Government review finds current IR35 rules are not working
Identifying employment status for both tax and employment rights purposes has always been contentious. In 2000 IR35 (also known as the intermediaries legislation) was introduced to address the taxation of workers who operated their own companies (known as personal service companies) and engaged themselves as a worker of the company. The legislation was an attempt to limit the number of individuals setting up such companies in order to avoid paying an employee’s rate of tax and NICs.
But the legislation is not being consistently implemented and is “little used” according to the Office of Tax Simplification. Although HMRC has strengthened its specialist compliance teams, increased enquiries related to IR35 tenfold, and clarified the application of the rules, the number of people paying tax under IR35 has not significantly increased since the legislation was introduced, even though there has been an increase in the number of personal service companies.
The government estimates such businesses increased by 65,000 in 2012-13 alone, and that the tax and NICs losses amount to £430 a year. As a result it is reviewing the operation of IR35 and has begun by publishing a discussion document.
Personal service companies now operate in all sectors, including construction, IT, professional services such as accountants, and are also used by a number of senior executives. End user organisations use them for flexibility, and because it avoids the employment protections associated with direct employment (not to mention paying NICs). The government does not want to curtail this flexibility unnecessarily but does want to increase the level of compliance.
The government acknowledges that it is a complex process to decide which contracts would be seen as contracts of employment if entered into directly between the end user and the person carrying out the work, and which are genuinely self-employment contracts. However, it is also clear that there is little reason for those working through their own personal service company to make this decision in a way which does not benefit them financially.
Given that both the worker and the personal service company can make significant savings by denying employee status and arranging a low salary and dividend payments instead, one of the questions raised is whether responsibility for determining the status of the relationship should be placed on the end-user organisation. Placing more responsibility on employers to identify the type of contract they are offering to the personal service company is unlikely to be a popular option, especially as the current test involves considering a complex range of factors.
The paper suggests that the test could be subject to time limits, which would make long term arrangements more likely to be identified as employment contracts for tax purposes. The second suggestion is a simplified employment status test looking at elements such as the supervision of the work, and who has the direction and control of the work.
Both suggestions are significantly different from existing the IR35 test, which is similar, though not identical, to the test under general employment law. The government emphasises that any change in tax rules to increase the likelihood of an employment relationship will not affect the determination of employee status for employment rights purposes. A worker’s tax status is a factor which can be considered in determining employee status for employment rights but it has never been the deciding factor.
The consultation paper accepts it is difficult to create and enforce a system that identifies disguised employment without having a negative impact on genuinely self-employed workers operating through a personal service company for legitimate, commercial reasons.
The consultation closes at the end of September.
Paula Rome is an employment partner at Shoosmiths
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