Lords 'slap HMRC in the face' over PSCs and IR35

A report by a Lords inquiry into Personal Service Companies has surprised the industry for reading as an indictment of the taxman rather than a nod to tighten the rules on contractors who use them.

In fact, out of the Personal Service Companies Committee’s 16 recommendations on PSCs and their impacts on tax collection, published today, 11 are critically aimed at HM Revenue & Customs.

While contractors may not welcome a few of the committee’s recommendations, such as its call to mandate the ‘service company questions’, most are likely to regard them as a fortuitous escape.

Indeed, opening the “inquiry” into PSCs in November, committee chair Baroness Noakes spoke of the importance of the state receiving all “the tax it should rightfully be receiving, from all those who should be paying it.”

But rather than putting forward new ways to boost tax collection from PSCs, such as setting a higher annual number of IR35 enquiries, the Lords say their report has ended up as a “particular examination” of HMRC.

It’s an examination that officials, potentially including those at the Treasury who the Lords slam for refusing to attend their inquiry, are unlikely to welcome, Egos, a legal firm for contractors, suggested last night.

“At first sight, this actually looks interesting… [as] it’s somewhat of a slap in the face for Her Majesty’s Revenue & Customs,” the firm’s founder Roger Sinclair said of the report.

“It’s a good thing that the Lords …spotlight that HMRC seem to be driven more by paranoid ramblings and speculation, than by hard evidence of concrete fact.”

His comments chime with many of the committee’s recommendations, notably the first. It says because the £550m that HMRC says is protected by IR35 is not a “reliable” figure, it should produce better ones.

Even allowing for HMRC’s “absence of reliable information” about PSCs (and quite apart from the fact that it initially said such a deterrent effect was £75m less), the £550m figure is unacceptable as it cannot be "directly substantiated."

Baroness Noakes reflected on these conclusions by her committee. “HMRC failed to demonstrate that they had a sound basis for the £550m of tax and national insurance that they cited as being at risk if IR35 were to be abolished or suspended,” she said.

“[As] the deterrent nature of the IR35 legislation is its main rationale, we recommend that HMRC publish a detailed assessment of this figure and we also call for an assessment to be made of the cost to the taxpayers affected by the rules.”

Put another way, the Lords say they believe that tax officials “need to do more” to demonstrate that the revenue protection they claim for IR35 outweighs the cost it imposes.

The committee adds that while the abolition or suspension of IR35 might be “attractive,” it feels that either avenue would be “unwise,” if the legislation has the Exchequer protection effect claimed by HMRC.

But one expert witness at the inquiry, the PCG, says that suspending the rule is necessary, partly on the grounds that it believes none of the proof that the committee wants to see will be provided.

“We have repeatedly asked HMRC to justify the £550m figure and the so-called 'deterrent effect’ but HMRC has been unable or unwilling to do so,” said PCG’s chief executive Chris Bryce.

He added: “It is now clear from the findings of the House of Lords Select Committee that the effectiveness of this legislation and the justification for its continued existence is built on smoke and mirrors.”

Her Majesty’s Treasury might have been best equipped to statistically justify maintaining IR35, but neither its exchequer secretary, David Gauke, nor any other Treasury official agreed to attend the Lords inquiry.  

“We were surprised by the lack of co-operation from the government,” the Lords say. “It was unfortunate that we were not able to discuss these issues [tax problems created by IR35] with a minister before making recommendations.”

Kingston Smith, a chartered accountancy firm, is also surprised at the government’s decision not to contribute to the Lords’ inquiry: “It's interesting that the Treasury refused to appear.

“This seemed to be for technical grounds, [but] you would have thought it was an ideal platform for the government to put forward its views on such a significant and growing part of the economy.”

Paul Spindler, a partner at the firm added: “It appears that HMRC considers IR35 as more of a deterrent than enforced anti-avoidance, citing a potential loss of more than £500m to the Treasury if the rules were not there. Though where these figures come from, is difficult to narrow down.”

In line with his reading, the PSC committee states that HMRC’s estimate of £520m as the Exchequer protection from IR35 represents a figure more than 17 times that of the actual yield collected by the rule.

The Lords cautioned: “There is a danger, however, that the value of this protection will diminish if taxpayers believe that HMRC are not willing or able to risk profile effectively in order to inform their compliance investigations.”

Yet overall, Mr Spindler and especially his PSC clients must be relieved, as in December he feared that the committee would recommend a tightening up of the IR35 rules, or an increase in the number of investigations.

If the Revenue had either of these objectives, then the committee suggests that either the department misunderstood a related question by the Lords or simply ‘shot itself in the foot.’

In particular, the Lords report says that when asked by the inquiry if more resources to enforce IR35 would be beneficial, HMRC “did not hold” that it would, contrary to “much of the evidence” submitted by other expert witnesses.

The committee adds: “It was also regrettable that HMRC were unable to provide precise costing for the current compliance and administrative work that directly relates to IR35.

“We were told that spending on the current compliance team of 40 people costs approximately £700,000 a year, a team which collected £1.1m in 2012–13 as a result of uncovering non-compliance with IR35.”

