Serocor Group – Written evidence (DFC0028)

This is the Serocor group’s response to the Call for Evidence from The House of Lords Economic Affairs Committee’s Finance Bill Sub-Committee on the Draft Finance Bill 2018.

While our response is focused on the implications of the Finance Act 2017 (and specifically the changes to off-payroll rules in the public sector – referred to throughout as ‘IR35’) and proposed changes to off-payroll working in the private sector, we believe that these examples speak volumes in relation to the legitimacy and use of HMRC’s powers.

HMRC itself has not, since the inception of IR35 in 2000, understood, interpreted or applied the IR35 rules correctly. That much is certain considering its woeful track record when cases are brought to tax tribunals. HMRC hasn’t enforced the legislation appropriately, whether due to a lack of resources, knowledge or because of the inherent difficulties of the IR35 ‘test’ itself. That is evidenced in the statistics produced by HMRC about the extent of non-compliance - £700 million in unpaid taxes due to IR35 non-compliance in 2017/2018. 

Simply moving the problem by requiring businesses – who are even less knowledgeable about IR35 than HMRC – to determine status, does not address the root cause and simply absolves HMRC of its obligation to design, implement and enforce appropriate tax legislation. It simply adds unnecessary, disproportionate burdens on businesses for the sole purpose of increasing tax revenues. There are easier ways to collect more tax. The business community has repeatedly put forward alternative options, many of which were expressly ruled out by HMRC without discussion or explanation.

Ultimately, if HMRC want compliance, its primary duty is to make it as easy as possible for businesses to do so. More companies will comply with clear, concise, easily-understandable rules. Indecipherable, complex, uncodified rules lead to more non-compliance due to a lack of understanding and/or willingness to learn the details. It also increases the very real risk of over-compliance through blanket ‘Inside IR35’ determinations, damaging the genuinely self-employed market that has played a significant part in the UK’s flexible labour market, relatively rapid economic recovery from recession and low unemployment statistics.

HMRC, the UK’s statutory authority on all tax-related matters, has won one IR35 tribunal in ten years.  It has lost seven of the remaining eight cases, and received a split verdict in the other. To put that into perspective, HMRC has a tribunal win percentage of just 17% since 2011[1].

When HMRC undertakes an IR35 investigation, the questions asked of the contracting parties number in the hundreds. Despite access to all types of documentation, financial information, hundreds if not thousands of pages of questions and answers, it still can’t accurately determine IR35 status.

The consultation document released by HMRC in May 2018 in relation to the extension of the off-payroll rules into the private sector states that: “The PSC (personal service company) may not have the right skills or systems in place to make this (IR35 status) determination”. We agree, because the ‘test’ for self-employment for tax has always been complex.

But it was HMRC who introduced IR35 in 2000, and their responsibility to enforce the legislation since its enactment. Who better than the ‘experts’, for whom an in-depth understanding of tax is their core function, to police the rules? What makes HMRC believe that recruitment agencies or end clients are better equipped than PSC contractors to make more accurate and/or valid determinations? If there is no evidence to suggest recruitment agencies or end clients are better equipped to determine IR35 status than HMRC itself, why refuse to consider alternative structures (such as a flat rate tax) or the criteria for IR35? If the ‘experts’ can’t do it reliably, then what chance do laypeople have?

The business community simply cannot see any evidence that HMRC are taking on board the evidence provided of the issues encountered in the run-up to implementation, or the implications and consequences since go-live of the public sector off-payroll rules. If lessons are not learnt from previous examples, any changes (similar to the public sector or otherwise) to the private sector will prove unnecessarily harmful to large and small businesses alike.

We recommend a comprehensive post-implementation review of the public sector changes as a minimum before any further changes are considered.  This is in line with the Regulatory Policy Committee views of policymaking best practice, whose 2017 report highlights the need for improved analyses and impact assessments.  The RPC report states “It is of concern that only 69% of government impact assessments were fit for purpose at first submission” and also that the “numbers of Post Implementation Reviews (PIRs) being conducted are still too low”[2]. Proceeding cautiously would allow the government time to address issues in the public sector and ensure that changes meet the needs of the UK’s diverse private sector. 

There are so many difficulties with the current public sector rules still to be resolved: how to account for the deemed payments, how to disagree with hirers’ determinations, how to claim back Employer’s NI and Apprenticeship Levy contributions if an Inside IR35 result is overturned, the exponential increase in tax avoidance schemes, issues with CEST online tool. These are just a few of the outstanding issues.

An area that we believe is critical to the success (or otherwise) of any changes to the private sector, is the continued use of blanket determinations by public sector bodies impacted by the 2017 Finance Act. It is so much more widespread than HMRC chooses to believe, and is still happening more than a year after the legislation took effect. A recent survey conducted by the Freelance and Contractor Services Association (FCSA) of 33,500 workers in the public sector found that 50% of them had not been individually assessed on their IR35 status. Of these 50%, 42% were simply deemed to be caught by IR35, while the other 8% were granted as outside IR35 contracts without an assessment.

Ensuring that the public sector are complying with the new IR35 rules, rather than over-complying, needs to take precedence over any changes to the private sector rules. We firmly believe that the blanket determinations are due to a lack of confidence in the PSBs abilities to interpret and apply IR35, which won’t get any easier because the rules themselves are overly complex and aren’t suitable for laypeople to be responsible for. The financial impact for an incorrect determination is simply too high for most PSBs – they prefer the risk averse approach of putting all contractors ‘Inside IR35’. Blanket determinations are wrongly classifying many more thousands of contractors as ‘employed’ for tax purposes; this issue will exponentially increase if the same changes are applied to the private sector. HMRC is adamant that blanket determinations are not happening; those who supply services to the public sector can categorically state that it is. Just because HMRC chooses to disregard that feedback does not mean it’s not happening.

