Travelling expenses – Our submission in response to HMRC’s 2014 discussion document

David Kirk & Co. Ltd. welcome the opportunity to respond to HMRC’s discussion document Employment Intermediaries: Temporary workers – relief for travel and subsistence expenses. The firm is a specialist consultancy in the field of employment intermediaries and personal service companies which make up over half its business. It director, Mr David Kirk, is the author of a book on employment status and he represents the Institute of Chartered Accountants in England & Wales on the IR35 Forum.

We feel that the starting-point from which the document is drawn up is at best based on some unproven and controversial assumptions, in particular these:

– That there is a clear-cut dividing line between temporary and permanent workers;

– That there is a clear-cut dividing line between employment intermediaries and service or consultancy providers;

– That there is a clear-cut dividing line between private commuting and travel at work;

– That there is a dividing line between allowable and disallowable travelling expenses that will be seen by all (or most) workers as fair;

– That over-arching contracts of employment are necessarily in fact contracts of employment.

In the modern world these dividing lines can very easily become blurred and people can slip from one to another easily, often without realising it. If a different tax outcome is required for different statuses, then a dividing line has to be made between those on one side of the fence and those on the other. However this dividing line is bound to be arbitrary, and to be seen to be arbitrary and sometimes unfair by some people. Moreover, because of the flexible nature of modern working practices it becomes very easy to morph from one form to another. This means that legislation brought in to outlaw certain practices is likely to lead to exactly that kind of seamless transformation from one business model, newly made non-compliant, to another one that is compliant. The Government then needs to step in with legislation to stop that, and so the show goes on. In the meantime the legislation almost inevitably traps people that it was not intended to trap, or force them also to seek new business models (invariably more expensive), thus adding to the complexity and incomprehensibility of the tax system.

It is indeed striking how much of this legislation has been brought on by previous legislation in different areas. First the Government brought in employment protection in the 1960s, which meant that businesses tried to get out of being liable for breaches of employment rights by insisting that they would only pay companies. This led to more and more companies being set up, some of which masked employment in all but name. This led to the introduction of IR35 in 2000, which made these companies unattractive where IR35 applied. This in turn led to the rise of umbrella companies, who were – still are – dependent on their over-arching contracts of employment and the tax relief that follows to gain a competitive advantage, and they were able to use this to persuade workers not to stay on agency payrolls as they would be better off with the umbrellas. Before long not many agencies were operating payrolls and everybody had to be paid through an umbrella or personal service company. It also led to the rise of managed service companies: this model was made unattractive by further legislation in 2007, which again led to umbrellas taking over where they left off. A further rise in the umbrella model was created by the forced placing of large numbers of construction workers on to PAYE last year, through the onshore intermediaries legislation.

The likely reaction of umbrellas and those working in them needs to be taken into consideration. As umbrellas are dependent on over-arching contracts of employment for their very existence, they will cease to be in their present form as they will become uncommercial. People who have a thriving business will not, however, simply retire from the fray, but will look at making other models work of employing the same people. From this, one can reasonably predict that those currently employed by umbrellas will split in three different directions:

– Some will go on to agency payrolls and so will lose the benefits of tax-free travelling expenses. We would expect these to be largely the lower-paid, who will not get any corresponding rise in their rates of pay and so will lose out. We urge HMRC to think long and hard about this before taking any steps.

– Others – mainly the higher paid – will go into personal service companies, many of whom are temperamentally unsuited to this as a business model. This will cause all sorts of problems, not least difficulties for HMRC in keeping up with ensuring the compliance of a large number of small companies, an area where they appear to be having much difficulty already.

– In other cases the umbrellas will attempt to ensure that they fall outside the definition of employment intermediaries, whatever that may be, and mutate into construction companies, or transport companies, or consultancies, or service companies. This will require quite a strong presence in a particular industry to pull off and will not be possible logistically in every case, but we point out that something very close to this was the norm in the construction industry with the ‘CIS umbrella’ model before April 2014, and in cases where there is a standard skill required it will be much easier.

