Public Sector IR35 – alternative solutions
IR35 was introduced in year 2000 and affects tax on personal services provided through companies, and partnerships. It was introduced to stop payment for personal services by way of dividend or self employment , the tax and NIC levels in both cases being lower than employment taxes and NICs. Most contractors operate through personal service companies (PSCs).
Where the employment status test is satisfied 95% of the income the PSC receives, less allowed deductions for certain expenses, is treated as employment income in the hands of the PSC to the extent that it is paid out to the individual. Payment is deemed to be made at the end of the tax year and the tax status as to whether IR35 applied to any work done during the year is reported in the end of year tax return.
HMRCs new approach in the public sector is to require the public sector hirer to decide where IR35 applies and, where it does, for that hirer (or a supplying agency) to then treat 100% of the contractor’s invoiced amount as deemed employment income, which is now to be in the hands of the hirer or agency. The 100% rule makes no allowance for expenses.
ARC believes this entire area requires modernisation, and proper review. As a result we have developed a number of less invasive alternative solutions for supply through PSCs that achieve the objective of addressing non conformity and consequent tax avoidance yet allow general principles to remain intact. See below.
ARC also believes that tax relief on travel expenses in particular is critical to encourage temporary workers to travel further and thus facilitate maximum flexibility of resource. Our full position on recruitment supply is set out in our Post Brexit campaign launched in September 2017, this predicated on making the UK a better place to do business in. A review of this whole area in the round, and formulation of a long lasting and coordinated government policy, is essential.
Alternative options to address tax avoidance under IR35
Option 1 – Reverse the IR35 test
Under normal IR35 rules the contractor reports whether IR35 applies and the default is that it does not. Where application of IR35 is not accepted it is for HMRC to establish that the rules did apply. This means that HMRC has to start an investigation in order to have any chance of success against a contractor who fails to report that IR35 applies, is highly burdensome for HMRC and has resulted in a perceived inability by HMRC to collect proper levels if IR35 employment tax and NICs.
Proposal. Instead of the contractor reporting whether IR35 applied, IR35 should be deemed to apply in the absence of evidence to the contrary submitted by the contractor with the end of year tax return. This would place the burden of proof on the contractor instead of HMRC. On the face of it the burden on the contractor would not be inconsiderable especially if the contractor is engaged in numerous assignments during the year, but that burden could be overcome by the contractor obtaining some supportive certification from the hirer, which could be submitted with the end of year tax return.
Option 2 – Simplify the law
Currently the IR35 test is based on establishing whether services were provided by an individual personally and then, if so, whether that individual would be regarded as an employee of the hirer were it not for the existence of the intermediary in the contract arrangements. This requires a full employment status assessment which involves consideration of all contracts in the arrangements, whether there was mutuality of obligation, direction supervision and control by the hirer, and all the circumstances that a Court would normally consider to reach a conclusion. This is enormously difficult particularly for lay hirers and contractors, and it also provides significant challenges for HMRC on investigation.
Proposal. There is a case for saying that the law should be simplified in this area and both Matthew Taylor and the Commons Select Committee under the Chairmanship of Iain Wright MP are currently reviewing this general area.
Accordingly a review should be undertaken to establish a more simple and understandable test rather than basing it on employment status. For example in the agency supply sector a new test could be that the contractor has been supplied through an agency. Hirers invariably require individual skillsets rather than company services and ‘supply’ is a common factor to all these arrangements.
Whilst ‘supply’ would not apply to direct hire arrangements, the test could be extended to whether the hirer requirement necessitates use of the particular individual, which could apply in both agency and direct hire situations.
Option 3 – Payment on account
Under the original IR35 rules a contractor pays tax following the end of the tax year, albeit the Tax Rules require the deployed individual to pay tax on account assessed on a 6 monthly basis. The on account payment considers levels of tax paid in the preceding period and assumes a similar level going forwards, and HMRC collects payments on account of the assessed income tax every 6 months. Although this partially addresses cash flow for HMRC it is difficult for HMRC to extrapolate the correct amount of tax on account where the tax return reports that IR35 rules do not apply, so it makes sense for HMRC to focus on cashflow.
Proposal. The hirer or agency as the case may be deducts a reasonable amount determined by HMRC from the contractor invoice and pays the deducted sum to HMRC on account of the contractor’s eventual liability. The tax credit can be applied by HMRC to employment taxes due from the contractor company. The level of the on account payment could be adjusted to take into account whether IR35 applies, particularly if the IR35 test is simplified as we suggest at Option 2.
This option works well in combination with a reversal of the IR35 test under Option 1 and a simplification of the law under Option 2. This method already operates in the construction sector under what is known as the CIS rules, albeit levels of on account payment depend upon registration of the contractor under the scheme.
All the above options allow the contractor to remain ultimately responsible for its own tax affairs in accordance with general principles, all parties concerned have clarity and HMRC achieves its tax objectives. The deduction on account should not equate to full levels of employment tax on 100% of an invoiced sum but should allow for proper expenses which can be set under policy.