We should thank the PAC, but an IR35 review which tackles all HMRC’s misrepresentations is still outstanding

In the government’s response to the Public Accounts Committee’s widely endorsed criticisms of IR35 and its implementor HMRC, we see yet again that if you ask the same questions of HMRC, you get the same answers, resulting in a pointless exercise, writes former tax inspector Carolyn Walsh, director of CWC Solutions.

The PAC’s probe was into the implementation of IR35 and so it does not attempt to touch upon the inherent flaws in the legislation, or what really went on in the run-up to its 2017/2021 reform. So, let's now make some possibly uncomfortable observations, at least for HMRC.

How we got into this mess in the first place

The government originally introduced the legislation known as IR35 in April 2000, aimed at workers/directors doing the same job in the same manner as an employee, who were able to avoid income tax and National Insurance Contributions by providing services through a Personal Service Company (PSC). The ‘same manner’ and ‘PSC’ were terms never fully or adequately explained until recently.

HMRC attempted to determine a PSC and its worker/director using a provision in the Finance Act 2000, where IR35 doesn’t apply; when they own less than 5% of the shares and where payments to them are not representative of services personally provided by them.

Get-out clauses. The first of a few HMRC missed...

But there was an easy ‘get-out’ clause. And this get-out gave rise to ‘composite companies’, where all directors held less than 5% of shares and were paid a low salary and the rest of any income generated as dividends.

It’s my contention that at this point, HMRC lost control and knew it had lost control. But it had also lost control of the so-called ‘agency legislation’ which was implemented before IR35. Only did HMRC get back on top of things when the agency legislation was tightened in 2014 to prevent labour supply agencies from ‘employing’ workers on any other basis than under PAYE. Yet even then there was another easy get-out clause, and this was to ‘employ’ agency workers through their own PSC.

In 2016, HMRC estimated that only 10% of PSCs were applying the IR35 rules correctly. But I believe that this compliance ‘guestimate’ is a gross misrepresentation. I’d go further, and say that this misrepresentation has led directly to small bonafide businesses (including freelance contractors) losing work, income and ultimately, the businesses they have worked so hard to build up over the  years. 

Even if they found this hidden HMRC document, agency workers can't have known the risks

If HMRC is going to be held to account for any failure – including by inquisitive MPs on the likes of the PAC, it should be this 10% compliance guestimate. Crucially, the HMRC guestimate includes the many thousands of agency workers paid through their own PSC to avoid the agency legislation, who were expected to know HMRC’s opinion – notably, that if the agency legislation applied, then it was the worker/director’s responsibility to consider and operate IR35. Here is the corresponding guidance that HMRC provided online which, significantly, has never been published in paper form and so, to my mind, must be up there with the best-kept secrets of any government department! This is why I say workers had to sort of somehow know HMRC’s stance on it all.

It's also my belief that if agency workers knew that setting up a PSC probably fell foul of IR35 legislation, leading them into potential tax avoidance, the vast majority would never have agreed to incorporate.

Remember, HMRC acknowledges that the majority of taxpayers are honest in their dealings with their tax affairs. And so the department really can’t have it both ways. 

Worse, the Revenue almost completely neglected to advise agency workers of the IR35 risks, at a time when there was an explosion in the numbers of people working via their own PSC, and it effectively suppressed the above guidance (by not making it physical nor being vocal about it). Agency workers needed to know and abide by this underreported guidance, to avoid owing the tax authority over their status. 

The Revenue rubbing its hands together

The cynics in the contractor sector may say that IR35 really wasn’t enforceable or even majorly newsworthy for 15 years. But the volume of agency workers operating as PSCs grew and then HMRC had a means by which to pin a juicy revenue number on non-compliance. Furthermore, since the introduction of the intermediary reporting requirements, HMRC could even get these individuals’ names and NI numbers too!

Continually disseminating that 90% of freelance contractors fail to pay the right amount of tax, and then craftily making their customers (end-user organisations) liable for any debt, was a dual master stroke on HMRC’s part. In fact, it’s little wonder that entrepreneurship among one-person businesses has been all but killed off. A needless sterilising of our once enterprising grounds here in the UK has taken place, as a result of these two moves by HMRC.

What we need from the Truss/Kwarteng-ordered IR35 review

Until any review into HMRC’s flawed IR35 is big enough and honest enough to tackle all of its mistakes and misrepresentations of the past (and yes, I’m aware prime minister Liz Truss has committed to reviewing the off-payroll rules), freelance contractors who are operating through their own PSC, albeit with PAYE deductions being made against their invoices, have just one option. And this option is explained on page 3 of the PAC’s report:

2.4 If a worker still disputes the determination, they can file their Self-Assessment return reflecting their own assessment. HMRC has 12 months from the date the return is received to open an enquiry, during which it may consider whether the employment status is correct.  HMRC will also monitor the number of customers who dispute their status through their Self-Assessment return and carry out checks to ensure the process is being used appropriately. 

Make no mistake, unless contractors use this mechanism a lot, the impacts of IR35 reform will not be evidenced by the number of tax return-season-disputes that clients are having with workers regarding their status determinations. And without doubt, HMRC is going to then use the lack of disputes reported via contractors’ self-assessment returns as proof that the reform was implemented properly.

To our PM, I say this. When a core issue with IR35 or any of other piece of tax legislation is ignored, any review into that framework will fail to achieve any real relevance. The many ‘fails’ of the Intermediaries legislation which has stymied the UK contractor sector for 20-something years all need to be considered in the round and while it will be a long process for new chancellor Kwasi Kwarteng to undertake, it will be worthwhile because it’s far better than giving up the chance to break out of the vicious cycle that IR35 has become, and which HMRC has perpetuated.