IR35 private Sector Reform (Update May 2019)

Our submissions on the off-payroll consultation

David Kirk & Co. Ltd have made the following submissions to HMRC in response to the off-payroll consultation:

General comments

We believe that making the client, rather than the contractor, responsible for PAYE matters is in general terms the right way to go. However how it is done matters a lot, and with anything as complicated as this there are likely to be side-effects that may turn out to be quite serious and create injustices and a great deal of extra work, in the latter case for HMRC as well.

Regrettably the proposals made in the consultation appear to us to have many flaws in them that will do exactly that, and we believe that a simpler approach is required, that makes the client liable in all circumstances. We understand that this is not favoured by HMRC because it would mean PAYE being operated on the agency’s margin as well as on what the contractor gets. However there is a simple workaround for this which is widely used where agencies make supplies for VAT purposes to clients that are exempt and so have a very similar issue: the agency’s margin is charged separately (and in this instance would not be liable to PAYE), and PAYE could then be operated on the rest of the payment. We believe that agencies would adopt this, and although matters would be slightly more complicated at the client’s end they would be greatly simplified at the contractor’s end, for HMRC when they investigate, and for all parties where there is a default.

Otherwise we have serious concerns about several matters arising:

    1. There will be two off-payroll regimes in place: one for contractors working for small businesses outside the public sector, and another for everybody else. This will not be properly understood by the former group who will have to operate the same rules that on HMRC’s account they are widely ignoring at the moment: the subliminal message that will go out with the introduction of these new rules is that the old ones will no longer apply. This subliminal message will gather extra force when people perceive (as is likely to be the case) that HMRC do not make any serious attempt to enforce the small company rules. Furthermore, when the message has gone out that it is too much of a burden for a small business client to operate the off-payroll rules, it is hard to justify passing responsibility for doing so on to a smaller one (the contractor’s PSC). Finally, unenforceable laws are unfair both on those who keep them and on those ignorant of them that have the misfortune to be caught.
    2. Those working for small companies will have no mechanism for knowing that they are doing so and therefore have to consider the off-payroll rules. They cannot be expected to look up their clients’ details at Companies House, still less to understand them so as to be able to make the decision, and even if they could there would be no such equivalent for non-corporates or foreign companies.
    3. There must be a proper appeal system for contractors, in which HMRC are involved and in which end-clients do not have the final word.
    4. We believe that this reform will result in more off-payroll business being passed to umbrella companies as a means of circumventing responsibility. Whilst we do not see anything intrinsically wrong with that, there are persistent rumours that there a large number of such companies not operating in a compliant manner in the public sector where these reforms have been introduced already (in that they are offering contractor loans which are largely untaxed, which is now flagrantly illegal), and if so this problem can only be expected to spread substantially once they are introduced into the private sector. This is likely to be controversial and the public, Parliament and other branches of Government should be warned about this so that they can take whatever action they feel to be appropriate.
    5. One other result of the public sector reforms which is virtually certain to be replicated int eh private sector is that clients and agencies quote an ‘umbrella rate’, which is a rate inclusive of employers’ NICs which the worker then ends up paying – or at least perceives that he is doing so. This is the cause of much bitterness and the problem would also be resolved or substantially mitigated by making the client responsible for operating PAYE in all circumstances, as suggested above.
    6. We remain concerned at HMRC’s track record in defending IR35 cases at the Tax Tribunal, where they have lost ten out of twelve cases since the new tribunal system came in in 2010, and have not clearly won the other two. This suggests that their officers do not understand employment status as well as they should, and is likely to lead to further challenges – this time from people who can afford to take HMRC on which PSCs generally cannot. Any reform is likely to fall flat until this is addressed.

In response to the particular questions:

Question 1 – Do you agree with taking a simplified approach for bringing non-corporate entities in to scope of the reform? If so, which of the two simplified options would be preferable? If not, are there alternative tests for non-corporates that the government should consider? Could either of the two simplified approaches bring in to scope entities which should otherwise be excluded from the reform? Is it likely to apply consistently to the full range of entities and structures operating in the private sector? Please explain your answer.

In our view this would not simplify things – having two different regimes never does. This is only likely to be a problem for sole traders as all other forms of non-corporate, partnerships included, are likely to have balance sheets. We suggest that the matter could readily be dealt with by specifying that if a non-corporate does not have a balance sheet, it is deemed to satisfy the qualifying condition on balance sheets.

Question 2 – Would a requirement for clients to provide a status determination directly to off-payroll workers they engage, as well as the party they contract with, give off- payroll workers sufficient certainty over their tax position and their obligations under the off-payroll reform? Please explain your answer.

Up to a point. It would be very beneficial for the status determination to be required to be given to the worker before he signs the contract, so that he can contest it if he feels it appropriate or walk away from the contract if dissatisfied. Beyond that, it is something that he is likely to find out very quickly anyway, as it will affect the way that he is paid.

Question 3 – Would a requirement on parties in the labour supply chain to pass on the client’s determination (and reasons where provided) until it reaches the fee-payer give the fee-payer sufficient certainty over its tax position and its obligations under the off- payroll reform? Please explain your answer.

No – because the client’s determination might be wrong, even when made after due deliberation and in good faith. If the client determines that the contract is outside the rules, and HMRC disagrees, then HMRC’s recourse is against the fee-payer not the client. This is unjust as the fee-payer is unlikely to have the information to be able to make a decision of this kind without extensive assistance from the client. It will also cause HMRC difficulties as they will have to investigate the client as well as the fee-payer, added to which the client is far more likely than the fee-payer to have the requisite money to pay the shortfall. (Fee-payers exist for the purpose of paying out what they get in, and so generally have very little in the way of reserves.)

Question 4 – What circumstances may result in a breakdown in the information being cascaded to the fee-payer? What circumstances might result in a party in the contractual chain making a payment for the off-payroll worker’s services but prevent them from passing on a status determination?

All the normal failures of office communication could cause this: holidays, key people being off sick, responsibility for making determinations resting in different places from responsibility for hiring. There are also likely to be problems proving that information was passed on after the event: looking for an e-mail with this particular nugget on it on a large company’s server a year later may well be problematic. This is also likely to cause HMRC difficulties as they will need to establish which person in the chain is actually responsible.

