Lords defend contractors, issuing 'damning' IR35 verdict against Treasury, HMRC

A “damning” House of Lords inquiry into IR35 today exposes a raft of failings by the taxman and Treasury, so large it reads as an indictment of both the rule and officials themselves.

Fundamentally, IR35 is “flawed” because the rule wrongly tries to treat all “flexible” contractors who are rightly “in a different category to employees,” as indistinct to employees.

“Unless the government accepts this distinction,” add the Lords economic affairs committee, in a stark warning, “off-payroll rules could eliminate by stealth contractor flexible working”.

'IR35 has been ineffective for 20 years'

Rather than accept the distinction, the government has chosen to reform the rule, despite its “ineffective” status for a “prolonged period” -- its entire 20-year history, the committee says.

But the initial reform in 2017 was “not applied properly” by HMRC; it built a tool of “limited assistance;” ran “no proper evaluation” and “recruitment and retention problems” resulted.

Then, instead of the government learning the lessons (peers say they’re “not convinced” it has), it “too narrowly” considered extending the 2017 reform, from public sector to private.

'Lords haven't missed a beat in IR35's sorry past'

Moreover, on the extension’s impact, HMRC has “not fully understood” the “significant challenges” or “heavy burden.” And on its cost, HM Treasury has “severely underestimated”.  

“This first-class report should be compulsory reading for all HMRC and HMT compliance and policy officers,” ex-tax inspector Kate Cottrell, a former HMT secondee told ContractorUK.

“Peers produced this report in record-time, not missing a beat relating to the sorry tale of IR35 for over 20 years, including all the concerns raised yet ignored, time and time again.”

'Official help with IR35 falls well short of what's required'

Despite delaying the private sector launch from April 2020 to April 2021 because of COVID-19, the government’s IR35 support “falls well short of what is required”, the report scolds.

The Lords therefore predict “widespread disruption”, “significant challenges” from testing IR35 status, and the “unfair” taxation of contractors (set to “bear the brunt” of client’s NICs).

“Given the dysfunctionality of the existing system, we call on the government to use the extra time to rethink fundamentally its [IR35] approach” say the peers, urging “wholesale  reform”.

“The severity of the economic impact of COVID-19 is so great that it would be completely wrong…to impose a new burden on business in the form of the existing off-payroll proposals.

“However, business is likely to need considerably longer than a year to recover from the disruption caused by the COVID-19 pandemic.”

'Full, accurate IR35 reform effects in six months not possible'

So the Lords want a number of actions taken.

Firstly, the government’s pledged review into the impact of the April 2021 off-payroll reform should be moved from six months post-launch, to 18 months post-launch.

This should offer a “full and accurate” picture of the effects but secondly (and before the reform bites), the government should consider at October 2020 whether to go ahead at all.

Thirdly, as the Lords agree with IR35’s policy aim of prohibiting unfair tax advantages, the government should assess reform alternatives floated by industry. It should put those to MPs.

Fourth, government should implement one such “simpler” alternative (to be based on six tax principles), ahead off fully actioning the Taylor Review (“highly regrettable” it is unadopted).

Fifth, and in the instance that the government ploughs ahead with the current framework, ministers should agree to an “independent” probe of the public sector reforms of April 2017.  

'Unhelpful resistance to off-payroll reform alternatives'

This ploughing ahead by the government has become both characteristic and part of the problem, suggests the committee, ominously.

In fact, when eyeing the reform’s extension from public to private, the peers found that HMRC and HMT “did not analyse sufficiently the unintended behavioural consequences”.

Towards the end of their 60-plus page report; the clearly unimpressed Lords add: “We do not believe that its resistance to alternative approaches has served the government well.

“The more intractable and difficult the problem, the more the government needs to be flexible and open to a range of ways of tackling it.

“Yet the government continues to focus on the off-payroll proposals - which are substantially the same as the existing IR35 rules, with all their inherent problems - as the only solution.”

'Government burying its head in the sand'

Seb Maley, chief executive of Qdos says “now, more than ever,” the government must listen to “the raft of concerns raised by the Lords” and act, not keep “burying its head in the sand”.

He also told ContractorUK: “[If it does], government may endanger hundreds of thousands of workers whose skills and flexibility will prove vital in helping the economy to its feet again.”

“How prepared will businesses recovering from the [coronavirus] crisis be to take on this extra burden on next year?” asks a similarly-minded Lord Forsyth, the committee’s chairman.

“The government needs to think this through very carefully. We call on the government to announce in six months’ time whether it will go ahead with reintroducing these proposals.”