Finally, we encourage HMRC to wait for a full tax year to be completed before making any decisions on changes to IR35 in the private sector. We accept that the evidence is there of increased tax revenues, but as discussed previously, that in and of itself does not constitute success.

If HMRC can actively target the challenges that are still ongoing as a result of the public sector changes, and be seen to clearly enforce the rules there, then it could with some degree of credibility consider extending similar changes to the private sector. That’s certainly not the case at the moment. Better still for HMRC to fundamentally alter the nature of IR35 (change the rules themselves) or remove IR35 and simply implement a flat rate tax on contractors and engagers (or some other viable alternative). Or consider some other alternative to IR35 that doesn’t rely on subjective terminology & case-specific, non-precedent case law.

HMRC’s solution to educating the public sector about how to assess IR35 status for their PSC contractors led to the publication of the ‘Check Employment Status for Tax (CEST) tool.  However there is simply no public confidence in the tool. The usage statistics do not indicate cause and effect; just because it’s been used does not mean it works.  Research undertaken by APSCo suggests as many as 81% of contractors would be deterred from working on a project if CEST was the only way of assessing status.

Recent research conducted by the CBI confirmed that only 11% of respondents – business owners and directors – trusted the CEST tool to make accurate determinations[3]. A recent REC survey asked its members (all recruitment agencies) how good the existing CEST tool is at producing results that match the characteristics of an assignment. 78% said it was ‘bad’ or ‘very bad’[4]. The tool has even been described as ‘grossly misleading’ by a former tax inspector[5]. Whether that is true or not, HRMC needs to acknowledge it has a significant PR problem with the tool; this must be addressed if the changes proposed are to go ahead.

When the tool has been challenged against recent IR35 cases, it has given an incorrect result or the tool was unable to provide determination. For more information on the details of these outcomes, please go to www.ContractorCalculator.co.uk. Where there is no outcome provided by the CEST tool, HMRC signposts users to the ‘specialist employment status helpline’ that we all know is under-resourced and long waiting/hold times make it unappealing for users. Can HMRC categorically confirm those lines will be suitably staffed in the future?

In June 2018, ICAEW tax faculty wrote to the Financial Secretary to the Treasury, warning that ‘CEST is designed for public sector contracts with the result that is not suitable for use in the private sector. Even though HMRC has undertaken to be bound by CEST decisions, we are concerned that as currently designed it does not command public confidence and needs further work.’

Furthermore, the tool ignores a cornerstone of IR35 status – Mutuality of Obligation (MOO). HMRC arguments that MOO is always present in any contract and therefore irrelevant to the determination of IR35 simply ignores case law where outcomes have been swayed on the specific issue of MOO. Bearing in mind all IR35 indicators are based on case law, that doesn’t bode well. If that is indeed the case that MOO is always present and doesn’t impact IR35, surely that is a fundamental difference of opinion between the legislature and the judiciary which needs to be ironed out as a matter of urgency. If the courts believe MOO is fundamental to IR35, but HMRC believes it is irrelevant, that may go some way to explaining why HMRC loses so many of its IR35 cases once they are brought before a judge.

The tool’s over-reliance on substitution calls CEST’s validity into question still further. Recent case law[6] – the only source of updates or clarity around IR35 and status indicators - has made it clear substitution is not a fundamental requirement of IR35.

The fact that CEST cannot give a result in 15% of cases needs to be addressed; an inability to give an outcome in up to 5% of cases is an acceptable ‘failure’ rate; 15% is not. When you consider the sheer number of private sector contractors, and bear in mind that existing contractors already in assignments will need to be assessed all at the same time in the run-up to go-live of any changes, an inability to rely on the tool for 15% of assignments will mean calls and emails to HMRC that simply cannot be supported / resourced. There cannot be any delay by HMRC in responding to these queries and providing a determination, so how will HMRC manage this huge influx of enquiries?

Before any changes to tax legislation that further impacts PSCs, HMRC must address the non-compliance in other payroll mechanisms (such as umbrella companies). It’s a recurring pattern that HMRC cannot seem to appreciate: tax laws change, the payroll mechanisms change. If the IR35 changes are enacted, end users may not comply appropriately and instead issue blanket determinations. As a result, the contractors affected move away from using a PSC and turn to the umbrella industry or other self-employed (e.g sole trader) options. Both of these have far greater scope for tax non-compliance and indeed have a long history of developing very creative tax avoidance & evasion techniques.

While HMRC has sought to address non-compliance through the 2014 onshore/offshore intermediaries legislation, that simply puts responsibilities onto agencies and really does not address the non-compliance of engagements between end users and contractors directly (with no agency in the chain). End users are responsible for ensuring there are no offshore intermediaries in the supply chain, but few do so because there is no impetus.

HMRC is not perceived as actively enforcing the rules, so for many companies that is a risk worth taking. Or they are simply unaware of the 2014 offshore rules. Agency-supplied contractors are probably the most compliant due to the amount of regulation and liability sitting with them. The only way to really tackle the non-compliance in the payroll industry is to actively regulate them – a suggestion made in the recent Agency Workers consultation[7]. That recommendation should be enacted first, before any changes to legislation affecting PSCs.

We hope that the above examples go to show how HMRC is not appropriately balancing the need to ensure correct taxes are paid with the needs of UK PLC. The department’s refusal to consider evidence which contradicts their beliefs, to the detriment of all concerned, amounts to an unfair use of their powers. There seems to be little accountability to the general public of the use and extent of their powers.

24 September 2018