficient for contractors working through limited companies to accurately gauge their risk level. Even so, there was general agreement that the shift of emphasis onto higher risk cases would be good for the contracting industry, even though some cases would inevitably end up at Tribunal.

PCG proposed a ‘tiered test’ strategy, where HMRC intervention would be dictated by clearly spelt-out indicators defining the nature of the business the contractor is involved in. This, the PCG believes, should be carefully evaluated first, before resorting to case law. It was also suggested that when evaluating risk, HMRC should consider whether or not specialist IR35 tax advice had been taken by a contractor.

The new risk profiling approach will start from April 2012 and the date of the next Forum meeting was set for 18^th January 2012.

New Freedom of Information data obtained from HMRC by the PCG reveals that the Revenue’s tax yield per individual IR35 investigation increased ten-fold over the last five tax years.

While IR35 cases yielded only £1,700 each on average until 2005/2006, the haul per case soared to almost £17,000 between 2006 and 2011. The data suggests better targeting by HMRC. In the first six years of the notorious regulations’ existence, the Revenue investigated 3,886 IR35 cases, which collectively netted £6.7 million. But between 2006 and 2011 only 322 cases were investigated, generating just slightly less – £5.4 million.

Even so, a leading chartered accountant and IR35 expert, Paul Spindler, remains decidedly underwhelmed by the figures. Over ten years, he noted, the average yield remains “shockingly low” at just £3,500 per enquiry. He shared his suspicion that many of HMRC’s IR35 enquiries have resulted in “no [tax] recovery whatsoever.”

HMRC has so far only revealed a “snippet” of the whole IR35 story, he added, making no mention of taxpayers who, like contractors working through umbrella companies, have opted for PAYE as a direct result of the legislation.

Mr Spindler’s views were endorsed by two other IR35 experts, Seb Maley of Qdos and Kate Cottrell of Bauer & Cottrell. Both believe that focusing on the apparent ineffectiveness of IR35 overlooks its “deterrent effect”, which may be the very factor that generates the most revenue for the Treasury rather than IR35 enquiries themselves.

The latter have fallen, they suspect, partly because HMRC is targeting higher risk workers, and partly because freelancers are learning how to operate outside of IR35 danger, such as taking the PAYE umbrella option.

Freelance contractors across the UK may welcome news that the body set up to improve HMRC’s handling of IR35 regulations is finally getting its teeth stuck into some real reforms.

Minutes of September’s IR35 Forum meeting reveal that HMRC has undertaken to improve four major areas of IR35 administration and wants detailed advice on how to improve its IR35 investigations, status reviews, IR35 helpline and contractor guidance.

Together, these processes lie at the heart of the reform project. Non-HMRC members of the Forum have been asked by Revenue representatives to consult their colleagues for detailed advice on each of these issues, a request which suggests that HMRC feels it has not received adequate information from its own sources thus far.

HMRC declined to share the details of its risk-profiling procedures with the Forum but has nonetheless agreed to share information about its broad risk assessment. Reading between the lines, the Forum would have preferred the former (the devil, after all, lies in the detail) but the concession can at least be seen as a step in a more helpful direction.

In addition, HMRC has agreed to draft 12 different scenarios that freelancers might find themselves in, each based on real-life events. The aim is to clearly identify scenarios that can be categorised as agreement between a contractor and HMRC, disagreement or uncertainty. At the next meeting of the Forum, which is scheduled for 9^th November, non-HMRC forum members will present their evaluations of these scenarios.

Plans are also underway to create an IR35 National Compliance Unit and a Business Educational Support Unit to supply contractors and clients with guidance on IR35.

Information on IR35, which was recently released by HMRC, reveals that contractors have a higher chance of winning the lottery than they have of being investigated under the rule.

Will the release of the information, which covers a period of 5 years, come to represent the start of the end of IR35? Due to the release of the information under the freedom of information rules, is IR35’s termination currently all but a certainty? Sadly not. It would be extremely naïve to believe that these numbers are news to the chancellor of the exchequer, George Osborne, who had the option this year to get rid of it. He instead chose to keep it, and in exactly the same form that Labour launched it over 10 years ago.

Thousands of individuals are impacted by IR35 and need to think about their IR35 standing. With merely 322 HMRC IR35 investigations within the past 5 years, the problem isn’t exactly high up on the HMRC’s list. Without a doubt, the concern of HMRC investigation prompts some people to look for advice from their accountant, to get their contracts evaluated and to join membership organisations, as well as to take out insurance protection. However, with the number of IR35 investigations at the current level, there is at present more possibility of winning the lottery than there is of being investigated.

Lots of people simply disregard IR35 and have done so for a long time. The creation of a new government provided those who have lobbied for the abolishment of IR35 with an additional chance to request its removal.

A startling decrease in the number of IR35 status reviews has occurred over the last few years, according to new data released by HMRC. The amount of tax raised through the investigations has also plummeted dramatically.

The information was disclosed in response to a request to HMRC about the number of IR35 status enquiries it has undertaken over the last five years. The figures show that 158 reviews were undertaken in 2006/7 and only 104 the following year. Subsequently, the number dropped precipitously: only 25 took place in 2008/9 and a mere 12 in 2009/10, rising feebly to 23 in 2010/11.

