OTS’s IR35 review expert says IT contractors face no easy answers

A ‘quick fix’ is absent in the review of IR35 because all existing data on the intractable legislation are not robust enough to quantify a neat way out, its author told CUK last night.

Kate Cottrell, at the Office of Tax Simplification, said all the available facts and figures on IR35 were not sufficiently objective or comprehensive to use as a basis for any “easy answers”.

“The biggest issue of the IR35 aspect of the report is that we just haven’t got the data,” she said. “If you go through it, we simply don’t know if there are 10,000 or 1 million people affected by IR35.

“And if you can’t establish the actual numbers affected… it will be very difficult to make a decision [on IR35 reform] unless indisputable figures can be found to back it up.”

This may be why the 82-page report prefers three changes to IR35 under a recommended merger of tax and NI, rather than proposing a “definitive ‘this is the way to go’” measure.

She added: “We were tasked to make recommendations to the chancellor, so we satisfied the review terms. But we were also told to find evidence; well, statistically that’s wanting.”

Ever since OTS’s inception, its consultative role of recommending tax simplification steps to George Osborne has meant, and still means, he is under no obligation to act on its advice.

While OTS director John Whiting has said such a rejection would be met with lots of questions from his team, the OTS’s first general principle – consensus – appears not to have been upheld.

“It is clear that consensus on specific policy options can be difficult to achieve,” said a more conciliatory OTS, established to “build consensus” among academics, businesses and their advisers.

The report reinforces: “There have been vocal calls for reform over the years since IR35’s introduction, but there is little consensus on the route to take.”

“Where there does seem to be agreement is that the current legislation is little used, and largely ‘managed round’ by contractors”.

The consensus, one employment status expert said, does not universally exist on IR35 due to the sheer diversity of the population it affects.

“You can’t have a one-size-fits-all rule – it’s not workable on a new IR35, and is extra difficult as the people it will affect can be at opposite ends of the pay scale.”

Among their own internal ranks of committee staff, advisers and secondees from the private sector, the nearest the OTS came to outright agreement was on income tax and national insurance (NI). 

As a result, OTS says a merger between the two tax systems is the “lead option” to address the employed/self-employed boundary and, at the same time, is also how to render IR35 “obsolete.”

“The merger would narrow the tax bands between self-employed, employed and incorporated and end the large tax differential,” Ms Cottrell said. “But the merger is linked to IR35 too, as it would nullify it.”

Seb Maley, freelance services manager at Qdos, says the integration of income tax and national insurance is not a new idea, but he believes it would indeed make IR35 redundant.

“Essentially employees and the self-employed pay tax at the same rate but a contractor is able to remunerate themselves by taking low salary and high dividends.

“Those dividends do not attract NICs and will only be taxed should the individual be a higher rate taxpayer,” he said. “Unification would ensure that all income, unless specifically exempt, would get taxed.”

Representing IT recruiters, the Association of Professional Staffing Companies (APSCo) condemned the recommendation: “Merging tax and NICs would erode the tax advantages of contracting.

“Contractors do not get the same rights as employees, so they need to be compensated for that. Eroding contractors’ tax benefits would make contracting considerably riskier and put many people off.”

The Freelancer and Contractor Services Association (FCSA), whose member companies include the leading service providers to IT contractors, is equally alarmed by the proposed merger.

Chairman Stuart Davis said: “The consequences of combining income tax and NICs… may throw up barriers for the genuinely self employed and disincentivise freelancers and contractors choosing to work in this way.

“Given the vital role the flexible workforce and small businesses plays within the UK economy, FCSA is concerned that some of the report's recommendations, if followed, will cause considerable damage.”

Moreover, IT contractors are unlikely to be the only victims of the alignment: pensioners and the government are already envisioned among the collateral.

Mr Maley at Qdos warned: “Unification of the two taxes is not easy to implement and will require a lot of thought as there are numerous implications to consider.

