When the fix for IR35-style legislation disappoints

With the UK contracting industry expecting the announcement of a consultation to review IR35 in the emergency Budget on Tuesday, CUK spoke with Independent Contractors Australia to find out what simplified tax laws for the 'self-employed' might look like.

Similar to their UK counterparts, Australia's freelance and contract professionals have complained about a lack of clarity and consistency with legislation which, similar to IR35, was conceived by the state to tackle 'disguised self-employment.'

Such complaints have reduced since 2001, when the unpopular legislation was superseded with the passing of the Personal Service Income Tax laws, as a director of the ICA told CUK below.

In the UK, Brookson, a tax advisor to the self-employed, says UK freelancers are "unlikely" to get a similar legislative solution that will "abolish IR35 completely" in tomorrow's Budget, or one that introduces its simpler, promised replacement.

However managing director Martin Hesketh says that, at the least, UK contractors "can expect the government to commit to a consultation period to review IR35," providing "an ideal opportunity to address" the issues around the contentious legislation.

But be warned, writes Ken Philips, executive director of ICA.

Even with a UK government now conceptually seeing common sense over self-employed tax issues, expect resolution of IR35 to be difficult.

Why? Well I can confidently say that Australia's journey of achieving a resolution superior to IR35 was good, but not as we'd want.

Most crucially, understand that tax officials don't understand. That is, the idea that an individual is a business is outside their worldly experiences. I know this also, because from a decade of lobbying and working with Australian tax officials, they openly express this conceptual blank. These same Australia officials network globally and have the same culture as UK, EU and North American tax staff. I recognise that self-employed people are a hub of entrepreneurship needing encouragement. But that policy interest is not in the job specification of tax officials. And political connections won't win the day. Instead, tax officials' 'quiet words' in the ears of appropriate 'ministers' will always prevail. So it's essential to work with tax officials. We've done this in Australia.

In late 2001, Australia passed the Personal Services Income Tax laws (PSI). This abolished a series of complex tax rulings that were as messy as IR35.

The passage of the new legislation was politically explosive. On advice from tax 'experts' the 'small business friendly' Australian government proposed the so-called '80/20 rule.' Under the rule, if more than 80 percent of your income came from one source, contractors would be denied business tax treatment. The uproar was enormous. The government dumped this, inserting a 'results' test that remains today.

Under PSI, a contractor must demonstrate he/she is working for a 'result' to receive access to business-style tax treatment. It's easier than IR35, but more complex than we'd like. It has taken eight years and several legal test cases to clarify the laws for contractors working through their own companies.

However in this Australian journey our tax officials have grown to appreciate that individuals can be businesses. There's now a helpful cooperate approach with small business, though that's not to imply that PSI doesn't cause annoyance. It remains too complex; few accountants understand it, as do even fewer contractors. There's an urgent need for education.

Most worryingly is that, now, Australia's first term Labor government wants to start the whole thing up again. What they want would make IR35 look a treat! Just look at the implications for a self-employed plumber for example. Here at ICA, we've written to our prime minister asking for clarity – an approach I expect many UK contractors might make to their own PM when the ground for IR35's replacement is finally laid.

So, what's my advice for a UK government looking to replace IR35 with "simpler measures," while still preventing what it deems tax avoidance? Firstly, it's that Australia's PSI laws provide a model worth studying. But it's still not good enough. The starting point for success should be some solid research on contractors. Too much policy is driven by assumptions, and a misunderstanding of one-person companies, rather than the facts. So to British Cabinet ministers: get the facts straight, then design the policy because, in the end, it's your country's entrepreneurship that's at stake.

"It is worth considering…the risks involved if the [UK] government does make the wrong decision concerning IR35," agreed Hesketh. "For example if the time isn't taken to properly understand the self employed, freelance workforce then this could lead to another flawed and inconsistent piece of legislation being drafted."