Nor do we believe that attempts to prevent the second of these choices by extending these proposals to personal service companies (‘PSCs’) is likely to be any more successful, as they will react in just the same way. A definition of a personal service company has proved elusive so far, and if one was established we can be sure that there will be attempts to circumvent it. Although it is a standard part of the PSC business model that the individual contractor is named on the contract documents (whether with or without a right of substitution, there is in many cases no particular reason why this should be so, and if it were to cause problems we would expect this to disappear. One would then be left with a PSC director looking much like any other director and it is hard to see how he could be subject to a special regime for expenses.

The fact is that unless one were to take a view that all travelling expenses should be allowed for tax including private commuting (which no-one is suggesting), or that no travelling expenses should be allowed (which no-one is suggesting either), the line drawn between what is allowable and what is not is bound to be arbitrary. There will always be a certain amount of unfairness built into the system wherever the line is drawn, and different people will have different ideas as to where that unfairness lies. Thus whilst we do perceive an element of unfairness in the present system, we do not see that on its own as a reason for legislating.

We should also like to point out that a number of things that the paper complains of appear to be contrary to existing legislation. Where existing legislation is being flouted, new legislation is unlikely to ensure a greater level of compliance. There seem to be several problems here:

– A small number of umbrellas are run in a manner that can only be described as criminal. (In this context we were particularly pleased to see Work Legal-E Ltd named as a deliberate tax defaulter on HMRC’s latest defaulters’ list: compliant organisations

throughout the industry will be relieved to see a competitor with such dubious methods driven permanently out of business.)

– A rather larger number do not understand the legislation properly. The larger businesses have access to good legal and accounting advice and so can remain compliant as long as the advice given to them is compliant. However what seems to happen is that whenever someone thinks that he has found a way of circumventing the law, he goes to a lawyer or accountant without the necessary expertise, who tells him that his plan works when he should be saying the opposite. As soon as this entrepreneur starts up, copies of his documentation get into other peoples’ hands who then do not see the need to take legal advice at all before implementing it. Those who take this approach are never going to be constrained by new laws: they will frequently not even hear of their existence. If they do they will understand the new laws no better than the old, and so will not keep to them for that reason. Their professional advisers, if consulted at all, will be none the wiser.

– The only solution to these forms of non-compliance is increased HMRC activity. Regrettably the opposite seems to have happened: in this field HMRC has a reputation for hardly investigating anybody at all and for being a soft touch when they do. Although most of the issues are well understood at senior level and by policymakers, they are frequently not by the inspectors who do compliance checks, who appear to lack the intellectual calibre to do the task properly. There are three areas in particular where HMRC have developed a reputation for being soft: o The ‘single place of work’ travel expenses rule in ITEPA s. 339(5)(a)(ii), which is hardly ever investigated;

o The managed service company legislation, where a number of accountancy providers appear to be sailing very close to the wind – surprisingly in view of the fact that their proprietors have unlimited liability for PAYE debts. The model in paragraph 37 looks very like a managed service company model;

o Minimum wage infractions, where again the legislation that HMRC is responsible for enforcing is draconian: the model described in paragraph 36 looks like an example of this, as indeed is expressly stated by the document which states that ‘the promoters and users of this model incorrectly believe that this entitles the individual to tax and NICs relief on travel and subsistence expenses’ (emphasis added).

We believe also that the employment status of these so-called over-arching contracts of employment is open to question. Contracts will vary but many that we have seen appear to fall foul of two of the most basic requirements for them to be contracts of employment:

– Mutuality of obligation is a pre-requisite of any contract of employment, and does not generally exist in three-way relationships. This is because while the obligation to pay the worker rests with the umbrella, the obligation that the worker has is to work for a different party – the end-client. This is dealt with at great length in James v London Borough of Greenwich [2006] UKEAT 0006_06_1812 (this was subsequently upheld in the Court of Appeal).

– Control by the employer is also a pre-requisite for a contract of employment. An umbrella company exercises no meaningful control over its workers: this is exercised by the client – see Bunce v Postworth [2005] EWCA Civ 490.

It is noteworthy that of all the enormous number of employment status cases that have been decided, even including those decided by the higher courts, only one has found that an employment intermediary or employment business is an employer. That is McMeechan v Secretary of State for Employment [1997] IRLR 353, which it has to be said looks odd alongside the other cases

even when bearing in mind that it had some rather unusual facts, and it is certainly arguable that has been implicitly overturned by Carmichael v National Power [1999] 4 All ER 897.