Question 5 – What circumstances would benefit from a simplified information flow? Are there commercial reasons why a labour supply chain would have more than two entities between the worker’s PSC and the client? Does the contact between the fee- payer and the client present any issues for those or other parties in the labour supply chain? Please explain your answer.

This would require a major cultural change as generally speaking clients engage agencies to fulfil their requirements, and will expect all communications to go through them – anything else would be seen as a confusing may of managing things. Besides, it is well known that supply chains in the oil and gas sector can be much longer: the specific sectoral reasons for this are not known to us but we can see a genuine role for four intermediaries between the client and the PSC, as follows: client > platform > master vendor > agency > fee-payer > PSC. Where a good many off-payroll workers are required it may be difficult for one agency to supply everybody, so a master vendor would come in to communicate with the client and find the agencies who can supply them. The use of platforms is probably more prevalent in the public sector but there is no reason why they should not be engaged in the private sector as well: they are large well-known companies such as Capita plc who would act in respect of all the client’s requirements, set the general rules and engage with the master vendor.

Question 6 – How might the client be able to easily identify the fee-payer? Would that approach impose a significant burden on the client? If so, how might this burden be mitigated? Please explain your answer.

The only way of doing this is to ask the agency. This would impose a burden but probably not a significant one once agencies became used to providing the information.

Question 7 – Are there any potential unintended consequences or impacts of placing a requirement for the worker’s PSC to consider whether Chapter 8, Part 2 ITEPA 2003 should be applied to an engagement where they have not received a determination from a public sector or medium/large-sized client organisation taking such an approach? Please explain your answer.

We see no chance of this happening in practice – see our comments in section (a) and (b) of General Comments above. We believe that if this reform goes through chapter 8 should be repealed.

Question 8 – On average, how many parties are in a typical labour supply chain that you use or are a part of? What role do each of the parties in the chain fulfil? In which sectors do you typically operate? Are there specific types of roles or industries that you would typically require off-payroll workers for? If so, what are they?

We advise people using supply chains, rather than using them ourselves, and so cannot answer this question.

Question 9 – The intention of this approach is to encourage agencies at the top of the supply chain to assure the compliance of other parties, further down the chain, through which they provide labour to clients. Does this approach achieve that result?

We believe that agencies are inherently unsuitable for this task and that therefore no serious compliance work is likely to be done by them. Many are substantially smaller businesses than their clients and they have neither the skills nor the clout in the market to be able to do this. This might change once a major and costly scandal has hit the headlines but even then we would be doubtful – compliance failures are likely to be seen by most of them as an occupational hazard which it is too expensive to do anything meaningful about. We are also concerned that businesses that were once reputable may cease to be, for instance after a takeover. It is not clear from the consultation document whether the transfer of liabilities is intended to be automatic or discretionary; we believe that if used at all it ought to be discretionary as there will inevitably be circumstances when intermediaries may become insolvent through bad fortune, and others that those responsible for ensuring compliance could not eb expected to pick up. We suggest that any transfer of liabilities be handled by a specialist department of HMRC that is experienced in telling malefactors apart from the genuinely unfortunate, such as exists for transfers of NIC liabilities to directors.

Question 10 – Are there any potential unintended consequences or impacts of collecting the tax and NICs liability from the first agency in the chain in this way taking such an approach? Please explain your answer.

We do not think that agencies are likely to make any serious attempts to protect their position here against unexpected liabilities, which as noted above are likely to be rare and to be seen as unfortunate and unavoidable. Furthermore, a major claim of this kind could well be sufficient to render an agency insolvent – their margins are generally not high. Whilst agencies do have this liability under the agency rules, they have generally dealt with it by either operating PAYE themselves, and thus retaining control over the process, or by insisting on paying through umbrella companies who, having contracts of employment, then have all the PAYE responsibilities themselves.

Question 11 – Would liability for any unpaid income tax and NICs due falling to the client (if it could not be recovered from the first agency in the chain), encourage clients to take steps to assure the compliance of other parties in the labour supply chain?

Not to any serious extent: risks of this kind are not usually seen as being capable of management and so it is always easier to do nothing and accept the consequences. It is difficult to see what assurancesonecangetfromotherpartiesinthesupplychainthatarereallyworthmuch. Where clients do take steps, they are likely to be of a kind where they only use large well-known agencies, thus either adding to the numbers in the supply chain and making it less efficient, or making it difficult for new start-ups to enter the agency world and thus being anti-competitive.

Question 12 – Are there any potential unintended consequences or impacts of taking such an approach? Please explain your answer.

See the answers to the two previous questions.

Question 13 – Would a requirement for clients to provide the reasons for their status determination directly to the off-payroll worker and/or the fee-payer on request where those reasons do not form part of their determination impose a significant burden on the client? If so, how might this burden be mitigated? Please explain your answer.

Yes, but a necessary burden. There is an acknowledged grey area when it comes to employment status, and anyone who suffers adverse consequences from getting status determinations wrong needs to take action to justify and protect his position.

In the private sector the requirement to take reasonable care will need specific legislation and a specific remedy for workers where it is not taken; in the public sector this is by contrast a matter of public law.

Question 14 – Is it desirable for a client-led process for resolving status disagreements to be put in place to allow off-payroll workers and fee-payers to challenge status determinations? Please explain your answer.

No. Clients will largely not have the expertise to resolve marginal cases (which ones where workers are dissatisfied are likely to be) and will hide behind CEST, or if CEST does not give an answer, outsource the issue to specialists who may or may not have the appropriate expertise. Workers are not likely to view them as impartial as the clients will all have an attitude to the risks that they are prepared to take and so may be excessively cautious. It is essential that there be recourse to the Tax Tribunal on this, and that HMRC are involved in the process in some way.

