Abbey Tax is a provider of insurance and consultancy services provided to end users largely via accountancy practices and trade associations looking to offer protection and additional services to their clients and members. We have a team of advisers and consultants staffed almost exclusively by ex-Revenue Inspectors and ex-VAT officers, and our primary role is to ensure that customers get best advice and can afford the best defence in the event that their clients or members are investigated.
Our services also include providing IR35 contract reviews, where we engage with thousands of contractors, agents and advisers annually. The review service considers the working practices as well as the contractual terms before offering an independent opinion as to the ‘IR35 status’ of an engagement. We therefore have significant experience in advising on, and dealing with, enquiries relating to status generally and IR35 specifically, as well as having an in-depth understanding of the practical issues relating to this Consultation Document Off-payroll working in the public sector: reform of the intermediaries legislation. In responding, we have sought to represent the views of our clients, who are also concerned about these issues.
We recognise the potential difficulty that HMRC faces in dealing with false self-employment generally, and IR35 specifically, but if HMRC does not wish to risk upsetting the balance in the flexible labour market – the importance of which the last three Governments have been at pains to stress – then surely the answer is better policing, not restrictive legislation; even if the focus of this consultation only initially concerns the public sector.
We also appreciate that there is a need for the public sector to show a lead on all compliance issues and following the complete lack of consistency shown by Government departments and other bodies in seeking to implement the requirement for tax assurances (emanating from Procurement Policy 08/15), a joined-up measured response to this issue would be welcomed. Unfortunately this consultation is not the answer.
We feel that the consultation contains a concerted attempt to change and circumvent established case law on IR35 (and status generally); it has not clarified how the practicalities of the measures might work – particularly in relation to the set-off of tax and NIC; relies upon aligning RTI, accounting and procurement systems in too short a time frame; doesn’t recognise the potential costs of implementation and the effect that it might have upon the public sector in procuring the right service providers and specialists to ensure that public sector projects meet their targets for on-time and in-budget delivery.
We will address all these points individually, and will do so by following the format of the consultation, as well as seeking to respond directly to the questions raised therein.
2. The Proposal
The language in this consultation is somewhat inflammatory: the proposal refers to the “off-payroll engagements of workers” and the term “workers” continues to be used throughout. Nowhere is there an acknowledgement that the Personal Service Company (PSC) could be a genuine, bone fide ‘service provider’ or ‘supplier’. On page 6 the reference is to “the individual” being engaged and not the PSC; finally we have the reference in connection with the interactive online tool to assist “public sector employers” – surely this should be public sector engagers?
Whilst acknowledging that there are issues with non-compliance and that the public sector no doubt feels duty-bound to lead the way in terms of compliance, we nevertheless, feel that this consultation is ill thought out; will create more problems than it solves; and will create an unnecessary and expensive burden upon the public sector. This will not only be felt by each and every department, but will be particularly onerous for HMRC, which will be dealing with many errors and claims for overpayment of taxes as a result.
3.1 References to non-compliance
On page 7, we read that “evidence shows there is widespread non-compliance with the intermediaries legislation. The government estimates only one in ten PSCs who should be operating the rules on at least part of their income are doing so. This non-compliance is estimated to cost the Exchequer £440m in tax year 2016 to 2017. This figure takes into account the changes to the taxation of dividends from April 2016.”
In responding to last year’s consultation on Travel & Subsistence and the IR35 Discussion Document, Abbey Tax noted that we also found it hard to believe that so few PSCs were operating on contracts which are ‘caught by IR35’; Abbey Tax’s contract review experience told us then and tells us now that the figure must be higher.
Our view echoes that of the OTS expressed in 2011; namely the intermediaries legislation was little used (albeit enquiry levels were shown to be even lower at that time) and that the House of Lords Select Committee on IR35 found in 2014 “many individuals simply take a risk that Her Majesty’s Revenue and Customs will not look into their employment status, an attitude that is fostered by the decreasing number of compliance investigations” and that “Her Majesty’s Revenue and Customs did not convince us that the resources currently allocated were sufficient to ensure compliance with the IR35 legislation.”
