TAC0086                           

Written evidence submitted by IPSE - The Association of Independent Professionals and the Self-Employed

Executive Summary

The taxation of employees v self-employed sole traders v company directors

The taxation of different forms of labour has led to heated debate that predates the coronavirus. Recent shifts in working practices – particularly the rise of people working for themselves, either through incorporated or unincorporated business structures – have led to concerns around the erosion of the tax base and the widening of the tax gap. The debate has arguably been brought into greater focus since the pandemic. There are perhaps two reasons for this:

  1. The pressure on the public finances, as a result of the recent economic shock, has naturally led to discussions about potential tax increases, and where those increases should apply
  2. Some aspects of the government’s coronavirus support packages have directly targeted certain populations which are perceived to be treated over-generously by the tax system e.g. the self-employed

Indeed, the Chancellor reinforced that view when he announced the Self-Employment Income Support Scheme (SEISS), saying:

But I must be honest and point out that in devising this scheme – in response to many calls for support – it is now much harder to justify the inconsistent contributions between people of different employment statuses. If we all want to benefit equally from state support, we must all pay in equally in future.[1]

This statement, supported by recent media speculation, has led IPSE to believe the Chancellor intends to increase tax on the self-employed – quite possibly at the Budget this Autumn. We are concerned by what we believe to be the Chancellor’s approach on this issue for the following reasons:

  1. The difference between the taxation of different forms of employment status is less than many perceive it to be, particularly since recent increases in the taxation of dividends
  2. We believe a small advantage in the tax system for the self-employed should be maintained, because the self-employed take on risk and lack the security of income enjoyed by employees. By taking on this risk, the self-employed de-risk their clients (who might otherwise have to employ them) making them more agile, better able to cope with peaks and troughs in demand and ultimately providing the UK with a competitive advantage over other countries
  3. Not everyone has benefitted from the government’s COVID support packages. Many, particularly company directors, have struggled through the pandemic with little support. It is hard to justify a tax increase that targets these groups.
  4. Although we accept that significant tax reform is necessary, we question whether now is the time to introduce tax hikes on the self-employed and would suggest instead a review of the tax system. Many of these very small businesses are in a fragile state due to the pandemic and subsequent economic shock. These businesses need to be nurtured and supported back to health, so they can drive the economic recovery that is so badly needed.

 

The difference between the taxation of different forms of work

In 2017, the Institute for Fiscal Studies calculated the amount of tax generated by employees, self-employed sole traders, and company owner managers at different income points. The figures provided would be marginally different if calculated using today’s tax rates, but the example remains illustrative.

The differences between the figures appear significant – and they are – but it must be noted that the vast majority of the discrepancy is made up of Employer NICs which aren’t technically paid by the individual employee, but rather by their employer. The graph below[3], also produced by the IFS in 2017, demonstrates this point.

The total tax revenue generated from an employment is clearly greater than that which is generated by the other two structures but the individuals themselves are paying comparable levels of tax. Indeed at £40,000, the self-employed individual (sole trader) actually pays more in direct tax and NI than the employee, as evidence by the graph.

The meaningful difference then, in terms of what the Exchequer collects, is accounted for by Employers’ NI. This is what the Exchequer misses out on when a firm engages the services of a self-employed business (either incorporated or unincorporated) rather than employing someone to do work.

Any reform must take the distorting factor of employers’ NI into account if it is to be perceived as fair and equitable by the taxpayer.

 

Not all self-employed benefitted from the government’s COVID support packages

As noted earlier in this submission, the Chancellor has suggested the delivery of the SEISS scheme, and other support offered to the self-employed, provides a justification for increasing taxation. We do not agree, for a few reasons, but principally because not all of those who would be equally impacted by a tax rise have benefitted from the support.

In our submission to this Committee’s previous inquiry into the economic impact of coronavirus, we listed the main groups which were excluded from support – the newly self-employed; those with historic earnings above the £50,000 threshold, those who earnt less than 50% of their total income from self-employment, and those who work through their own limited company and receive the majority of their income by way of dividends. (With regard to this last group, we are extremely grateful to this Committee for supporting our ‘pay now, claw back later’ proposal.)

These excluded groups have suffered very badly through the recession and have felt ignored by government. Any tax hike which is sold as ‘repayment’ of SEISS will be seen as a charge for support they didn’t receive.

Even those that were eligible for support are in a worse condition than they were before the pandemic and less able to shoulder an increased tax burden. In the second quarter of 2020, freelancers’ average income dropped by 25 per cent[4]. As the lockdown restrictions have eased, they have attempted to rebuild their businesses, but they remain in a fragile state. Imposing a sudden tax hike on these businesses now could be fatal.

In addition, we remain unconvinced that temporary support measures introduced during a time of crisis provide an appropriate springboard for longer term tax rises. That is not to say reform isn’t needed – it is – but that tying the two together is unhelpful. The government is absolutely right to strive for a fairer, more transparent, more simple tax system, but that would have been the case even without coronavirus and the subsequent support made available to some taxpayers.

Those in business should maintain a modest tax incentive over employees

The self-employed – both sole traders and those who work through their own limited company - play a unique role in the UK economy. A study led by Professor Andrew Burke at Cranfield School of Management[5] found that those working for themselves, particularly in highly skilled roles:

IPSE fully supports these findings. The UK’s army of self-employed are a tremendous resource for our businesses and citizens, and contribute a combined £305bn to the UK economy. The government should encourage and support them, and this support should be reflected in the tax system.

The additional risk taken on by the self-employed, along with requirements to purchase their own insurance, dealing with administrative functions (such as filing tax returns), dealing with being paid late or not at all by clients, should be reflected in the tax system.