There is a further issue in that some employment status considerations are known only to the worker, such as the number of clients and the nature of the work performed, when the worker claims to be in business on his own account. This is accepted by HMRC (see the Employment Status Manual, pages 549 to 553). It is not generally appropriate that these should be shared with the client (either in relation to the worker’s own affairs or that of his clients), and the client would have no means of knowing whether the worker was telling the truth or not without an exhaustive and intrusive inquiry which most clients would be ill-equipped to carry out. We note in particular with reference to this the FTT’s decision in the recent case of Atholl House Productions [2019] UKFTT 0242 (TC), where this was the criterion for the decision made and the judges, in their section on this (paragraphs 105 to 114), made no reference to the contract at all. It is therefore essential, at least in cases where being in business on one’s own account is claimed to be a factor, that the worker should have direct recourse to HMRC to determine the matter.

Question 15 – Would setting up and administering such a process impose significant burdens on clients? Please explain and evidence your answer.

See our answer to the previous question.

Question 16 – Does the requirement on the client to provide the off-payroll worker with the determination, giving the off-payroll worker and fee-payer the right to request the reasons for that determination and to review that determination in light of any representations made by the off-payroll worker or the fee-payer, go far enough to incentivise clients to take reasonable care when making a status determination?

No, because they will hide behind CEST and so will not have any incentive to engage properly in the process.

Question 17 – How likely is an off-payroll worker to make pension contributions through their fee-payer in this way? How likely is a fee-payer to offer an option to make pension contributions in this way? What administrative burdens might fee- payers face which would reduce the likelihood of them making contributions to the off- payroll worker’s pension?

We do not have the requisite experience to be sure but suspect that the answer would be that there would not be much appetite for pension contributions.

Question 18 – Are there any other issues that you believe the government needs to consider when implementing the reform? Please provide details.

See our answers in General Comments above, in particular paragraphs (d) and (e). Also:

  • –  There needs to be a deemed employment marker in HMRC’s systems, so that this legislation does not end up getting used by fee-payers to deduct student loan payments or operate pensions auto-enrolment.
  • –  We recommend that HMRC should make clear what the position is when the OECD Model Tax Treaty is in play. If there is no intermediary, and the client has no tax presence in the UK (unless bearing the cost for a resident party), article 15 specifies that income of someone resident in the foreign state should only be taxed in the UK if that person is in the UK for 183 days or more. In marginal cases – particularly in industries that are project-based, such as construction – the number of days spent in the UK will not be known until close to the year end. If HMRC are expecting a UK-based fee-payer to operate the off-payroll rules irrespective of this, this should be clearly stated.
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OnMay 22, 2019, posted in: Articles by

IR35 private sector reform

How to reform IR35, keep the Exchequer in funds, and avoid the hassle that comes with the current private and public sector regimes

On May 18th 2018 HMRC published a consultation document proposing to extend the current public sector regime to the private sector. My own view is that this would be disastrous and unworkable.I do nevertheless have sympathy with HMRC’s view that the current private sector rules areunenforceable and the subject of widespread non-compliance, and feel that – with over 80% ofthe take from IR35 being represented by employers’ National Insurance Contributions (‘NICs’) – some radical change is needed.

This paper, which has been submitted to HMRC, suggest a way forward that ought to get the Exchequer 95% of what it seeks without the hassle and the poisonous feelings that have grown up around the public sector reforms.

Is it possible to consider this?

Basically my proposal is similar to the one at paragraph 6.34 in the Consultation Document, by which the client pays the employers’ NICs and the personal service company (‘PSC’) the employees’. This has been ruled out of scope as ‘it would fundamentally change the NICs treatment of those who would otherwise be within the off-payroll working rules’. I confess that I cannot see why it should. It could be done so that the rules apply equally to the client and to the PSC, just with different parties responsible for paying the various parts (the client the employers’ NI and the PSC the employee’s NI and the PAYE).

The client and the PSC could, of course, take different views as to whether IR35 applied, but if they did so one of them would be wrong. However, bearing in mind that virtually all that was being sought would come from the client, there would be very little in it for the PSC and the worker, as I shall show below. This being so, most of them would comply, and the loss to HMRC where they did not would not be serious.

It would be a less bureaucratic alternative to suggest that IR35 did not apply to the PSC in any event, so that all that happened under this rule would be for the employers’ NI to be collected. This would also raise less money, but only marginally less. It would certainly be true under this alternative that there would be differences of treatment as between the client and the PSC, and it may be that prospect that led the authors of the consultation document to suggest that it should be out of scope. Personally, I cannot see any objection to it on that ground and it would make things simpler for small businesses to deal with their tax obligations. However it is not essential to the operation of this proposal.

Point 1 – the end client must be the liable party, not an intermediary.

This seems to me to be both just and essential in any event, irrespective of whether the rest of the proposal is adopted.

It is just because most of the money raised consists of employers’ NICs: in my estimation about 82%. This is, as its common name suggests, an impost on employers and should be paid by employers (in this instance the clients). Putting the responsibility on to intermediaries allows the employers to ignore their responsibilities here. The idea behind this was that the employers should pay the intermediaries enough to cover the employers’ NI, but I know of no-one who thinks that this actually happens in practice – the issue is simply never raised.

The 82% figure can be gleaned largely from the last Office for Budget Responsibility report, which has the following figures for increased revenue from the new public sector rules. To get there, go to and click on Policy measures database, then scroll down to rows 1380 to
1382. I would suggest ignoring the figures for 2017-18 and 2018-19 as it is obvious that it takes time for the full effect of this measure to bring in the full Income Tax receipts. However we see the following for 2019-20 and 2020-21 (in £ millions):

The first point to note here is that the Corporation Tax lost exceeds the Income Tax gained, by quite a substantial margin. As Corporation Tax is a form of income tax paid by companies, and in this case companies owned by people who would be paying Income Tax on the same profits if the companies were not there, it is clear that the measure has not been introduced with this sort of tax in mind. Indeed, as one would expect, the gains come from NICs and easily outweigh the net losses on the income taxes front.

What these figures do not show are the split between employers’ and employees’ NICs, and so I have had to make assumptions here. On the basis that the average deemed salary is £60,000, which would seem to me to be a good working assumption in the absence of any evidence, the proportion is about 60% employers’. As the table below shows, it goes steadily up from 53% on a salary of £30,000 to 69% on a salary of £100,000:

On the assumption then that 60% is correct, this allows us to recalculate table 1 as follows (£ millions):

Or, put more simply:

The average is 82%, and in subsequent years it settles down at about this level.

