Association of Independent Professionals and the Self-Employed (IPSE) – Written Evidence (DFD0101)

IPSE is the Association of Independent Professionals and the Self-Employed. IPSE has over 74,000 members and associates. We represent the approximately 5 million self-employed individuals living in the UK.

IPSE believes the proposal to extend the off-payroll working rules (often referred to as IR35) to private sector businesses will be deeply damaging, not just to ‘Personal Service Companies’ (PSCs) and the agencies in the supply chain, but to their private sector clients and the economy as a whole. We are concerned the legislation will:

• Heap significant cost onto businesses
• Restrict the private sector’s access to the specialist skills it needs
• Reduce flexibility in the supply of those specialist skills
• Force compliant self-employed businesses to close
• Further complicate employment status
• Give rise to legal challenges, particularly with regards to employment rights and status appeals
• Swamp UK businesses in red tape
• Damage UK productivity
• Result in multi-national businesses shifting projects offshore
• Encourage further use of non-compliant umbrella arrangements and tax evasion schemes

IPSE strongly agrees that everyone should pay the right amount of tax but this measure is a sledgehammer to crack a nut. Government should delay implementation to allow time to consider alternative arrangements which would protect Exchequer revenue, while also allowing compliant self-employment to flourish.

In the Appendix to this submission we have included the recommendations we made to the government in our response to the 2019 consultation.

INQUIRY QUESTIONS

Existing measures in the public sector

1. What has been the experience of the new off-payroll rules in the public sector? What lessons have been learned from this experience, and how have they affected the draft Finance Bill proposals?

IPSE is aware that significant numbers of contractors left the public sector as a result of the 2017 legislation and that this resulted in public sector projects being delayed or cancelled.

In 2018, IPSE and the Chartered Institute of Personnel and Development (CIPD) undertook joint research[1] into the impact of the off-payroll working rules in the public sector.

The research found the legislation had had a severe impact on the ability of public sector bodies to access skilled resources, particularly in the NHS, with a rapid rise in projects being delayed or cancelled. It also prevented independent professionals from working freely in the public sector.

Over half of hiring managers in the public sector (51%) had lost skilled contractors with 52% experiencing delays, cancellations or increased costs as a result of the change.

IPSE raised many concerns about the public sector rules. Some of these concerns have been partially addressed in the new private sector proposals. For instance, the client-led dispute resolution clauses in the draft Bill addresses a concern that individuals in the public sector have no route to challenge an incorrect status decision by their client.

However, IPSE has very little faith that a client-led process will result in an incorrect decision being overturned. Without access to the courts, or some kind of independent arbitration service, it is unlikely a client will be persuaded to change its initial decision.

Impact of new off-payroll rules on organisations

2. Has the impact of the extension of the off-payroll rules to the private sector been adequately assessed? In particular, is the assessment that has been made of the compliance burden (including costs) of these new rules realistic? Has the right balance been struck in the compliance burden on the taxpayer and on HMRC?

Several large companies, particularly in the banking sector, have stopped engaging contractors altogether, as a direct result of the draft legislation. It is not clear the government anticipated this, which would suggest the impact on the private sector was insufficiently assessed.

For companies that continue using contractors, there will be a compliance cost. In May 2018, the government commissioned research into the impact of the reform in the public sector. It found that central public sector bodies spent an average of £7,550 ‘setting up the systems and processes required to implement the reforms’.[2]

All independent commentators IPSE has spoken to say this figure is wildly underestimated. Some say the true figure is ten times that, and that is before Employers’ National Insurance (13.8%) and the Apprenticeship Levy (0.5%) are taken into account. These charges will apply to any ‘deemed employees’.

A Note on Employers’ National Insurance (NI)

Employers’ NI makes up the vast majority (around 82% by some estimates) of the additional tax which is due where IR35 applies.

In the public sector, hiring organisations have sought, in many instances, to pass this cost down to the individual by negotiating a lower rate. This practice is standard where an umbrella company is inserted into the chain as the ‘fee-payer’. It is not clear what the government’s view on this is. Does it believe that where an individual has been deemed as ‘employed for tax purposes’, that the client is an ‘employer for tax purposes’? And should it therefore shoulder the Employer NI burden?

