OTS comes out against IR35 changes
An independent body set up with the sole aim of simplifying the tax system has declined to endorse Her Majesty’s Revenue & Custom’s IR35 proposals for the public sector.
The Office of Tax Simplification says that while it supports the need for “greater certainty and clarity” on IR35, the Revenue’s proposals “will not, overall, deliver simplification.”
Beyond complexity, OTS has concerns about effectiveness. For example, unless the digital tools (it recommends two to cater for all PSCs) becomes “trusted,” it is “unlikely to be used.”
Similarly, in any test where one party will need to consult another, there is an admin burden and unless there is an incentive to answer the question, “it is likely to go unanswered.”
As to the questions OTS is referring to, there are four in total and they form the proposed 'gateway process' that HMRC hopes will quickly weed out those outside of the proposed rules.
The problems OTS has found is with the set of four that agents must ask where they - and not the end-user – are the ‘paying agent,’ and therefore responsible for considering the rules.
The first question (‘Is 20% or more of the contract for materials consumed within the service?’) will cause agencies “significant difficulty.” OTS says it may even stump PSCs.
But assuming both parties get beyond question one, the office regrets that “it is not clear how the other three questions bear any relevance to establishing employment status.”
It is this trio that agencies/end-users of IT contractors or other knowledge-based PSCs will find themselves facing, because the typical answer to the ‘20% question’ for them is ‘no.’
“It is unlikely that the gateway process will weed out any of the PSCs whose services are based on knowledge, regardless of whether they provide their own equipment because they will not pass the 20% test,” OTS said.
As a result, a “defined population of contractors working in the public sector who provide services based on their knowledge, through an agency will move to the second part of the test.”
“If the engager cannot answer ‘yes’ (in which case PAYE should be applied) or ‘no’ (in which case PAYE should not be applied) to both questions, they will have to use yet another test in the form of a digital tool,” OTS says.
“This seems to add unnecessary complexity, to use a three-part process and to have to contact another party (either the agency, engager or the PSC) to get additional information.”
The office is also concerned about part two and its two questions: 'Is the worker required to do the work themselves?' and ‘Does the engager decide or have the right to decide how the work should be done?’
Firstly, the less control there is (suggestive of an outside IR35 position) due to the worker being highly skilled, the higher the likelihood that the person will not substitute (suggestive of an inside IR35 position).
“It would seem to be poor practice to just pick a part of the test in isolation, which is likely to cause unreliable results,” OTS says. “The case law guidance is to stand back and view the whole picture.”
The tax unit then indicates that highly-skilled workers will be at a disadvantage compared with their lesser-skilled counterparts, as it is the latter for whom part two of the proposed system is most appropriate for.
It says: “The second part of the test that is being proposed does not take this [different weighting depending on whether skilled or unskilled] into account and the indicators would be more appropriate for unskilled or lower skilled labour.”
And while it recognises that designing a system able to give an accurate decision on employment status based on case law is a “difficult task,” it sounds unsatisfied at HMRC’s attempt with these IR35 proposals.
“There needs to be a project to try to develop a simpler test that can provide binding certainty taking into account both tax and employment status,” the OTS says, writing in the Annex of its response to HMRC.
“We think that a review focusing specifically on the taxation of the flexible workforce should be considered...[and] we think it would be useful for the Cross Government Working Group on Employment Status to develop a definition of the term Personal Service Company”.
The tax simplification unit’s other recommendations include abolishing the 5% expenses rule on IR35; rethinking the proposed VAT treatment of PSCs who will be caught, removing from scope private firms carrying out public functions and publishing a list of taxpayer-funded bodies that must abide the rules from April 2017.
“We assume that this proposed legislation will be carried through,” the OTS reflected. “However, we think there is a need to keep this whole area of how the flexible workforce engages with the tax system under review.”
It explained: “There are various other measures that have just been introduced into the tax system which are likely to affect the same population of taxpayers, notably the dividend tax and the new rules on travel and subsistence.”
Editor’s Note: Related Reading –