It is essential because otherwise either the employers’ NICs will end up being paid by the worker, which is the source of much unfairness and controversy at the moment, or the intermediaries will resort to avoidance and evasion. The fact is that the intermediaries simply cannot afford to pay the employers’ NICs. At 13.8% on most of the deemed salary, it will be very close to the gross margin (i.e. before overheads) of an agency, and well above the gross margin of an umbrella. If they are to stay in business they need to pass the cost on to someone else. This means that if they cannot charge the client enough to cover it, they reduce the rate paid to the worker. The client obviously has no incentive to pay anything extra, particularly with other agencies being prepared to say that they would take a different view. The only way to make the employers pay is to make them pay directly, not indirectly.

This also avoids the temptation to route payments through non-compliant umbrellas. This I understand to be a major issue in the National Health Service, which has a well-known recruitment problem as it is: it is my understanding that there are some 40-50 umbrella companies, most but not all of them offshore, still paying people though contractor loan schemes, and it is not difficult to see how this happens with these three factors in play:

  1. NHS trusts (many of which are short of money) refuse to pay any extra to cover the employers’ NI;
  2. The workers know that they can get higher net pay through umbrellas that give them contractor loans, so they refuse to work for the ones that do not;
  3. The agencies, unable either to get the NHS trusts or the workers to pay the impost, succumb and contract with these offshore umbrellas. It is likely that in many cases the agency staff would be unaware of what was happening anyway – it is not what they are paid or trained to look out for.

An additional point is that whilst the intermediaries cannot afford to pay this, and the workers see no reason why they should (and often cannot afford it either), many of the clients can absorb the costs without too much trouble. An extra 13.8% on a cost that only amounts to 5% of your total revenue, which will be the case for many enterprises using this sort of contract labour, will put that 5% up to 5.7%, which is unlikely to put the venture at risk, and which they may well be able to recover–atleastinpart–fromtheirclients. Wherethecontractlabourcosts50%oftheirrevenue it is of course another matter, but there will be plenty of cases where this is not so.

If this is a problem in the public sector now, it will be a very much greater one in the private sector if the public sector rules are extended there. The public sector is much smaller and there is more of a compliance culture in it. By contrast, the profit motive in the private sector is likely to come out on top, particularly if businesses can blame someone else for compliance failures.

Added to that, I understand that HMRC are taking action against these non-compliant umbrellas. It obviously remains to be seen how successful this will be, but I do nevertheless have two reasons for being sceptical. Firstly, they are likely to get tripped up when it comes to deciding who the responsible party is. If the worker has a contract of employment with an offshore umbrella, this will be the client (under s. 689 ITEPA), but if not it will be the agency (under s. 44). HMRC will not find it easy to establish the truth as it will have no powers of inquiry vis-à-visthe umbrella, and any attempt to find out from the other party to the contract (the worker) will certainly be time-consuming and probably fruitless. They will therefore be obliged to assume that it is not and challenge the agency to prove otherwise. As most contracts between umbrellas and workers are contracts of employment, their chances of being wrong-footed by an agency that does find out the truth are quite high. With non-compliant onshore umbrellas it will usually be the umbrella that is liable, but there will invariably be no money in it. I suspect that this is going in itself to need legislation to deal with.

It is also worth pointing out that, if found to be on the wrong side of the law, clients are much more likely to pay up than umbrellas or agencies. Intermediaries basically exist to pay out what they get in and rarely have much in the way of reserves (umbrellas in particular). They are more likely to shift their businesses into another company and start again there, leaving HMRC to salvage what little it can from the wreckage.

Thus it can I hope be seen that making the client liable ought to bring three benefits:

  • It will prevent the practice of making the workers suffer the employers’ NI;
  • It will forestall evasion through umbrellas offering contractor loans;
  • HMRC are more likely to recover what they are owed when the law is transgressed.

Point 2 – liability for employee taxes and NICs should remain with the PSC

This means that the PSC would have to operate PAYE on all its receipts under IR35 contracts and pay employee NICs, but not employer NICs as these will have been dealt with already. This has these advantages:

  • It prevents arguments. One of the side-effects of the new public sector rules is that there are two industries where relationships between the clients and their workers have become absolutely poisonous, these being broadcasting and the health service. It is no accident that these are industries where staff costs are high as a proportion of revenue and the clients cannot easily afford to pay the extra. However the workers are not locked in a struggle with HMRC about this: they are locked in a struggle with their clients, which is tying up management time to unproductive ends and cannot be good for business in the long run. If the PSCs were left to sort out the employee taxes themselves as well as the clients being left to sort out the employers’, there would be no reason for this and it should all disappear, and with it a great deal of pressure on HMRC who I know are also spending an inordinate amount of time dealing with the problems.
  • Administration would be much easier. The PAYE system is simply not designed to collect tax off payments not made to workers directly, and this explains a good deal of the awkwardness that surrounds the current public sector regime. Software would be required that recognised when employers’ contributions were not payable, but this is hardly novel – we have the Employment Allowance already.
  • Big business would also find the software much easier. Frequently large companies’ systems are integrated and the introduction of something as complicated as the public sector rules will have knock-on effects. In this instance one has to identify people who are like employees, and so go through the payroll, but are not actually employees, and so do not appear as such in management statistics. They can also be paid VAT, which employees cannot, but on an amount that on the face of it looks incorrect. Leaving big business simply to pay an NI charge on certain contracts, which its software could identify quite easily once the contracts themselves had been identified, would be a great deal simpler. I would hazard a guess that this might enable the reform to be introduced a full year earlier.
  • PAYE tax coding would suit the worker and avoid the need for extra tax to be paid through SA returns, or for refunds to be made. Currently unless the fee payer gets a P45 it is supposed to use the BR code, which will lead to the wrong amount of tax being paid – generally an underpayment.

