HMRC’s ‘Small Company’ exemption from IR35 reform ‘could cause big problems’

The taxman must go back to the drawing board with his ‘small’ engager exemption -- the key question he fails to ask in his consultation on the corresponding off-payroll rules, experts say.

He should also look at developing an online tool -- to be used alongside CEST -- to help affected parties determine if the engager is ‘small,’ says one of those advisers, JSA Group.

But ‘affected parties’ is another of the now-closed consultation’s unanswered questions, in terms of who decides if the engager is ‘small’ and who passes the decision down the supply chain, the group said.

And exactly when the passers-down of the decision must act is another question that needs an answer, according to the Institute of Chartered Accountants in England & Wales.

'Too complicated'

Of the consultation respondents to criticise the carve-out for ‘small’ engagers (defined as fewer than 50 staff or under £10.2m in annual turnover), the institute is among the more positive.

It “welcomes” the exemption which in effect means companies within it need not apply the IR35 rules from April 2020 but, even so, says the definition used for ‘small’ is “too complicated.”

“There are a number of practical considerations that require further consideration for the exemption to be workable,” the ICAEW warns.

“[Such as] at which point in time the test should be performed together with when the new rules should be operated -- for example at the start of the following tax year.”

'Appropriateness'

Another tax body the ATT isn’t overly impressed with the exemption either. “We question the appropriateness of the proposed definition of ‘small.’

“[We] suggest an alternative test based on the extent of an entity’s engagement of off-payroll workers. We think that further consideration is required to the date from which an entity is required to apply the proposed provisions once it has ceased to be ‘small;' however defined.”

The definition, as currently proposed by HMRC, is found under the Small Companies Act, but the act’s rules are “regularly misapplied by accounting professionals,” says JSA chair Chris James.

'Increased confusion'

“In addition, size criteria are determined retrospectively in the normal course of business. Here, the reform is intending to exclude small business from the reform, which has merit.

“However the process of deciding who is small and who is not is not defined,” Mr James says in JSA’s consultation reply. “This will lead to increased confusion, and the rules being misapplied.”

Other ‘misapplication’ may be intentional. “It will be necessary to consider anti-avoidance rules to prevent the fragmentation of a large client into many small entities who could then engage all the contractors and supply them to the fragmented client,” says the ICAEW.

'Standard HMRC form'

So the prospect of HMRC certifying engagers as ‘small’ and therefore exempt from the 2020 framework has been raised to the department, alongside ‘self-certification’ if end-users themselves will decide their applicability to the rules.

“Where the client qualifies as ‘small,’” says the ATT, “we think that there should be a requirement for the client to communicate that fact to the fee-payer and/or worker.

“We suggest the provision by HMRC of an appropriate standard form or wording.”

'Arbitrary and unfair'

Currently, the indication from the Revenue is that engagers would gauge whether they are ‘small’ -- and therefore exempt -- by applying the Companies Act criteria on an accounting period by accounting period basis.

Then, and assuming the engager qualifies as ‘small,’ the off-payroll working rules would apply from the start of the next tax year, following the end of that accounting period.

The Association of Taxation Technicians (ATT) reflected: “The amount of time that affected organisations will have to prepare for the application of the off-payroll working rules will depend upon their accounting period end, which appears to be rather arbitrary and potentially unfair.

“By way of example, an organisation with a March year end will only have five days from the end of their accounting period before the rules apply, whereas a business with an April year end will have over 11 months.”

'Question the logic'

The association says the answer is for HMRC to grant a period of at least one year from the end of the accounting period in which an engager ceases to be ‘small’ before the rules must be applied.

A recruitment drive or the securing of a large contract are among the developments that could cause engagers to lose ‘small’ status. But strangely perhaps, such factors won’t apply in the public sector.

“We question the logic of confining the application of the small test to the private sector and recommend consideration of its application to public sector organisations which meet the same criteria,” the ATT said.

The ICAEW agrees, saying :”We strongly believe that having different tax rules for some engagers in the private sector is unsustainable in the longer term, leading to greater complexity, unfairness, a greater administrative burden and the likelihood of more mistakes and ultimately non-compliance.” 

'Far more onerous'

Greater administrative burdens -- like the small company carve-out – are another area that the consultation fails to give enough consideration to, according to IR35 firm Bauer & Cottrell.

“Saying the ‘smallest organisations will not have to determine the employment status of the off-payroll workers they engage’ sounds good, but has anyone considered the fact that tens of thousands of small organisations will become ‘fee-payers’ under the new rules?,” asks the firm’s Kate Cottrell.

“The government claims to be fully behind these small businesses and everyone is encouraged to give contracts to them, but the mechanisms needed to deal with these rules, as a fee-payer, are far more onerous than deciding the status. And what of the costs -- Employer NIC, new software and reporting requirements to name just a few?”

'Same principle'

The Association of Independent Professionals and the Self-Employed (IPSE) recommended: “Clients that meet the small company exemption requirements must be obliged to declare their status to the PSCs they engage. PSCs should not be expected to apply tax rules based on the silence of the end user client.”

In its submission to HMRC, the association added that the "same principle" should apply throughout the supply chain.

“Small companies should be required to inform the supply chain they are ‘small’, according to the Companies House definition, and that the IR35 liability therefore rests with the worker’s PSC,” IPSE said.

'Critical'

Meanwhile, Mr James of JSA suggested HMRC was wrong not to ask more broadly about the small company exemption.

“The consultation proposes the use of Companies Act size limits to classify end-users as small or otherwise. It does not ask an explicit question about this approach other than a very narrow question about applying parts of this test to unincorporated entities,” he said.

“It is not clear why this is, as the assessment of company size is critical to the law – if you are small, the rules don’t apply.”

Editor's Note: Futher reading on the IR35 'small company' exemption:

Contractors face IR35 limbo as Finance Bill lets small clients stay silent

Agencies shy to say 'small company' in contractor job adverts