The government has suggested it might be possible to challenge the client’s status determination retrospectively, through the self-assessment form. If it found that IR35 was applied incorrectly, how will the Employers NI be repaid? After all, the individual has paid it, but indirectly. The complexity of the way payments under IR35 are made, makes it extremely difficult to unravel in the (actually very likely) event that the client has got the determination wrong.

3. Is the exclusion of small organisations sufficiently robust, and how might small organisations gain sufficient assurances that they fall within the exclusion?

IPSE supports the small business exemption. IR35 compliance is burdensome and without sufficient resources, small businesses could quite easily become swamped by the inherent complexity of the rules.

However, 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.

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’.

4. What will be the effect of these new measures on a chain of contractors and subcontractors?

Where a contractor (C1) pays another contractor (C2) and the end client has determined that IR35 applies, C1 becomes the ‘fee payer’. C1 there has the tax liability and must put payments to C2 through payroll. C1 options are to operate the payroll him or herself, or introduce an umbrella into the chain. Neither of these options will be attractive to C1 due to cost and administrative burden, so the likelihood is that the relationship between C1 and C2 will be forced to end.

5. What scope might there be for simplifying or otherwise reducing the administrative burden of these measures? What should HMRC do to help businesses understand the new administrative rules?

Due to the inherent complexity of IR35 it is difficult to simplify the process of compliance. Indeed, it may even be undesirable to simplify it, as it may very well lead to incorrect determinations. Some companies will make ‘blanket determinations’ where they declare that all engagements are ‘inside’ IR35. This is very simple, but it is also wrong. Nevertheless there is evidence to suggest this is already happening.

Determining tax status of workers

6. Are the tests for determining employment for the purposes of these rules sufficiently clear to both engager and worker? Do they reflect the reality of the contracting environment?

No, the tests are not clear and there is no consensus on what they truly mean. The definition of mutuality of obligation, for example, is contested. HMRC say mutuality is present in every contract, thus neatly removing one of the central considerations when determining status. The courts, however, have frequently diverged from this view.  For example, in Usetech Ltd v Young (H.M. Inspector of Taxes) (2004) 76 TC 811, Parker J said at paragraph 60:

"I would accept that it is an over-simplification to say that the obligation of the putative employer to remunerate the worker for services actually performed in itself always provides the kind of mutuality which is a touchstone of an employment relationship. Mutuality of some kind exists in every situation where someone provides a personal service for payment, but that cannot by itself automatically mean that the relationship is a contract of employment: it could perfectly well be a contract for free lance [sic] services."

There is also considerable divergence of opinion on personal service and control – the other key tests as set out in the seminal Ready Mix Concrete case of 1968.

Instead of relying on, and arguing over, the vagaries of case law, IPSE believes a statutory definition of self-employment is needed. Where the engagement meets that definition, IR35 should not apply.

7. What is your assessment of the Check Employment Status for Tax (CEST) tool? Does it require improvement? If so, how might it be improved?

IPSE does not believe that CEST generates accurate results and further, is not convinced that a simple tool can ever be relied upon to gauge something as nuanced as IR35 status. In addition to this general view, we make the following specific observations:

• HMRC must have run cases it has taken to tribunal through the tool. HMRC has lost most of these cases, which would seem to demonstrate the tool’s inaccuracies.
• The lack of any questions on mutuality of obligation is a fatal flaw.
• In the new version of CEST, it seems to us that the outcome hinges on the answer to the substitution question, making all the other questions somewhat meaningless.

8. How effective will the status determination process be in resolving issues of employment status? Are there adequate safeguards, allowing decisions to be challenged? If not, what more is needed?

As mentioned above IPSE does not believe the client-led dispute resolution approach provides a genuine opportunity for a decision to be re-examined and overturned. Without access to the courts, or some kind of independent arbitration service, it is unlikely a client will be persuaded to change its initial decision.

Policy objectives and wider context

9. Are there better or simpler ways in which the objective of the new rules might be achieved? If so, what are they?

IPSE believes there is a growing need for a new company structure just for freelancers. In 2015 we worked with EY to develop a concept called the Freelancer Limited Company (FLC). It will not only provide certainty about businesses’ tax and employment status, but should also protect revenue for the exchequer.