We assume this consultation is recognition that HMRC’s risk based approach to IR35 introduced in May 2012 is not yielding results and the way to enforce status is to by-pass the legislation. This would be done by ensuring that engagements are classified as ‘caught’ at the outset by virtue of deducting tax and NIC from the start of the engagement, rather than attempting to change taxpayer behaviour by a robust regime of enforcement. An enquiry regime where perhaps now the chance of selection is less than one in 1,250 is unlikely to encourage compliance.
3.2 The current rules
These are set out on page 8 of the consultation document, but immediately we note that mutuality of obligations has been removed from the list of employment status questions; nor have the key factors of personal service and control been given the additional weighting that was attached to them in the judgement in Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance 1968, and in virtually every status case since – whether that be employment or tax; First Tier Tribunal or the Supreme Court.
The absence of mutuality as a valid test is again noted in Diagram 4 on page 26. How can this reform seek to subvert case law at such a fundamental level and expect the courts to accept judgment made on this basis?
The Examples given on page 9 of the consultation are straightforward and easy to understand, and the important point that the duration of the engagement is not relevant to the IR35 status of an engagement is correctly made. However, they are extremely simplistic and represent two extremes – against which one would not wish to argue – but they do not recognise that there is an extremely large and grey area in between the two which is the space occupied by most PSCs. So much so that even the author(s) of this consultation must recognise that the statement on page 15 that “the Government acknowledges that at the margins there can be genuine uncertainty over employment status for tax” is patently a ridiculous understatement and simplification of issues around employment status generally and IR35 specifically. Indeed, even David Gauke in the foreword states that “the current rules can be difficult and complex” (page 4). It seems that to everyone with whom we have discussed this document, that there appears to be a concerted attempt to reduce the concept of employment status to a ‘binary’, ‘tick box’ approach, which if it were an effective method of achieving the correct outcome, would surely have been employed long ago – and would not have resulted in the withdrawal of the Business Entity Tests.
It is worth remembering that despite reams of employment legislation, there is no statutory definition of an employee and certainly nothing which determines what constitutes a self-employed individual. Therefore, how can one realistically expect the answer to a complex issue like employment status to be reduced to flow charts and an Employment Status Indicator Tool which needs to have the confidence of the contractor/freelancer marketplace and have been operationally tested by next April?
We believe it is for the Government to define the public sector, but if companies in the private sector are fulfilling the same services as their public sector counterparts, then in the interests of fairness, we do wonder how the private sector companies can operate under separate rules? (Q.3)
In terms of impacts (Question 4), our concern is the general impact of the intended approach, not specifically for individual departments.
- Currently, the PSC pays the employers NIC under the deemed calculation if IR35 applies to an engagement. Now it will be public sector body; the cost of engaging PSCs will increase by 13.8% at current rates.
- If the PSCs are engaged with PAYE deducted; will that be seen as additional headcount? How will that play against a background of reducing headcount in the public sector?
- Will the public bodies have to suffer increased costs in relation to size-related issues such as the apprenticeship levy?
- If PSCs are being taxed at source, will the pressure not be for rates to increase, which, in turn increases the NIC bill to that department?
- The Government by its own estimates engages approximately 10% of the nation’s PSCs, will public sector departments lose skills and expertise to the private sector because rates are higher, or perhaps more importantly, IR35 compliance is less rigidly enforced?
- Commentators have argued that the regime of providing tax assurances has not necessarily adversely affected the public sector, but engagements have been cut short (by both sides), and it is evident that implementing the process for requesting tax assurances has not been as fully enforced as might have been expected. But even if the process had been rigidly enforced, it would not have affected every engagement in the way these reforms would.
- What will the cost be to public sector bodies to engage the services of employment status specialists to determine how to start the process of determining status before the interactive status tool can be used?
- The complexity of aligning RTI with other accounting functions to allow for the deduction of PAYE at source on a purchase ledger expense will add to the administrative burden of the individual public sector body AND the scope for underpayments and overpayments of PAYE is likely to add significantly to HMRC’s workload. Not least in dealing with any offset, which is mentioned in passing only in Box 8 on page 17.
- Finally, even though the consultation establishes on page 21 that there will be no change to employment law; it is surely only a matter of time before the first claims for employment rights are considered by the courts.