To ensure that firms are not simply using self-employed workers to avoid their responsibilities as employers, and thus to guard against disguised or ‘false’ self-employment, more clearly defined employment status rules are needed

Options for reform

Review the tax system to deal with longstanding confusion over the status of the self-employed

Knee-jerk tax rises would only add to the animosity felt by the self-employed towards a tax system which they feel doesn’t work for them. The government should be radical and seek to devise a tax system that fits with the way people want to work (rather than forcing people to work in a way which best fits the tax system – arguably this is what IR35 is designed to do).

The government should take pause and seize the opportunity to rethink the tax and employment system in the long term. This would help clear up ongoing confusion and longstanding complexities, notably the IR35 legislation, that have led to the current situation. The review should look to deliver a fair deal on taxation for the self-employed that recognises the additional risk this group takes on. IPSE would be pleased to convene a working group of interested parties and relevant ministers and officials to take this forward.

Employers NI makes straightforward tax raises politically impossible - an ‘Engagers’ NI’ could be the answer

The government should consider introducing an ‘Engagers’ National Insurance Contribution’ or perhaps more straight-forwardly, an ‘Engagers’ Tax’. This would ape Employers’ NI in that it would be paid by the firm that hires the self-employed individual and calculated as a percentage of the total amount paid to the self-employed individual.

This idea was suggested by the think tank Demos in its 2018 report ‘Free Radicals’[6], authored by Alan Lockey. Lockey proposed the new tax be phased in slowly:

The Government should introduce a new ‘engagers tax’. This would initially be levied at 2.5% on a given firm’s annual expenditure on contracted self-employed labour, rising to 5% in 2021 and 7.5 per cent by the end of the Parliament.

If tax is to be increased on self-employment, IPSE believes this idea is worth exploring further. As noted earlier, sole traders already pay roughly the same, and sometimes more, direct tax and NI as employees. Increasing their direct contributions will be perceived as unfair – it will be perceived that the self-employed would now be paying significantly more than employees. The Engagers Tax would truly create a more level playing field.

Consideration would have to be given to exemptions. One option would be to exempt any hiring firms or individuals which are not VAT registered.

IPSE believes the Engagers Tax could work well for sole trader engagements, but less so for limited company engagements. It would become difficult for the hirer to know which of their supplier companies might be considered ‘self-employed’, and therefore require the additional tax payment, and which are larger companies supplying a service (which we would not expect the engagers’ tax to be applied to).

For limited companies the government should consider IPSE’s Freelancer Limited Company proposal

IPSE worked with EY in 2015 to develop the Freelancer Limited Company (FLC) concept in 2015. The idea was recommended for further consideration by the Office of Tax Simplification in 2016[7] and we held productive meetings with senior HMRC officials on the matter, though they were cut short and unfortunately not restarted, perhaps in the wake of the EU referendum.

The FLC would be a new categorisation of company for tax purposes that would provide a benign environment for freelancing to flourish, and allow HMRC to focus its attention on higher risk and more fruitful areas.

The FLC would be a normal company formed under the Companies Act but would choose to operate under particular restrictions in order to qualify for the specific tax treatment. This would free freelancers from the perils of unnecessary and burdensome IR35 audits, allowing them to focus on the contribution to growth that their activities deliver.

The FLC could be taxed differently to other limited companies, if the government choose to do so. Those attempting to disguise employment would be precluded from achieving FLC status because they would not meet the entry criteria.

The FLC would be optional. No business would be forced into it, but we believe many would find it attractive, particularly in light of the impending IR35 changes in the private sector.

A paper detailing the FLC and how it would work is attached in the Appendix to this submission.

Clearer rules on employment status to prevent disguised employment or false self-employment

As IPSE believes a modest tax advantage should be retained in the tax system for those who take on the risk of working for themselves, we acknowledge it will be necessary to continue to police the boundary between employment and self-employment.

Currently the rules on what is, and what isn’t self-employment are opaque. This is demonstrated by the widespread confusion over IR35 (and when it should and shouldn’t apply) and in high profile court cases over employment status – particularly in the gig economy in recent years.

The government, in its Good Work Plan, has committed to looking at this issue, though that report was published almost two years ago and there has been no meaningful progress since.

IPSE believes a set of clear rules should be developed which would enable individuals, hirers and HMRC to see whether the appropriate employment and tax status is being applied in every case. We have previously submitted detailed proposals on this to the government and we would be keen to work with the appropriate Ministers and officials to tackle this difficult issue.

 

About IPSE

IPSE - the Association of Independent Professionals and the Self-Employed - is the representative body for the UK’s self-employed community, including freelancers, contractors, consultants and independent professionals. IPSE is the largest freelance membership organisation of its kind in Europe and seeks to represent the views and concerns of the UK’s five million strong self-employed workforce.

 

(see: https://www.ipse.co.uk/uploads/assets/43cea20b-c776-4ba9-9df41cc91dd1261b/freelance-company-limited.pdf)

 

September 2020

 


[1] Chancellor statement on Coronavirus Support, 26 March 2020

[2] Differences in the way the tax system treats the self-employed, owner-managers and employees are costly, inefficient and unfair, Institute for Fiscal Studies, February 2017

[3] The IFS Green Budget, Tax, Legal Form and the Gig Economy, Institute for Fiscal Studies, p.14

[4] Freelancer Confidence Index Q2 2020, IPSE, August 2020

[5] The Role of Freelancers in the 21st Century British Economy, Professor Andrew Burke, 2012

[6] Free Radicals, Demos, Alan Lockey, 2018, p.77

[7] Small Company Taxation Review, Office of Tax Simplification, 2016, p.10