“These include ensuring that a unified rate is not impunitive for pensioners. In terms of implementing such a proposal, it could take a number of years.”

A personal tax commentator agreed: “I think it’s going to be a very brave government that stands up and imposes standard NICs; particular because hard-up pensioners rely on [NIC-free] dividends to get by in retirement.”

But Richard Baron of the Institute of Directors saw the upside: “There will be a lot of debate about merging income tax and national insurance. Until we have that debate, we cannot be sure what the best way forward will be.”

The IoD is more enthused about the OTS’s third recommendation – the creation of a new business test to remove those who pass it from IR35, so much so that Mr Baron is “disappointed” it isn’t the lead recommendation.

In front of the proposed test is option one – suspend IR35 with a view to future abolition – and option two – leave the legislation in its current form but improve the way HM Revenue & Customs administers it.

Like the IoD, the Chartered Institute of Taxation is backing option three, as the CIOT’s Anthony Thomas explained:

“If the proposed business test can be formulated in a straightforward way – and we don’t underestimate the difficulties with this – then 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. “  

Matt Boddington, a director of Accountax Consulting, which successfully defended MBF Design Services against IR35, was less convinced: “There is already such a test enshrined in case law. 

“If a more prescriptive approach is to be taken, as in all these things, the devil will be in the detail and we will be closely monitoring any proposed legislation.”

A legal firm in the contracting sector was more dismissive. It asked, “How can we believe that the addition of a new test is truly ‘simplification’?”

“Almost any change is a complication. Then look at any of the definitions being considered [for the test] and you can see how complicated it might become”.

Under the self-posed question, ‘What grounds is it simplification?’ even the OTS admitted: “The downside [of] introducing a business test will mean additional legislation, and a change to the system that all parties will need to adapt to. There are significant risks that any test may include criteria that are misinterpreted.”

A similar acknowledgement came from Ms Cottrell. Asked about the feedback from the OTS road-shows, she responded: “The message we heard is that constant change is undesirable.

“Businesses want certainty; certainty that their tax affairs are clear and accepted so they can get on and concentrate on doing business.”

According to the OTS report, scrapping IR35 (option one) would deliver “the greatest improvement, providing individuals with certainty over [their] tax status”.

Yet Accountax believes contractors shouldn’t get their hopes up: “It seems unlikely now that IR35 is in place that it could be entirely withdrawn without replacement.

“This would open the floodgates to abuse by limited companies and leave a hole in an already depleted exchequer.”

The Treasury is mindful of such abuse: while the annual yield from IR35 is estimated at £1million (based on 2007 figures), the revenue loss from a new dash to incorporate could run into the hundreds of millions. 

But Accountax says it is option two (keeping IR35 on the basis that HMRC improves how the rule is administered) that is the least creditable of OTS’s recommendations.

The PCG, set up to lobby against the original IR35 proposals of 1998, echoed: “Keeping IR35 unchanged but with improved HMRC administration is not a valid solution to IR35”.

It may be this ‘retention’ proposal from the OTS, or its focus on employees and what’s fair to them, which prompted the IoD to admit “the OTS’s conclusions may not be all the right ones”.

Signalling a similar uneasiness, the FCSA expressed a “deep concern that the [OTS] recommendations display a continued lack of understanding of the flexible workforce.”

And feeling the need to stress that this atypical workforce needs encouraging and “promoting” rather than “undermining”, APSCo chief executive Ann Swain said it had become vital to the engineering and IT sectors.

These less than positive responses will disappoint the OTS and its IR35 team in particular. “I hope that everybody can see that the IR35 review team has a really good grasp of the industry and the issues,” Ms Cottrell said.

The former tax inspector added: “Personally, it’s been a very worthwhile experience. With an open mind, we went up and down the country meeting hundreds of people affected by IR35.  I think our report reflects that. Overall, and bearing in mind our terms, we were sent on a journey; we’ve been there and this is what we found out.” 

Friday 11th March 2011