Disappointingly, the FLC was specifically ruled out-of-scope in the government’s 2018 consultation document on private sector IR35.

10. Will the Bill, as drafted, achieve the Government’s objectives?

IPSE understands the objective is to ‘improve compliance with the existing rules’. The legislation will, in our opinion, lead to over-compliance i.e. IR35 being applied where it shouldn’t. It will also lead to unintended consequences such as an increased use of umbrella companies (some of which will be non-compliant – see below) and to UK contractors seeking work abroad, retiring earlier than planned and being forced to close their businesses.

Recent IPSE research found that nearly a third (32%) of freelancers are planning to stop contracting in the UK because of the changes to IR35 due in the private sector.[3]

11. What is your view of the role of umbrella companies in the context of these proposals?

Umbrella companies will play an important role in compliance. They will frequently be brought in to act as the ‘fee-payer’ and will shoulder the tax liability burden. Many umbrella companies are entirely compliant, but many are not and regulation in this area is not as stringent as it could be.

Some umbrella companies will make use of what HMRC would almost describe as disguised renumeration schemes. If and when they are challenged, they have a tendency to disappear, leaving others in the contractual chain with a large liability.

The government has recently consulted on whether umbrella companies should be more closely regulated. IPSE’s believes they should, and that the change to IR35 should not take place until that regulation happens.

12. How do the new measures relate to the wider context of changes in working arrangements, including the “gig economy”? Is it fair that some individuals are taxed as if they are employees, but do not have the rights of employees?

This question cuts to the heart of the inherent unfairness of the IR35 rules. The legislation seeks to identify certain individuals as ‘employed for tax purposes’ and deduct PAYE and NI without providing the benefits and protections that come with employment. This will cause complexity, confusion and conflict.

If workers are taxed like employees, as some will be under the proposal, it is likely, and not unreasonable, for them to expect employment rights. It will cause tensions between the worker and engager, which in turn will give rise (in all likelihood) to legal challenges.

If the engagement is pre-determined to have characteristics consistent with employment, the role should be filled by an employee, not a PSC being taxed like an employee.

Under the proposal, the engaging company will in some cases need to consider whether the engagement will require personal service and whether the worker will be under its supervision, direction and control. This will help it to determine whether the engagement has characteristics of employment, or self-employment. It may also refer to the CEST tool to further assist it with this determination. For new engagements, it will do this before advertising the role, so that it can explain to the PSC whether it will be paid gross, or whether employment deductions will be made at source. For current engagements, it will do this when the PSC is already under contract.

IPSE believes that where the engager determines that the role is inside IR35 - and therefore has characteristics of employment – they should employ the worker. The proposal to engage a PSC, in full knowledge that the role is more suited to employment is inconsistent. Either it’s employment or it isn’t. The disadvantage of this more consistent, and in our opinion more logical, approach, is that where the engager makes the wrong determination it will unnecessarily rob itself of the flexibility, efficiency and specialist skills that PSCs provide.

One of the central tenets of the government’s work around the Taylor Review and the Employment Status consultation is ensuring individuals are provided with the appropriate employment rights for the roles they undertake. This proposal flies in the face of that laudable aim. A more consistent approach would be to clarify the position on employment status, then consider tax reforms that complement those changes.

Xx February 2020

Appendix 1

List of recommendations made in IPSE’s response to the 2019 consultation

IPSE’s central recommendation is that the proposal should be abandoned.  We set out the reasons for this in our response to last summer’s consultation. Unfortunately, the government has decided to push ahead with the policy and so we make the following further recommendations:

Recommendation 1 – Delay implementation. There are several compelling reasons to postpone the implementation of the policy. These are:

• April 2020 does not give businesses sufficient time to implement the necessary processes to deal with this measure, particularly in light of the complications highlighted by this consultation. The legislation for the reform has not yet reached the draft stage for publication. Businesses will need to see the final legislation before they can put in place the necessary measures to ensure compliance. A delay will provide businesses time to understand and prepare for the changes with access to detailed information set out in the legislation. This will give businesses greater certainty of their responsibilities.
• To ensure certainty and stability for business, government should delay any changes to IR35 until it has brought forward measures on the back of the recent Taylor Review and last year’s Employment Status consultation. IR35 compliance could be made much simpler, or even redundant, if clear, unambiguous rules around status are introduced in the first instance. In addition, it would be undesirable for businesses to implement complex status determination processes based on the current rules, which may subsequently have to change.
• A delay to implementation is required for educating the private sector. HMRC’s commitment to provide support and guidance to help businesses implement the rules, and improvement in appropriate guidance to suit the needs of the private sector ahead of reform, is vital. Many businesses remain unprepared for the changes and currently lack the knowledge to make decisions concerning employment status and will therefore rely heavily on guidance from HMRC.
• There is a damaging lack of faith in the reliability of the CEST tool. It is therefore welcome that HMRC are committed to improving the tool, however, it remains unclear whether sufficient improvement can be made to fundamentally change attitudes to the tool. Implementation should be delayed until there is agreement that CEST generates accurate results.
• As mentioned above Brexit continues to have a major impact on UK business. At the time of writing the government has no clear, agreed plan to remove the problems caused by Brexit. Implementation of the proposal should therefore be delayed, allowing business and government the time to concentrate on negotiating Brexit.

Recommendation 2 - Liability should remain with the client, not the agency, and individuals deemed to be operating inside IR35 should be placed on the client’s payroll, not that of the agency or other third party (typically an umbrella).

Recommendation 3 – Introduce a statutory appeals process to allow individuals to challenge incorrect determinations. The client-led dispute resolution service proposed in the consultation document is woefully insufficient and will only serve to heap more burden on business.

Recommendation 4 – 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.

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’.

Recommendation 5 - Commission an independent body to conduct a full review of the public sector reform. The Government has a unique opportunity to comprehensively review the impact the recent reforms have had on the public sector prior to private sector implementation. A comprehensive review should be undertaken over at least a full tax cycle since implementation. This should allow issues that occur throughout the tax cycle to be identified, with solutions to tackle issues prior to potential implementation of any private sector changes.

Recommendation 6 - Undertake an implementation impact assessment for the private sector.

Key statistics, such as the total off-payroll anti-avoidance in the private sector and the cost of implementation for business, are driving the debate. However, these figures are disputed. HMRC’s recent losses at tribunal have raised doubts over government’s claims about the scale of non-compliance. With such drastic changes proposed to off-payroll in the private sector, it is necessary to understand the full extent of costs, and an accurate reflection of the true level of anti-avoidance, the policy is aiming to prevent.

Recommendation 7 - The reasonable care clause should be put in statute. In the public sector, clients have made blanket assessments. IPSE has spoken to hundreds of contractors and supply chain insiders since April 2017 – all of them agree that blanket assessments are common. It seems that only HMRC are of the view that blanket assessments have not happened.

This problem can be mitigated by placing a statutory requirement on clients to take reasonable care and then defining what reasonable care means. IPSE believes ‘reasonable care’ means:

• Assessing each engagement individually
• Reviewing the contract and the working practices independently
• Assessing all the factors that would be assessed at a Tax Tribunal

Recommendation 8 - Introduce a new tax relief aimed at encouraging pension savings for those caught by the IR35 rules. There is already a pensions crisis among the self-employed. Just 31%[4] of self-employed people are currently saving for later life. Prior to the off-payroll reforms in the public sector, many off-payroll workers made pensions contributions though their intermediary, and tax relief was effectively claimed on those contributions. Those caught by IR35 in the public sector have lost this ability as a result of the reforms, because all income is taxed at source. 

Recommendation 9 – Reinstate the 5% expense allowance where IR35 applies. The proposal suggests that IR35 caught engagements with small clients will allow for a 5% allowance to cover some of the costs of running a business. However, the 5% will not be permitted if the engagement is with a medium or large client. There is no justification for this difference and no adequate justification was given for removing the 5% allowance when the rules changed in the public sector.

Recommendation 10 – Government should consider alternatives to the proposal. This should include ideas that were deemed ‘out-of-scope’ in last years’ consultation.