The House of Lords Economic Committee's review of the proposed extension to the IR35 Off-Payrolling rules, 'Off-payroll working: treating people fairly', concludes that the rules are flawed and the government should re-think tax and employment status. It also makes some radical recommendations for short-term tax fixes.
The committee's review of evidence was cut short by the events of COVID-19 and the government's subsequent announcement the extension of the Off-Payroll Working rules would not be applied to private sector engagements until April 2021. Noting that no changes have been made to IR35, this continues to apply.
In its review the committee found that:
- The growth in self-employed people and Personal Service Companies (PSCs) partly assisted by the growth of the gig economy has in some cases come at the expense of employment protections for workers.
- Trying to address all the issues raised from a tax perspective alone is unlikely to deliver the optimal solution.
- The non-tax issues were considered in the 2017 Taylor Review of Modern Working Practices.
- Off-Payroll rules build on a flawed system, IR35. They separate employment status for tax purposes from employment status under employment law.
- It is unfair that contractors within the rules are treated as employees for tax purposes but do not qualify for employment rights, thus creating a class of 'zero-rights employees'. The government is replacing one unfairness with another.
The committee says that it supports IR35’s original policy aims of trying to ensure greater fairness in the tax system, and of preventing some contractors and client businesses from gaining an unfair tax advantage.
Highlights and recommendations of the review
The committee noted that the government has yet to respond to its own 2018 consultation on Employment Status, "The lack of strategic co-ordination on this issue across Government and between Departments is highly regrettable." It suggests that the government should:
- Carry forward its work on the Taylor Review, to develop the review’s ideas into legislation that is responsive to the changing labour market and works across both tax and employment law.
- Undertake an independent review of the implementation of the Off-Payroll rules in the public sector and an analysis of the impact of those rules on the labour market.
- Improve support offered by HMRC in determining status.
According to HMRC’s own forecasts, improved compliance could bring as much as £4.1 billion by 2024/25 to the Exchequer. The value of this potential tax take requires any measures to improve compliance to work effectively for contractors, clients and HMRC.
It welcomed the Government’s decision to postpone the start date for extending the Off-Payroll rules to the private sector to April 2021.
Alternatives to IR35 and Off-Payrolling Working rules
The committee notes a series of alternatives ways to tax contractors and it propose that the government implements "one of the simpler, less burdensome alternatives to the Off-Payroll rules that stakeholders have advanced".
Alternatives mooted include:
- A flat-rate withholding tax. Tax is deducted by the fee payer, similar to the Construction Industry Scheme.
- A freelancer limited company (FLC): a proposal by the Office of Tax Simplification which would impose a set salary requirement.
- A levy paid by engagers, or a levy paid by both PSC and the engager to make up for lost Primary and Secondary National Insurance.
- A statutory employment test.
The committee also has in mind alternative measures:
It recommends that the government design a short-term means of raising revenue that will not prove burdensome for businesses as they emerge from the COVID-19 pandemic and a long-term alternative solution to the Off-Payroll Working rules.
In so doing, they should apply six principles. Any alternative to the Off-Payroll Working rules should be:
- Certainty: The complexity of the Off-Payroll rules and the limitations of the Check Employment Status for Tax (CEST) tool mean that it is difficult for clients and contractors to be certain about their position. All parties should have certainty about the tax treatment that will apply.
- Simplicity: The Off-Payroll rules are too complicated. Any solution should be as simple as possible.
- Fair: The proposed Off-Payroll rules are unfair because they treat contractors as employees for tax purposes only, essentially creating 'zero-rights' employment. Treatment as an employee for tax purposes should only apply where there are employment rights and risk-sharing between employer and contractor.
- Supportive of growth: Any solution should respect and preserve the flexibility that exists within the UK labour market.
- Administratively straightforward: The burden that the Off-Payroll rules impose on clients is unreasonable. Any alternative needs to be straightforward to operate and not excessively burdensome to administer.
- Enforceable: With limited resources, IR35 became impractical for HMRC to monitor and enforce. Any new proposal should be manageable for HMRC. (Paragraph 177)
The committee's final recommendations could raise the odd eyebrow. The idea of 'one of the simpler, less burdensome alternatives' to IR35/Off-Payrolling is difficult to imagine. Perhaps a statutory employment test would fit that bill. What also is this magic thing; the 'short-term means of raising revenue that will not prove burdensome for businesses as they emerge from the COVID-19 pandemic'? Is this a suggestion for some new one-off tax?
The House of Lords committee was heavily lobbied by anti-IR35 groups and its report does not consider the wider impacts of the use of abusive tax avoidance schemes which have been such a fundamental feature of the PSC contracting market over the last two decades and ultimately have to be the reason for the introduction of the extended Off-Payrolling rules. HMRC, whether by coincidence or not, have published the results of research conducted into that aspect this week too. That makes interesting reading in contrast to the Lord's review.
Useful guides on these topics
COVID-19: Government support tracker
This rolling tracker covers measures announced by the government to support individuals and businesses, as we get through COVID-19.
Off-Payroll Working: At a glance
What is off-payroll working? What is IR35? What are the tax rules for off-payroll working or IR35? How do you check employment status? What is a personal service company?
Employment status checklist
The employment status of an individual worker depends on whether the individual is engaged by the engager under a 'contract of service', or a 'contract for services'.
Personal Service Companies (PSC) & tax (subscriber)
A Personal Service Company (PSC) derives its income from the activities of one individual. It is also a close company for tax purposes.
The special tax rules apply when a worker supplies their personal services through an intermediary trading vehicle such as a company or partnership to an end client.
Off-Payroll Working: PSCs & Public Sector Engagers (subscriber)
The 'Off-Payroll Working' rules moved IR35 to public sector engagers in April 2017.
Off-Payroll Working: PSCs & Private Sector Engagers (subscriber)
The Off-Payroll Working rules only apply in cases where, if you worked directly for the end client you would be deemed to be its employee in terms of the employment status tests.