Tackling the IR35 elephant in the room

Knowing now, as we do, that HMRC’s plan to restrict PSCs in the public sector isn’t going to be made extinct a la ‘controlling persons’ proposal still leaves the contractor sector with an elephant in the room, writes Barry Roback, director of the Anderson Group.

Plainly put; the fear is that what’s incoming on IR35 today for the public sector is going to be on its way tomorrow for the private sector. Its origins don’t bode well because, if you recall, the then-chancellor made this initiative a major selling point in his March 2016 Budget, presumably in a bid to show the public at large, just how seriously the government takes ‘cracking down’ on so-called tax abuse. This new government won’t want to appear soft either.

Before addressing the feasibility of superimposing the IR35 plan for the public sector on the private sector, let’s recap. Although it was introduced in the last Budget, a new IR35 regime affecting public sector PSC contractors is not set to become law until April 2017. By which time it is intended that HMRC will have created a far simpler method than available today, to help determine IR35 status.

However the real sting in the tail is that where a PSC contractor is paid ‘off payroll’, (i.e. without the deduction of tax and NI under PAYE), yet subsequently it is determined that such payment(s) should have been ‘caught’ by IR35, then in the event of non-payment of the correct tax, the public sector engager making such a misclassified payment (or, in the case where an intermediary is involved in the supply, the last entity paying the PSC) will be ultimately responsible for any shortfall in the correct amount of tax due. And ‘tax due’ is going to includes employers’ NI. The effect of this will be that the decision on the application of IR35 will rest with the engager and not with the PSC.

As alluded to at the outset, even though these proposals are stated to apply only to ‘public,’ taxpayer-funded bodies engaging PSCs, many observers have commented that this fundamental change in how IR35 is applied, is merely a ‘dry run’ which, if successful, will subsequently be rolled out to cover all PSC engagements – both in the private sector as well as the public sector. If this is to be the case, the question arises – how and when?

To address these two vitally important questions, there are a number of critical hurdles that HMRC must first overcome:

a) Is it acceptable to ask one party to a contract, to make a determination of the other party’s tax classification? IR35 determination is an imprecise science at best (as evidenced by the number of IR35 cases that HMRC have fought and lost, to date) and is actually based on a number of wide ranging factors. Critically, it is not based purely on empirical data. Where subjectivity comes into play, what is considered caught or ‘inside’ by one person, may be determined as ‘outside’ IR35 by another. HMRC have stated that it is their intention to issue new guidelines/online tools to help determine IR35 status. But notably, previous attempts at this have shown that it is much more difficult to do in practice than the tax authority likes to believe. Unless the regulations applicable to IR35 are fundamentally overhauled, status is governed by tax law and subsequent case precedent, and not by a set of HMRC questionnaires. For a correct IR35 assessment to be made, not only must the relevant factors be considered pertaining to the contract in question, but also so must many other factors, most of which are unlikely to be known by the engager. To err on the side of caution will undoubtedly lead to ‘false employment’.

b) The temporary recruitment industry has been a major factor in the UK’s ability to bounce back from the recent recession so quickly and successfully. HMRC has conducted research into the acceptability of their proposal, to pass ultimate responsibility for unpaid tax to the engager. The results (published in July 2016) suggest overwhelming disapproval from all sectors – including end-users of contract labour as well as most intermediaries. In the face of such overwhelming adversity, how strong is the government’s appetite to go ahead and introduce such unpopular regulations? If silence speaks volumes, the absence of a response from a spokesman for HMRC suggests this appetite to be strong. My concern though is that without debt transfer, these proposals will be as ineffective as the current IR35 legislation

c) In view of the recent Brexit decision, will the government have more on its plate than it can reasonably handle over the next few years?  

Therefore, HMRC and the government have quite a challenge in front of them, if they are to: a) make a success of introducing their proposals as they pertain to the public sector, and; b) to roll these changes out to the private sector at large. 

My best guess is that until such time as IR35 is scrapped and replaced by legislation that is clear, concise and much easier to enforce (based on empirical rather than subjective evidence), tinkering around at the edges will only lead to confusion and frustration for all.