Additional paperwork

Any additional paperwork will be unwelcome, but one piece is essential here which I believe will be simple to operate and far easier to understand than the current public sector system. The client will need to give a certificate to the next in the chain to say that IR35 is being operated, and the next in the chain will be required to issue a certificate to that effect to the next, and so on until one gets to the PSC. This will have two effects:

  • It will authorise the PSC not to pay employer’s NI contributions on any salary up to the amount on the certificate; and
  • It will at the same time put the PSC on notice that the client is applying IR35. The PSC will therefore need to have good grounds not to do the same. HMRC would be able to have regard to the fact that the client had issued a certificate when investigating the PSC, and I would expect the Tax Tribunal to take it into account as well in any subsequent action in that forum.

There would need to be penalties for failure to pass these certificates on, and it would help if there were incentives to do so as well. As between the client and the agency, one possible way of doing this would be to allow the agency to get a rebate for employer’s NICs paid on sums that exceed the amount paid to the PSC. For example, if the client pays the agency £100 and the agency pays the PSC £85, then the client will have paid £13.80 in employers’ NICs on a deemed salary of £85, a rate of 16.2%. If the agency could claim back the NICs on the differential (£2.07 in this instance), this would give it the incentive to get the certificate from the client, as well as providing an automatic mechanism for getting the employer NICs paid at the right rate on the right amount. I would also expect the market to work in this instance, so that agency margins were reduced to compensate.

As between the agency and the PSC, it would probably be necessary for the agency to get confirmation from the PSC that it has received the certificate and to be able to refuse to pay until it does so.

Possible objections

Objection no. 1 – the client pays NICs on a higher sum than the deemed salary paid to the worker.

This is because of the agency’s margin, as noted in the previous section. My preferred solution would be the one suggested in that section, but an alternative would be to charge NICs at a lower rate where IR35 is in play. If one works on an average agency margin of 14%, the rate would be 11.9% instead of 13.8%.

Objection no. 2 – the client has to work out which contracts are paid through PSCs and which are not.

There may be other off-payroll workers paid through umbrellas or directly by the agency. The short answer is that clients have to do this now in public sector cases – the only difference will be that they will have to pay the employers’ NI themselves where IR35 applies, but will have to give the agencies enough money for parties down the chain to pay it where the agency rules apply or where an umbrella has a contract of employment with the worker.

If this is an issue (and I do not see why it should be – agencies are quite adept now at collating the requisite information about how people are paid further down the chain), it might be worth considering extending this regime to agency worker cases as well. This would resolve a number of problems in the agency sector, which has many of the issues described above too.

It would in turn however necessitate distinguishing cases where the SDC test applies (for agency workers) from those where the normal employment status test does (in PSC cases). The result would generally be the same anyway, but again, if this is considered an issue, it might be worth while standardising the entire intermediary sector around the SDC test, which would certainly be simpler to operate.

Objection 3: the PSC might take a different view.

As noted above, it would be doing so on notice that it was taking a different view, and so much more aware of the risk that it was running than it is now, where many PSCs do not perceive any risk at all. If the certificate were to include a statement that that the PSC was recommended to show it to the company’s accountants or tax advisers – a statement that could be made mandatory – most of their accountants would become aware of the issue too: something that is conspicuously lacking at the moment. All this would encourage compliance.

However I suggest that the most likely factor to encourage compliance would simply be that it would not be all that costly to comply. It would also be administratively easier, in that payment of tax would all be done through PAYE not long after the money is received, and not through and combination of Corporation Tax and Income Tax a long time after. Although it would mean paying tax earlier, many PSC owners would prefer that if it means that they do not have to keep track of large liabilities looming many months ahead.

The table below shows the difference in taxes paid by the PSC and the individual as between a full salary model and a salary/dividend model.

Using the £60,000 average once again, this would mean that with a compliant client and a non- compliant PSC, HMRC would receive:

  • All of the employer’s NICs (82% of the total due)
  • 78% of the 18% due from the PSC (14% of the total due).

Thus even if all PSCs failed to comply, HMRC would still receive 96% of the sums due to them.

It would be untrue to say that nobody would consider these differences to be too small to be worth forgoing the money, but many would think that, when they weighed in factors such as ease of administration and the risk of being found non-compliant, they would prefer to use the PAYE model.

Objection 4: this does not deal with the problem of income splitting.

Income splitting is a set-up whereby the PSC is not wholly owned by the worker, but some shares are also owned by his spouse. This enables him to divert dividends (but not salary) to that spouse and so double up on the personal allowance, the dividend allowance and the basic rate band. This was found to be legitimate by the Supreme Court in Jones v Garnett [2007] STC 1536.

I do not see this as a major problem. This was widely used in the days when wives did not do paid work, but that is comparatively rare nowadays. It is only of any real use where there is a serious disparity of earnings as between the two, and very rarely of any use except where the lower earning spouse earns substantially less than the top of the basic rate band. Also it is my experience that, even where it might be of benefit, people are reluctant to ‘give’ their earnings to their spouses in this way, for reasons of retaining control over those earnings.

Objection 5: this does not take account of people stacking up their profits in their PSCs and not distributing them.

It is possible to avoid Income Tax altogether (paying only Corporation Tax) by drawing from one’s PSC only sufficient to pay one’s living expenses, and saving up the rest in the company. The plan would be to liquidate the company when the worker has no further use for it and pay Capital Gains Tax on the final distribution, claiming Entrepreneurs’ Relief and so paying CGT at 10%. Otherwise only Corporation Tax is paid on the profits.

Despite the propensity of some parts of the press to draw attention to this possibility, in my experience very few PSCs do this: most people need the money to live on. I do not therefore see this as a major problem.

Objection 6: this does not deal with the problem of PSCs that get incorporated and then never file anything

Under this type of evasion the PSC receives all the money from the contract, pays it out to the worker, and never files any further paperwork with either HMRC or Companies House. The result is that the company gets struck off the register after little more than a year, and well before HMRC realise that there is anything that needs investigating there. If the worker still has any use for a company, he will set up another one and repeat the process.