4.1 Application of the reforms to agencies
Abbey Tax has no vested interest in the agency sector; but we cannot understand why the agency should be asked to deduct tax and NIC from engagements. This will increase the administrative burden and costs for those agencies which exclusively deal with PSCs and do not offer engagements to agency workers. However, we simply cannot understand the logic that the agency (whether the only agency involved, or the last in the chain and closest to the public sector body) should have any liability for determining the status of the engagement.
Only the public sector body as the primary engager can determine – and indeed should have the sole responsibility for determining – the status of the engagement. Only the engager will know what they expect from the engaged individual in terms of working practices: what level of control they wish to seek to exert over the individual undertaking the services; whether they would accept a substitute; whether they would pay that individual on days when services are not provided etc.
If the public sector body is unwilling or unable to make that decision, surely it is both nonsensical and inherently unfair to ask an entity at least one step removed from the engagement to make the status decision? Moreover, if the interactive status tool is a reliable tool, why wouldn’t the public sector body use it themselves? (Question 5)
4.2 When 20% of the contract value being materials
It is not entirely clear from where this concept has arisen and how the percentage has been calculated. It is introduced on page 17 as part of the decision-making process and repeated again in Diagrams 2 & 3 on pages 24 and 25 respectively. At this point, it is established that: “This removes relationships that are unlikely to be ones of employment, for example plumbers”
It seems hardly likely that plumbers, electricians, builders etc were ever on the radar in respect of IR35 and the public sector. This issue relates to knowledge-based workers who are likely to come armed with a laptop, phone and calculator and not necessarily all three. This concept really has no place in this consultation if the document is to be taken seriously.
However, what would make sense would be to consider the assets that a service provider may have which are inherent to their business; e.g. specialist equipment, bespoke computer programmes etc, which are not necessarily brought on site as ‘materials’, but are integral to the provision of the service.
4.3 Accounting for tax
We can see real issues in the alignment of systems to allow payments to be processed which are deemed to be purchase ledger items attracting VAT, but would include elements of PAYE and would require accounting for the 5% deduction for general expenses. Businesses across the country struggle with elements of RTI already; this is not going to improve matters and it will require systems to integrate in a manner that they have not done so before. Is there any likelihood that this can be achieved by April 2017?
4.4 The 5% allowance
HMRC are best placed to determine whether this allowance is a fair deduction from the fees to cater for general expenses. Assuming it is fair and reasonable, then to withdraw the allowance would certainly increase the amount that the public body would pay in NIC and we can see the fairness argument against employing staff, but it would not affect the position with the private sector.
However, to remove the allowance is not just about the saving of NIC for the engager or indeed any tax saving for the PSC; but what it would do, is remove the last vestige of evidence that the individual was effectively operating a business. In that instance, we believe you would radically increase the likelihood that the individual would press for employment rights, as there would be no way of distinguishing his or her status from that of an employee. If anything, the cost of working in the public sector should be an argument for increasing the allowance.
One argument for an increase in the 5% allowance (or the ability to have more flexibility in claiming expenses) is that it currently does not cover the investment in the business and purchase of assets that a PSC might make of the type not considered under the ‘20% materials’ heading (4.2 above).
4.5 Deducting PAYE at source and extracting income from the PSC – Example 6, page 21
In addition to the difficulties which the engaging organisation will face in accounting for tax, there is also the issue of how Ayesha will account for the income and indeed extract money from her business in example 6. Using the figures, will her company need to recognise the full £2,400, but be allowed the deduction for PAYE not actually paid? How will this affect RTI?
Or will the net amount of £1,666 (£1,556 net pay + £100 general allowance) be treated as income? If the net amount, this will throw out the VAT calculation.
When will the appropriate amount be set off? Will it be a similar model to CIS? If the amount is set off at the end of the financial year, is the thinking that Ayesha will draw a salary from the £1,556 and deduct PAYE to reclaim the deduction at the end of the year? If so, that will have a dreadful impact on cash-flow, which will either mean Ayesha will need to charge a higher daily/hourly rate to compensate, which only adds further to the cost of engaging contractors in the public sector.