Keen to head off suggestions that its officials raise a mere £1.1m if they spend £700,000, HMRC told the committee that it was unfair to make such a deduction, partly as the compliance team work on other rules.

The Revenue’s caveat, however, appears to have been sounded too late to the committee, which states: “HMRC did not convince us that the resources currently allocated were sufficient to ensure compliance with the IR35 legislation.”

As a result, the Lords recommend that HMRC “articulate with greater clarity” the costs they incur from IR35 compliance efforts and administration, and the relationship between those costs and the overall yield gained.

Simon Dolan, founder of SJD Accountancy, reflected on this -- recommendation seven: “Reading between the lines [of their report], it seems that the committee rather think that IR35 is a bit of a waste of time and money for the small sums it collects.”

The Lords were much less equivocal in their assessment of HMRC’s current IR35 guidance, which they condemned as “far from satisfactory.”

They explained: “If IR35 is to be maintained, the guidance which is currently made available to those affected must be improved.

“We recommend that HMRC undertake a full consultation on how the Business Entity Tests could work better to provide greater certainty to taxpayers.

“HMRC’s Contract Review Service needs to be improved; in addition they should provide greater clarity as to the questions asked concerning service company usage on annual tax returns.”

The latter point, covering the committee’s third, fourth, fifth and six recommendations, relates to the ‘service company’ questions, asked by HMRC on both the personal tax return and the RTI employer year-end declaration.

The Lords say in their report: “HMRC told us that although they may consider any lack of completion as a risk-indicator, they do not see it as a ‘key question’ that would render the individual liable to penalties for an incorrect completion.

“We did not understand HMRC’s rationale for asking questions on the tax returns but not considering their completion as important or insisting that taxpayers complete them.”

As a result, the Revenue has been called by the Lords to look again at whether it needs to ask the questions; mandate them with the threat of penalties if it does, revise the accompanying guidance notes but -- if it doesn’t need to ask them -- remove both the notes and the questions.

At the same time, and in light of the “mixed” views about the IR35 Forum, the tax authority should “go to greater lengths” to show that it is “receptive” to the feedback it receives through the forum. The Lords also want HMRC to review the breadth of the forum’s membership.

“It’s recommendation 10,” said Egos’ Mr Sinclair, when asked to pinpoint one call by the Lords which should please the typical PSC contractor. “Essentially, the Lords are telling HMRC to listen on the IR35 Forum; that would be good.”

Similarly, the committee’s eleventh recommendation will also benefit taxpayers if it’s adopted, as it asks the Revenue to develop and publish a short guide setting out the basic differences between self-employment and employment.

The guide, to be made available both online and on paper, will be aimed at all individuals working in all industries where intermediaries are prevalent, and is likely to be particularly useful to lower paid workers.

Freelancers in the public sector are bound to be the guide’s readers too, but they are the subject of their own recommendation – number 15 in the report – which says a review of those ‘off-payroll’ workers on less than £58,200 should be carried out, partly to “build confidence” in the rules.

More positively for public sector contracting, the committee warned: “We believe that any blanket restriction on public sector use of personal service companies would not be beneficial to the delivery of public services.”

Another review called for in the Lords’ report concerns umbrella companies, which the committee says should be scrutinised afresh, and enforced against, in light of evidence that they are abusing their expenses dispensations.

Moreover, adds recommendation 14, the Revenue’s existing process for granting and renewing such dispensations should be examined, so that potentially “high risk” organisations are granted dispensations only “when appropriate.”

However regarding all issues that the committee has made recommendations on, whether it is HMRC, umbrella companies, the service company questions or the off-payroll framework, the Lords conclude that their report is not a “comprehensive reference work”.

Nonetheless, some of the committee’s findings about IR35, such as the discovery of “little evidence of individuals leaving employment” on a Friday “only to return in a consultant role” on a Monday – the very reason IR35 was introduced, are being seized on.

Kingston Smith's Mr Spindler reflected: “Underlying this report is the feeling that the economy and business models of the UK have changed significantly in the last 15 years and that IR35 is trying to put square pegs in round holes.”

The PCG went further: “We are calling for IR35 to be suspended while proper consideration is given to its abolition. Removing this unnecessary legislation will allow the UK’s flexible workforce to do what they do best – boost British business.”

The group added: "The government has refused to listen to the cries for help from the hundreds of thousands of contractors, freelancers and independent professionals blighted by IR35, but they cannot ignore the findings of the committee."

The committee, which received evidence from 28 witnesses and 44 written submissions, expects the government to respond to its recommendations within two months. After that deadline, both the committee’s report and the government’s response will be debated in the House of Lords, "in due course."

Editor's Note: Further Reading on the PSC Committee's report -

Don't get your hopes up about the Lords' attack on HMRC

No quick fix for HMRC's misunderstanding of IR35

IR35 being scrapped or shelved? Don't hold your breath

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Written by Simon Moore

Simon writes impartial news and engaging features for the contractor industry, covering, IR35, the loan charge and general tax and legislation.
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