This is not particularly an IR35 problem, and in my experience the only sector where I have seen it in operation at a serious level is construction. Paradoxically, not much money is likely to be lost to HMRC in this sector because of the Construction Industry Scheme, which is a good antidote to this. It is nonetheless very difficult for someone without access to HMRC’s figures to estimate how serious this is. It is, though, a flagrant example of evasion of tax, and will not appeal to people who are prepared to indulge in avoidance but draw the line at evasion. If it is perceived to be a serious problem, the solution is that suggested and discarded on paragraph 6.36 of the consultation document (a withholding tax similar to that operating in the construction industry). This would be very bureaucratic and is not recommended unless substantial sums outside the construction sector are at stake.


In summary, I recommend this model for serious consideration. The first part – placing responsibility on to the client rather than intermediaries – seems to me to be essential in order to make the private sector roll-out leak-proof. The second part – leaving responsibility for the employee taxes with the PSC – would be much easier to operate, would reduce the lead time for introducing it, and would remove a great deal of the political heat from the scene in exchange for leaving the Exchequer with a very small, and certainly manageable, loss of tax.

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OnJuly 30, 2018, posted in: Articles, IR 35 by

Carry on consulting

David Kirk

12 August 2015

Dialogue about making IR35 work has been ongoing for the past four years, but to very little effect.

  • The government wants to improve the effectiveness of the IR35 legislation.
  • HMRC have issued a discussion document.
  • IR35 is ineffective and the government or HMRC would like to find a solution.
  • The rules in fact require the taxpayer to pay more than their fair share of liabilities.
  • Why should the secondary National Insurance liability not be paid by the person for whom the work is actually done?
  • Many contractors using personal service companies are working for the public sector.
  • It is time to scrap IR35 and replace it with something that works.
They may have been easily overlooked by readers of Taxation, but tucked away on page 44 of the summer budget’s Red Book, and followed a few days later by a discussion document with the innocuous title of Intermediaries Legislation (IR35), were the following two paragraphs:
“The government recognises that many individuals choose to work through their own limited company. However, where people would have been employees if they were providing their services directly, anti-avoidance legislation commonly known as IR35 introduced in 2000 requires that they pay broadly the same tax and National Insurance as other employees. As highlighted by reports from the Office of Tax Simplification and the House of Lords, it is clear that IR35 is not effective enough. Non-compliance in this area is estimated to cost over £400 million a year.
“The government has asked HMRC to start a dialogue with business on how to improve the effectiveness of existing IR35 legislation. The government wants to find a solution that protects the Exchequer and improves fairness in the system.”

The driving seat

As always, it is helpful to understand who is behind this initiative: HMRC or the government? I do not know the answer for certain, but these paragraphs came as a real surprise because HMRC have already been “having a dialogue” with those parts of business most affected by IR35. This has been going on since 2011, when the IR35 Forum was set up at the suggestion of the Office of Tax Simplification, its aim being to “advise on improvements in the administration of IR35”.
There seems to be a lack of joined-up thinking here. The only obvious results of four years of deliberations were the famous business entity tests. Unfortunately, these had to be withdrawn after a couple of years because the public sector was incapable of operating them properly. As for the private sector, the reality is that hardly anyone pays any attention at all to IR35, even though there is an obligation on personal service companies to self-assess IR35 liabilities if they arise. This cannot be condoned, but it is a fact of life. It is also the case that very few cases are actually investigated. We have ended up in an environment which does not work for anybody.
What is really doing on here? HMRC’s document is revealing. Having discarded several other options which they recognise as ineffective, the document suggests that “those who engage a worker [emphasis added] through a PSC [personal service company] would need to consider whether or not IR35 applies … and, if so, deduct the correct amounts of income tax and National Insurance contributions as they would for direct employees.”
I will consider the implications of this later in this article, but first one very important point needs to be made.

Who pays?

The Red Book referred to above says “IR35 … requires that [those it affects] pay broadly the same tax and National Insurance as other employees.” This is fundamentally wrong. It actually requires quasi-employees to pay very much more than this, because they have to pay the employer’s share of National Insurance as well as their own, while the business that HMRC regard as the employer is for some reason let off this impost. The “employer” may pass as the person paying it in the eyes of some in government, but to purveyors of plain English, and to those in the real world who might be affected by the tax, this is plainly not the case.
The idea presumably is that the “employer” pays some extra money to the contractors which they can use to pay this levy. Like all such utopian ideas, this just does not happen.
The effects are startling as shown in The IR35 Effect. The marginal rate of tax is 48.6% for a higher-rate taxpayer on IR35, as opposed to 42% for an employee and 39.2% as opposed to 32% for a basic-rate taxpayer.
Any analysis which does not take this basic point into account is fundamentally flawed.

Time for replacement

Let me put forward a suggestion. Instead of trying to “improve the effectiveness” of IR35, which is broken beyond repair, why not replace it with something simpler? This could be levying a new class of employers’ National Insurance on those that HMRC deem to be employers, when payments are made to companies providing their labour. There will doubtless be squeals from the very same businesses that lobbied the government into backing down from making them operate IR35 when it was introduced in 2000, but this suggestion is a great deal simpler than that original proposal. That would have made the “employer” responsible for the whole of the PAYE and National Insurance contributions, whereas this suggestion leaves the employees’ side as it is.
“Employers’ National Insurance should be paid by employers” is, I think, pretty hard to argue against as a principle for raising tax.
While “employers” will doubtless protest, how many of them would actually be affected by such a proposal? A good many of the contractors that IR35 is aimed at work for the government. Employers’ National Insurance, in this instance, is circular money travelling around various government departments and it should not be difficult to find a solution that satisfies everybody. These comments also apply to local government and large charities, because these are substantially funded by the central government too.
So what about the private sector? Banks have, traditionally, been wholescale engagers of labour via personal service companies and would be affected by my proposal, but in the current political climate they are not in a strong place to lobby against additional tax liabilities. What about the construction industry? There may well be protests from that sector, but it is not noted for the widespread use of personal service companies.
The reality is that if the government were to put this charge on to deemed employers, it would be easier to collect and more likely to be paid, without any theoretical change in the circumstances giving rise to the tax. Facing down the lobbying cries would be a price well worth paying for that.

