Why contractors might have the Summer Budget blues
As we’ve come to expect with the chancellor’s pronouncements, the devil is in the detail but at Summer Budget 2015, the potential devil for contractors took more than a week to finally show his face, writes Jason Piper, technical manager of tax and business law at the ACCA.
In particular, the ‘discussion document’ to make IR35 more effective in protecting the Exchequer was not mentioned in the chancellor’s speech on July 8th. It was published sometime later, on July 17th.
What else the chancellor didn’t mention
Before addressing this seminal proposal, let’s first assess something else that George Osborne didn’t mention, but many contractors might think he should have.
Buried on page 94 of the Summer Budget’s full report is the reappearance of Enforcement by Deduction from Accounts, the measure formerly known as Direct Recovery of Debts (DRD). While there have been a few changes to the mechanics, including the use of suspense accounts, concerns remain over the treatment of joint accounts and insolvency cases.
But the big issue with DRD is still its safeguards. We have been concerned all along that the powers created by statute should be clearly limited by statute. Opportunities for HM Revenue & Customs to dip into private bank accounts should be restricted to clear cases where there is a policy imperative to override normal due process.
No definition on HMRC ‘satisfaction’
However while the current clauses in the Finance Bill create a wide-ranging power to go after any debt where HMRC is “satisfied that the person is aware that the sum is due and payable,” there is no binding legal definition on what HMRC has to do to satisfy itself, or of what “aware that the sum is due” means.
We know that the Revenue is currently clear that they don’t want this power used against anything but the tiny hardcore minority of recidivist scofflaws. Yet there is the argument that simply sending in a signed tax return declaring the liability should be enough to ‘satisfy HMRC that the taxpayer was aware of it.’
Meanwhile, the welcome non-statutory guidance about personal visits and identification of vulnerable taxpayers could be discarded the moment Lin Homer, HMRC’s chief executive, walks out the door. If that happened, taxpayers across the board would face the prospect of instant freezing of any amounts due under an Accelerated Payment Notice, or that are unpaid once the deadline for amending the tax return had expired. The only appeal would be to the County Court, and the only grounds of success being extreme hardship or previous payment of the debt (unless the account frozen actually belonged to someone else).
Self-employed seem vulnerable to DRD
As I’ve spelt out previously, a contractor who is the director of their own limited company is not in the crosshairs of the incoming DRD power. However other one-man bands seem vulnerable, as HMRC plans to use 12 months’ worth of a debtor’s bank account information to determine how much that debtor needs to pay in expenses. It will also use this historical data to assess hardship and, where appropriate, leave more than £5,000 across the debtor’s accounts after recovering the debt. Is the historical financial information of the self-employed, whose earnings are known to fluctuate more than anybody else’s, a sound way to assess such debtors’ ability to pay? The Revenue has decided it is.
Reforming fundamentally flawed IR35
Elsewhere, what HMRC hasn’t managed to do is bring together all the acknowledgements it makes in the IR35 discussion document about the different elements of the underlying problem with the Intermediaries legislation to get to the nub of why the rule is so complex and, in the real-world, fundamentally flawed.
On the one hand, we have a system which tries to distinguish between employed and self-employed income, taking more tax off employees, but in the expectation that they will get better treatment (sick pay, maternity leave, pensions etc) from the employer, and leaving the self-employed more of their income to pay for the benefits they don’t get, and try to act as a buffer against the risks of no income that they face.
On the other hand, the UK system tries to tax a return on invested capital (the product of wealth/savings) differently to a return on labour. The return on capital invested into a company – dividends – is taxed at a lower rate than returns on labour. The big problem is that buying the right to get your returns taxed as investment income, rather than labour income, only requires £1 of share capital, plus a few spare minutes and the payment of Companies House formation costs.
When you add in some of the other advantages of contracting between two companies, rather than as between employer/employee, then the attractions to all sides become clear. At one fell swoop, anyone (whether employee or self-employed) can convert their expensive labour income into cheaply taxed dividend income. That’s clearly wrong for employees; the waters are far muddier for the self-employed, many of whom will have had to invest massively to build the business they have, whether in time, effort or money.
The helpful (and unhelpful) IR35 discussion document
The IR35 discussion document (open for responses until the end of September) recognises that putting all the risk and all the burden onto the weakest bargaining partner has caused difficulties – which have been made worse because often the contractor has the least clear idea of anyone just how the engager actually wants to run the relationship. It’s always going to be difficult to properly establish employment status under a hypothetical contract, and the discussion paper is, helpfully, looking for views on how that can be addressed.
One area it doesn’t help to shore up is the potential imbalance in the tax system between a self-employed contractor who works as a sole trader, and one who is incorporated. While it is wrong to allow disguised employees to play the system for advantage, the system should not be set up to disadvantage incorporated sole traders just because of the risk that others abuse the system.
All too often the ‘choice’ of whether to incorporate is no choice at all, as I told ContractorUK earlier this month. Many of the skilled and experienced contactors who are among the most valuable assets to the UK’s increasingly digital economy are already subjected to the stress, expense and administrative burden of trying to operate IR35, potentially against a backdrop of ignorance or indifference from the end-users who now, more than ever before, will hold the key to their status. The government must take care not to add the further final indignity of taxing them even more heavily than those who can operate as sole traders.
Rhetoric, risk, responsibility and recognition
A skilled, mobile and agile workforce is, we keep hearing again and again, one of the keys to success in the modern world. If that is the case, then we should take care that our tax system doesn’t penalise individuals for trying to be a part of that economy. Reforming IR35 to put more of the emphasis on the end users’ inputs should not involve them in any additional expense. Rather, it should mean nothing more than them assuming an element of risk as to the status of their contractors. But given that the risk is almost entirely within their own powers to minimise, it need not be a risk at all.
If end-users must have the control and direction that would make the contractor an employee, then trying to buy that ‘on the cheap’ by paying B2B rates and shirking their responsibility to pay the taxes properly due (while leaving the contractor to bear the financial and administrative burden of sorting out the mess), is an abuse of their bargaining power and a failure of social responsibility on their part.
We welcome the fact that the government has recognised the role it played in creating this mess through the implementation of the theoretically elegant but practicably unworkable IR35 rules, and look forward to contributing to the design of measures which properly recognise the risks taken - and benefits seen by us all - when contractors genuinely leave the comfort blanket of employment.