In view of all this, and in the knowledge that there are other employment status problems receiving attention as well and a major review of travelling expenses generally, we believe that the best response would be to do a holistic review of travelling expenses in the light of the bigger picture on both these two subjects, and tackle any particular problems then.

We comment in more particular detail on the document as follows:

– Page 5: the juxtaposition of businesses seeking to avoid tax with those depriving people of employment rights and the minimum wage is highly misleading. Most umbrella companies, and we would suggest all reputable ones, do not deny any employment rights and do pay the minimum wage as a wage (i.e. not as expenses). Indeed the very title ‘over-arching contract of employment’ suggests a contract that is acknowledged to give employment rights and, following on from that, to pay the minimum wage. Moreover the minimum wage is payable to all those with worker status, not just employees – something much harder to avoid. Good tax legislation will never come out of muddling the issues and regrettably this kind of approach exhibits that.

– The example of Sarah at the top of page 11 is only correct if she goes on to do another assignment for the same employment intermediary.

– Contrary to what is stated in paragraph 21, salary sacrifice schemes are very unusual with umbrella companies, except where attempts are being made to circumvent minimum wage legislation (in which case as noted above HMRC ought to have sufficient powers under that legislation to take whatever action is necessary). The normal model is to pay a basic salary of the minimum wage and anything else that is paid on top of that is a discretionary bonus. Salary sacrifice is largely a red herring in the context of OAC expenses.

– The statement in paragraph 22 that the fee due to the umbrella company can be greater than the value of the travel and subsistence tax relief that the workers are able to claim ignores the point that running a payroll is an economic function that has to be paid for. If these people were to go on to temporary agency contracts they would not get the same rate of pay as the agency would then need to pay for the running of its payroll; it would therefore reduce it.

– The position on pay day by pay day models (paragraph 28) is one of some confusion, not made any better by HMRC’s published statements on them being unclear what they are intending to counteract (they could do with some examples, both at the minimum wage level and above). The ‘salary-plus-bonus’ model described in the preceding paragraph is not a pay day by pay day model in legal terms, but the way that the bonuses are calculated may well make it look like one in economic terms. The result is that umbrella companies all genuinely think that they are not operating pay day by pay day models when the reality is that they might be, and are certainly much closer to them then they genuinely believe.

– We do not agree with the assertion in para 45 that those who do not claim expenses will find themselves in a worse condition than if they had been hired on a more common employment business contract, for the reasons stated above – viz. that running a payroll has to be paid for and so their rate of pay would be reduced to compensate for this.

– Para 49: we emphatically do not agree that individuals are liable to potentially large claims of tax if their employers’ practices are not compliant with tax rules. Unless there is collusion between employer and employee or an innocent error, the PAYE regulations are absolutely clear HMRC can only collect such shortfalls off the employer. It is highly regrettable that HMRC does sometimes attempt to collect the shortfall from employees, many of whom are low paid: this practice is illegal and oppressive and ought to be stopped.

– Para 70: one result of this would be that people whose work is essentially itinerant, such as meter readers, would not get any travel expenses relief if they worked through employment intermediaries (which many of them do). This would be very unjust – they are not well paid and travel enormous distances. This would also be a case where mutating form an employment intermediary to a meter reading company would be relatively easy. They may be a special case but it is one that shows the difficulty of legislating in this area.

– Para 72: the aim of keeping secondments out of the regime will be its Achilles’ heel. Many umbrella contracts are secondments in all but name as it is: it would take very little in the way of drafting to make what is implicit explicit.

– Para 73: it will be very difficult to legislate to bring PSCs into this framework. A PSC director does not generally have any employment contract at all, but is brought within the PAYE regime by being an officer of the company. In order to bring PSCs in it will be necessary to come up with a definition of a PSC: something which can be virtually guaranteed to attract attempts at circumvention. On the other hand if that is not done the rules will deny travel expenses to all company directors, which cannot be the intention. PSCs will find it much easier than umbrellas to maintain that their directors are not ‘supplied’ to end-users, so rendering any legislation ineffective. Again there is a fine line between an employment intermediary and a consulting company here.