The tax incentive

It is when the attempt is made to force the deemed employers to deduct employees’ National Insurance and PAYE that one can expect trouble. With the new dividend tax coming in next year this ought not to be necessary anyway – there will be little incentive to incorporate if employers’ National Insurance is paid by employers.
The PAYE system is not geared up towards collecting money from the end-users of labour when there is a string of companies in the way, and trying to do so is bound to be messy. If the users of labour were to pay the secondary National Insurance contributions, there would obviously need to be some system for identifying what has been paid, so that if the PSC pays a salary above the threshold this does not have to be paid twice. That, though, would be a minor piece of bureaucracy compared with many and a small price to pay for getting rid of some of the more intrusive and complicated requirements of operating PAYE. That there is very little incentive to incorporate now is shown by Dividend v Salary.
Dividend v Salary compares an employee on a salary with a taxpayer with his own company who has the employers’ National Insurance paid by the “employer”, after the new dividend regime comes in in 2016. Under the “dividend model”, the person takes a salary equivalent to the personal allowance; I have also assumed that his company pays £1,500 in accountancy fees.
On gross pay of £20,000, he is now better off without a company. After that, the advantage moves towards incorporation, but starts coming back down again, because – for higher rate taxpayers – the marginal rate is 46% for those on the company model against 42% for those on the salary model. The point of maximum advantage for companies is about £58,500, giving a difference of a little over £3,000. At that level there might be some tax-motivated incorporations but, bearing in mind that it is barely worth it at both lower and higher levels, I suspect that it is not something that accountants will suggest as a matter of routine. Many people do not like the hassle of having to run a company and require a bigger incentive than is shown in the Dividend v Salary table to feel that it is worth the bother. Further, there is always the danger that these tax rates will be tinkered with in the future so as to reduce the differential still further. Perhaps the government could take a deep breath and abolish IR35 altogether, just collecting the employers’ National Insurance as suggested above?

Flawed design

It is clear beyond any doubt now that IR35 is not just an unenforceable and punitive tax provision: it is deeply flawed in its design in a number of ways. One of the most controversial things about it is that, when investigating and as a matter of routine, HMRC must go to the contractors’ end-clients to get information about their contracts and the way that they work. In the private sector this causes huge resentment. Contractors feel, in some cases with justification, that their clients will think that they are causing trouble and wasting their time and will want to get shot of them. HMRC compliance activity ought not to lead to the loss of work.
It is not as if this kind of risk is something that ought to go with the turf. In certain industries, a contractor will probably have heard about IR35, but what does he find when he wants to know whether it applies? Remember that there is legal obligation to self-assess each and every contract to determine whether or not IR35 applies.
Consider a contractor who wants to be compliant. The HMRC’s Employment Status Manual is 370 pages long and virtually all of it is relevant to the subject. What happens if the contractor asks his adviser to deal with it? In reality, accountants are struggling with this, never mind their clients. Even if they can wade through the department’s manual, they will inevitably have to make judgments for which they are ill-equipped and which they have little incentive to research. Even if they were minded to add a course on this to their continuing professional development for the year, remember that we are talking about general practice accountants who coping with a number of other changes being thrown at them at the same time.
It will be truly awful when the new regime for travel-to-work expenses comes in. The normal employment status tests for deciding whether the company is within IR35 will still be necessary, but completely different tests (purely based on supervision, direction or control as to how the work is done) will be needed to determine whether travel-to-work expenses can be claimed. Who on earth thought of that one? I think I can say with complete confidence that few, if any, advising accountants or inspecting HMRC officers will get this right.

Calculating the liability

Once HMRC have done their work and concluded that IR35 does apply, the department will send the client a bill which can be truly mind bending. If HMRC have gone back six years, it may well be three times the company’s actual turnover. But surely the client will not have to pay as much as HMRC’s figures suggest, because they have already paid higher-rate tax on the dividends? This is where time limits can be a real problem. The time limit under ITEPA 2003, s 58 is five years and 10 months from the end of the tax year, so if the investigation has gone on for a long time, and in my experience it often does, the early years do not count. Protective claims need to be put in as soon as an investigation starts.
Then there is corporation tax. As readers will know, the effect of IR35 applying is that there is a “deemed payment” of salary, with accompanying employers’ National Insurance. In principle, that gives rise to additional corporation tax relief. I say “in principle” because time limits are a problem here as well. The limit here is four years from the financial year end. So the taxpayer will probably lose for the earliest years even if a claim is made as soon as IR35 becomes an issue. There is the possibility of special relief under TMA 1970, Sch 1AB, but who wants to have to rely on that?
If this were not bad enough, there is a further problem. Having just explained the counterclaims that can be made on behalf of the taxpayer, the adviser will find that the department has an “interesting” way of further increasing the client’s bill. If HMRC go back six years, interest can be charged on the IR35 claim at 3%. The higher rate and corporation tax counterclaims come back with interest at 0.5%. Advisers might think that HMRC would do what is obviously fair and offset the latter against the former – but no. They will find (in my experience at least) that there is no offset until the matter is finally settled, so the department can make a 2.5% turn on a balance that exists only on paper and is not actually owed. In this way, the interest will very likely add 50% to the overall bill. Whatever the strict legal position, clients in this position feel that the result here is very unfair – and I agree with them.

Impartial advice?