'Unfair treatment of contractors, amid COVID-19 turmoil'

At Qdos, which reviews contracts for IR35, Mr Maley reflected: “To commit to introducing IR35 changes next year would result in the unfair treatment of contractors.

“This would be at a time when the economy is in turmoil. Who’s to say that the UK will have recovered from the devastating financial impact resulting from the coronavirus by then?

“But the Lords calling for a decision to be made in six months isn’t just because of COVID-19. It’s to do with the government’s frankly weak and flawed plan for IR35 reform.”

Asked to evidence his charge, the status reviewer cited CEST being found by the peers to be unreliable (“ongoing deficiencies”), and an alert they issued about ‘zero-rights employees.’

'Replacing one unfairness with another'

On the latter, the Lords seem to have based their warning on PSCs being taxed as employees but with none of the rights of employees, from contractors' written submissions to the committee.

And also potentially from a submission by contractor accountant Graham Jenner, who on March 12 told ContractorUK that the government is “replacing one unfairness with another.”

Using identical wording, the peers say in today’s April 22-printed report: “[By] creating a class of zero-rights employees, the government is replacing one unfairness with another.”

But the only ‘unfairness’ likely to be on the government’s lips is in the expected event that it argues that not proceeding in the private sector is unjust on the public, says Bauer & Cottrell.

'Revenue-raising is HMT's/HMRC's major driver'

Writing today exclusively for ContractorUK, the status advisory says: “A further argument in favour of going ahead is that HMRC/HMT are working in other areas due to COVID-19.

“There’s no doubt that taxes and NIC will have to go up significantly for everyone, so just letting this [the off-payroll reform] go ahead, irrespective of the current lack of financial support for outside IR35 contractors, would be extremely concerning -- but unsurprising”.

In their report, the Lords confirm that quite apart from the government’s rhetoric about ‘fairness,’ it is “revenue-raising” which is the “major driver” of the new IR35 framework.

After they state but do not back a £1.3billion tax loss projected by HMT/HMRC, and remind that its extra haul (£4.1bn by 2024/25) is of ‘high uncertainty,’ the peers add:

“In April 2021, the private sector is likely still to be recovering from the COVID-19 pandemic; the government will therefore need to consider carefully the merits of various approaches to revenue-raising.”

'Riddled with problems, unfairnesses and unintended consequences'

Reflecting on his committee’s work and report ‘Off-Payroll Working: Treating People Fairly,’ published this morning, Lord Forsyth said: “[We] welcomed the government’s decision to defer these off-payroll working rules in the wake of the COVID-19 pandemic.

“However, our inquiry found these rules to be riddled with problems, unfairnesses, and unintended consequences.

“The potential impact of the rules on the wider labour market, particularly the gig economy, has been overlooked by the government. It must devote time to analysing all of this.”

'It took Coronavirus to illumunate Treasury and taxman'

Sounding confident that the Lords could now chalk up their second delay to private sector IR35 reform is Kevin Austin, managing director of Access Financial.

“The excellent work done by the Lords Select Committee…[is] likely to upturn the law.

“It has to be said, though, that it took COVID-19 to illuminate the true attitudes of the Treasury and HMRC towards the genuinely self-employed.”

A compliance and risk contractor is much more cautious, saying: “Personally, I have a lost so much interest in IR35, [what] with the contracting market drying up to a muddy puddle and only set to get worse with COVID-19.

“So I’m going to take stock and go back to FT [Full-Time work] after 10 years of [being a professional contractor], I think.”

'Could ruin all our industries'

Similarly downbeat, and also speaking on the eve of the Lords’ report, a testing contractor said: “IR35 isn't going away. It’s only postponed.

“[So there’s] just under a year to change what could ruin all our industries.”

Nonetheless, now with peers on their side, the co-founder of off-payroll advisory Bauer & Cottrell says contractors have a reason to rally.

'Lords not only listened; they've also understood'

“Contractors and many others in the contractor industry should now be thinking of celebrating,” Ms Cottrell said. “The Lords have not only listened; above all else they’ve understood.”

Fellow IR35 adviser Qdos’ Mr Maley, agrees. “Above all else, this a thorough investigation by the Lords,” he says. “Of the proposed changes to IR55 reform in the private sector, it’s both eye-opening and damning.”

UPDATE at 12.34 on April 27th: A spokesman for the Treasury, which is due to respond to the Lords' findings said: "It is right to ensure that two individuals sitting side-by-side and doing the same work for the same employer pay the same tax and national insurance contributions.

“Those who don’t comply with the off-payroll working rules pay significantly less income tax and NICs than an equivalent employee, and the cost of this non-compliance deprives our public services of vital funds.”