Tax yields from the reviews don’t always correspond to the year in which the investigations took place, but the money raised has also undoubtedly been declining just as sharply.

The HMRC data also shows that it’s not just the number of IR35 status reviews that has shrunk massively in recent years: the amount of tax yielded as a result has also nose-dived, falling from almost £2 million in 2006/7 to a paltry £155,502 in 2009/10. The sum for 2010/11 was £219,180, almost a tenth of that raised just five years earlier.

The lamentable numbers are likely to undermine any continuing justification for retaining IR35. The PCG’s Managing Director, John Brazier, said that the figures confirm what his organisation has always maintained – the tax yield from IR35 is “minimal” and the damage it has done to the UK’s 1.4 million freelance businesses “is completely unnecessary.”

Brazier believes that it is becoming increasingly difficult for the Treasury to justify the continued existence of “this unwarranted measure.” Is that a death knell tolling in the background?

The Liberal Democrat Working Group on Information Technology, headed by Cambridge MP Julian Huppert, maintains that a Nick Clegg-led government would ditch IR35.

More precisely, IR35 would be suspended to enable a data-gathering process aimed at ‘permanent abolition’ of the much-criticised legislation, a Liberal Democrat paper on the future of the digital economy argues. Entitled Preparing the Ground, the document appears to have sown as much confusion as hope amongst the UK’s contractor community. The chief reason is that it refers to the deleterious effects of HMRC rules on IT contracting but fails to mention contractors equally affected who work in other sectors.

Nonetheless, the paper constructively revisits some of the issues that could so easily succumb to social amnesia – namely, the alternatives set out for IR35 reform by the Office of Tax Simplification (OTS). In particular, it draws attention to the options the government rejected – the development of a new ‘business test’ (option one) and the immediate suspension of IR35 to gather additional information on the effects of permanent abolition (option three). This is the option the Lib Dem document argues is the preferable one.

Freelance trade group PCG endorses this view, stating “Our position remains that we support the suspension of IR35 and we look forward to discussing this new report with Julian Huppert MP who heads the report in person in the near future.”

The PCG went on to say that the Government, which Mr Huppert supports, opted in the 2011 Budget to go for option two – improved HMRC administration of the regulations. Is dissension stirring in government ranks? Watch this space – we’ll keep you informed.

In keeping with its promise to improve HMRC administration of IR35 regulations, the Government plans to set up dedicated helplines throughout the UK and staffed by specialist advisers.

Exchequer Secretary David Gauke and Office of Tax Simplification Director John Whiting were joint signatories to a letter to the OTS Chairman, Michael Jack, confirming that immediate abolition of IR35 was now off the government’s agenda, as indeed was the introduction of a new business test to assess whether or not individuals should be classified as self-employed.

As is well known amongst the UK’s contracting community, IR35 legislation has been dogged by sustained criticism for its lack of clarity over the issue of self-employment.  Many freelancers consider it excessively punitive and fatally ambiguous, so the government’s decision to retain it has not passed without some considerable controversy.  However, Chancellor George Osborne has insisted that the administration of the notorious regulations by HMRC will be substantially improved, and the dedicated helplines appear to be a clear step in this direction.

The letter makes clear that the helplines are actually part of a series of measures designed to improve IR35 administration.  Others include the publication of new guidance on the type of cases HMRC consider beyond the scope of IR35, restricting reviews to high-risk cases in order to promote a more tightly targeted approach to compliance activity, and the continuing monitoring of HMRC’s new approach by the newly created IR35 Forum.

Mr Gauke explained that the option of a new business test was discarded because, after due consideration, it was felt to be too challenging to devise in such a way that it would work for both business and HMRC.

A specialist in IT contracting has won a five-year long battle with HMRC over her IR35 status, the news outlet Shout 99 reports.

Elaine Richardson, who owns ECR Consulting Ltd, was accused in November 2005 of being a disguised employee.  As with a significant number of contractors who work through their own limited companies, she fell victim to the ambiguities surrounding IR35 from that moment onwards.  At the time, she was working as a freelance contractor for the firm Vertex Data Science; should HMRC have succeeded in designating her as a disguised employee, she would have faced a wounding tax bill of more than £50,000.

Thankfully, her recent tax tribunal found that on all three key status tests, her company was clear of IR35.  The tests – mutuality of obligation, substitution and control – clearly proved to the tribunal that ECR, in its wording, “is a genuine business and therefore not a target of the IR35 legislation.”

The tribunal ruling went on to acknowledge that ECR operates from a dedicated business area at Ms Richardson’s home, has a company domain and a website and advertises its services as a member of the PCG.  It has, the ruling continued, “… retained reserves and invested in development and has over the years taken on fixed price work for a variety of clients”.

Ms Richardson was represented by tax specialist Matt Boddington of Accountax Consulting, who expressed his satisfaction in the findings, saying that the Tribunal “had their commercial heads on and understood that contracting through a single person limited company is a prudent and sensible method of providing freelance services, and not about disguising employment”.

His views were endorsed by PCG Chairman Chris Bryce, who added that his organisation aims to “take all legitimate freelancers out of the scope of IR35”.