The HMRC IR35 helpline also merits a mention. This has been a consistently good source of advice throughout the unhappy history of IR35, and users are promised that “any information you give won’t be shared with HMRC compliance teams”. However, I gather that I am not the only person to have found somebody working on both sides of this particular Chinese wall. I am not the only person to have discovered the same inspectors working on the helpline as in compliance teams. While I can accept that information will not be deliberately shared with compliance teams, what procedures are in place to see that this does not happen accidentally? This does not look right.
If IR35 appears to have been designed with the needs of big business in mind, there is a little corner of industry where HMRC practice increases its advantage. In 2008, HMRC agreed a set of guidelines to determine employment status for the radio industry. However, although the big fish in this business know all about them, it seems that nobody thought about letting IR35 advisers into this. Should an adviser be lucky enough to know of their existence, a copy can be obtained very easily by phoning HMRC’s TV and Broadcasting Unit on 0161 261 3254; the guidelines will arrive by return. But can they be found on the HMRC website? No, and I am told that there are no plans to put them there. For the benefit of practitioners needing to give IR35 advice to contractors in the radio industry, they can be found here.
This is not fair. Let’s recap. We have a tax that allows big business taking advantage of this labour to say “nothing to do with us”; is incapable of proper enforcement by HMRC; those potentially affected cannot be expected to understand; their advisers cannot be expected to understand either; requires clairvoyance to put in the correct counterclaims against HMRC to stop them getting away with more than they are entitled to; and allows the department to contact a taxpayer’s client and disrupt relations between the two. Finally, this is a tax where inadvertently getting it wrong risks leaving the taxpayer in a state of financial ruin. To make it worse, this oppressive and unjust tax is causing all this havoc for the sake of raising £550m a year or, so HMRC say, enough to keep the government going for a mere six-and-a-half hours.

Time to go

It is time for IR35 to go. I have mentioned one possible solution to it in this article – there are doubtless others and some were proposed in the Office of Tax Simplification’s report on employment status last March. When the time comes for HMRC to have a dialogue with Taxation readers, I think that there should be a robust response: “We are not interested in making IR35 work. We’ve been having a dialogue about it for years. It can’t work any way you try it. It is time to scrap it completely and replace it with something that collects the tax from those who ought to be paying it. Employers’ National Insurance should be paid by employers.”
David Kirk represents the ICAEW on the IR35 Forum; however the views expressed here are his own.
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OnAugust 18, 2015, posted in: Articles, IR 35 by

Employment status – proposals for change

The Office of Tax Simplification has published (on 3 March 2015) a report “into simplifying the difficult issue of how to determine whether a worker is employed or self-employed for tax purposes”. In this analysis, our guest blogger David Kirk – author of Employment Status: The Tax Rules – welcomes the report as a serious analysis of the complex issues that arise in relation to this topic.

When I was invited to meet the Office of Tax Simplification to make my contribution to their employment status enquiry I expressed the view that they must be absolutely mad to touch the subject: the OTS deals in quick wins and this was a subject where there were categorically no quick wins. Indeed, rather the opposite, as tinkering about with it as the Government has been wont to do in recent years has generally produced knock-on effects which HMRC failed to predict but everybody else did. It gives me genuine pleasure then to say that their report on the employment status, published on March 3rd, is a real tour de force and ought to be read by everyone with an interest in it. There are, it is true, no quick wins here, but they do at least recognise that there cannot be. When it comes to sorting out the subject for the longer term, by contrast, there is plenty to mull over, both in terms of the problems as they are now, some potential solutions, and the problems that would be caused by those solutions. It is absolutely clear that only a very wide-ranging enquiry designed to examine all the purposes to which employment status tests are put has any chance of sorting everything out and leaving a lasting impression.

Foremost in all this is a recognition that both tax and employment rights must be looked at, as the straightforward employment status tests feature in both and affect a very large number of people. Indeed one of the things that had made the current situation look ridiculous was that the Department for Business, Innovation and Skills (‘BIS’) has been conducting an employment status enquiry at the same time as the OTS has, with outsiders seeing no apparent linkage between the two. This kind of unjoined-up government really must come to an end, and with any luck a report of this kind will ensure that it does.

An impressive amount of research has been done into the drivers behind employment status decisions, and one that particularly struck me was that the tax – or specifically employer’s NI – that could be avoided by either a judicious or a fraudulent decision to get people into self-employment was not at the top of the list. Apparently businesses are even more worried about giving away employment rights. It will certainly be good for BIS (and indeed other government departments) to know that their mania for employment rights not only causes businesses to want to get out of giving them altogether, but also by doing so leads to a reduced yield for the Exchequer. Likewise HMRC need to be firmly told that putting people on to PAYE without giving them the associated employment rights that normally comes with that is fundamentally unjust.

The report then goes on to explain ‘direct routes to improve the current situation’ and ‘indirect routes to take the heat out of the problem’. The former part is on the face of it a bit disappointing, with a focus on better HMRC administration (heard that one before?) and an improved employment status indicator tool (there is an interesting discourse on the one used in Australia which appears to be far more user-friendly than ours, but it is going to be very difficult to arrive at one that is not too rigid). There is also discussion of a statutory employment test which could take a number of forms: this one really ought to remain in the ‘too difficult’ box. In the author’s view the disappointment lies not in the OTS’s report, but in the implications of its analysis which suggest at the end of the day that there really is not much that can effectively be done here.

It is therefore to the final part that one must look for solutions, and bearing in mind the breadth and complexity of the subject they very sensibly do not recommend anything for any more than further study. But the agenda for further study is spot-on. There is a firm recognition – displayed several times – that the ‘elephant in the room’ (their phrase) is employer’s NI, and that any solution that does not address the requirement that employers pay it, but engagers of self-employed labour do not, is unlikely to be much of a solution. Abolishing it altogether is mentioned, which would be very radical, although it is not something that the OTS can pick up and run with as significant sums of money would need replacing from some other form of tax. Also mentioned is a mechanism for putting certain company directors on to classes 2 and 4: this idea could be developed further I suspect. Additionally discussed, although not recommended, is an inbetween status for a freelancer company which would have a sole director and a minimum salary level. However pride of place is given to a system where deductions would be made in a similar manner to the Construction Industry Scheme, so that some payments on account of tax are made and engagers can carry out their responsibilities without being frightened of the consequences of having got their status decisions wrong. The report indicates that this would command a surprising amount of support from business, which one would have thought would resent the bureaucracy involved.

All in all this is a most welcome and timely report, and it is much to be hoped that the Chancellor will pick it up and run with it on budget day.

David Kirk, MA, FCA, CTA is director of David Kirk & Co., a niche tax consultancy specialising in payroll taxes and employment status, with particular reference to intermediary staffing companies (employment agencies and umbrellas).
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OnMarch 5, 2015, posted in: Articles, Company Tax, IR 35 by

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

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OnFebruary 16, 2015, posted in: Articles, Company Tax, Employment, IR 35 by