– Para 74: this is a very substantial risk and one which will make it much more difficult for HMRC to keep up with what is going on and enforce compliance. That alone strikes us as a very good reason for not legislating any more in this field.

Our answers to the document’s questions are as follows:

Question 1: Do you agree with our description of an OAC?

Yes, subject to the caveat mentioned above that we do not accept that they are necessarily contracts of employment at all.

Question 2: Do you agree with our description of how OACs are used? Are there variations which we haven’t covered here?

Yes, subject to what is said above, and we are not aware of any other models.

Question 3: Do you agree with our description of why OACs are used? What is the main motivation for using an OAC? Are there any other reasons not described here?

We think that the main motivation is to reduce tax bills: without this most umbrella companies would not be viable. However there are other reasons, such as the desire to avoid giving away employment rights, the desire of employment businesses not to get involved in payroll work, and the convenience to workers of having all their tax administration done by one party.

Question 4: On which of these reasons would you place most weight in explaining the recent increase in the use of OACs?

This is largely driven by legislation making other business models less attractive, as noted above.

Question 5: Do you have any other comments? For example, do stakeholders agree that it is unfair that workers engaged through OACs with employment intermediaries get access to travel and subsistence relief whilst others in similar circumstances don’t?

We do agree that this is unfair but do not see any ready solution to this. In a world where the dividing line between those entitled to claim travelling expenses and those not so entitled is arbitrary, some unfairness is unavoidable.

Question 6: Do you have any evidence on the extent of the usage of OACs by employment businesses?

We have no direct evidence but this is probably low. Employment businesses on the whole do not want to get involved in payroll work which they regard as a distraction.

Question 7: Do you have any further evidence of the recent trends in the use of OACs? 18

They have increased significantly as a result of the onshore employment intermediaries legislation that came into force in April 2014: as a result of this a large number of formerly self-employed construction (and other) workers are now on OACs.

Question 8: Do these differ between umbrella companies and employment businesses?

We have no evidence either way on this.

Question 9: Do you expect the prevalence of OACs to increase in the near future?

This depends a great deal on future legislation in other areas. If other business models are made unattractive then OACs will increase.

Question 10: Which income groups do you expect will be the greatest users of OACs in the future?

Mainly those paid between £10 and £20 an hour. For those paid below £10 an hour it is not really economic to use OACs which are an extra link in the chain that needs to be paid for; for those earning over £20 a PSC would be more popular. This is not industry-specific.

Question 11: Do you have any evidence on the extent of any competitive distortions created by misuse of the tax rules through OACs and other schemes noted in this document?

See the narrative above.

Question 12: Do stakeholders agree there is a strong case for the government legislating to restrict tax relief for travel and subsistence in these circumstances?

No, because of the risks of circumvention and the unintended knock-on effects.

Question 13: Do you have any evidence on the likely impact of option 1? Do you think any particular sectors will be affected more than others?

See the narrative above. We think that this will have only a limited effect and lead to the incorporation of a large number of PSCs.

Question 14: Do you have any evidence on the likely impact of option 2? Do you think any particular sectors will be affected more than others?

As with 13.

Question 15: Are there particular groups of people who will be significantly worse off if tax relief was restricted?

People across the board will be worse off, but proportionately principally those paid above, but not much above, the minimum wage. These are some of the people who can least afford it.

Question 16: Are there examples of where Option 1 or 2 may affect cases where it is fair that tax relief should apply?

This depends on how the legislation is framed, but if it to be at all effective there almost certainly will be.

Question 17: Do you think the removal of relief for travel expenses under option 1 should be extended to PSCs?

No. Although it will stop the incorporation of inappropriate PSCs the consequences may well be even worse. There will be attempts to circumvent the description of a PSC (whatever it might be) that can be expected to catch on, leaving people in a situation where they think that their companies are not PSCs when in fact they are. In this part of the market there is bound to be an abundance of misinformation and HMRC will not be able to keep up with events.

Question 18: Do you have any other suggestions, including broad based T&S reform as part of the T&S review announced at Budget 2014, for how the identified unfairness could be removed?

We think that broad based T&S reform is the best approach moving forward