The Government surely must produce proposals very soon to deal with the mechanics, which have every chance of producing a system which “can be difficult and complex”; more so than the existing IR35 legislation!
5. Minimising Burdens on Engagers
5.1 The Online Status Tool (Questions 8-13)
There is a current online status tool for self-employment in which no great confidence exists and which is rarely used. The first objective of the Government will be to create a tool which is straightforward to use and which has every chance of producing the correct outcome most of the time. This does not mean that the workings behind the tool will be simple; in fact far from it. The tool will need to understand that ‘control’ in one sector is not the same in another; it will have to recognise that some sectors will require security clearances for staff, others won’t – how will this be factored into personal service/substitution? In some sectors Professional Indemnity cannot be purchased by individual PSCs because the premiums are too restrictive; some industries will provide safety kit and in others the supplier will bring their own and so on. How will these differences and nuances be recognised?
If our argument is accepted that only the engager can determine status, then parts of Diagram 2 are surplus to requirements and diagram 3 is not required at all.
Diagram 4 is flawed as it ignores mutuality of obligations. As recently as 2011, the judgement in the Tribunal case of MBF Design Services was influenced by the fact that when the systems went down for a long period, employees were told to ‘make themselves look busy’ whilst contractors were sent home without pay; i.e. no mutuality of obligation. There are also the landmark cases of Carmichael & Another v National Power plc (1999) and Cornwall County Council v Prater (2006) in which mutuality played a key part in determining the outcome. How can the consultation state on page 11 that “The basis on which the rules are applied to determine whether a worker would have been an employee if engaged directly is not changing” and then drop mutuality as one of the key tests?
We have been made aware that using the Online Status tool will not be obligatory. If that is the case, then one wonders how any consistency will be achieved.
5. 2 Diagram 4 (Question 9)
It would seem the indicator tool will test first for personal service and then for control rather than giving both equal weighting. We have genuine concerns that the tests will not be robust enough to provide a correct answer, and this is borne out of cases which we have argued on behalf of contractors where:
- HMRC have tried to argue personal service existed despite actual and genuine substitution having taken place;
- HMRC have been dismissing expertise as an indicator of being responsible for how an engagement is undertaken by misapplying the ruling in Morren v Swinton & Pendlebury Borough Council (1965). In this case the Judge ruled that the absence of direction and control would be of little interest because the employer didn’t have the knowledge to tell the client what to do; whereas contractors are often working with clients who do have the specialist knowledge, but are happy to give the contractors the autonomy to do their work
If HMRC are misapplying case law, it gives us little confidence that the tests will be fair. On the other hand, we see some merit in the argument that HMRC cannot afford for the indicator tool to be challenged in the courts and found wanting. The proof of the Online Status Tool will be when HMRC provides the contractor marketplace an opportunity to test the status tool and determine its value as true indicator of IR35 status. If the test passes muster, then this will answer Q.12, albeit we believe there will be training costs for each public sector body in order to understand how to recognise status; and we doubt that these have been factored into the consultation.
6. Transfer of Liability (Questions 14 & 15)
We believe that the liability should be transferred to and then remain with the Government Department or public sector body because only the engager can decide the status of the engagement. It is the duty of the engager to pass on correct information to the agency (if applicable), and to the PSC if the body is engaging directly. Indeed where an agency is involved, we believe the public sector body would still have a duty of care to the PSC to inform it of the engagement’s status.
On that basis, even if the agency was to engage the PSC under false pretences; i.e. advise the PSC that the engagement is ‘not caught’, the body will still deduct PAYE. Even if this comes as somewhat of a shock to the PSC, then any action will be one which the PSC might take against the agency, but no tax will have been lost.
Indeed, unless there is some mechanism for claiming set-off to which the PSC would not be entitled, it is hard to see how there can be any issue of the PSC not paying the relevant amount of tax.
There are two potential issues here: firstly, a challenge to the status of the engagement by the PSC, which we believe unlikely. The PSC will either take the engagement or refuse it on the basis that it is prepared to accept the status or not. The second scenario is more interesting and will involve those PSCs working for public sector bodies at the time that the new rules are introduced. What if the tax assurances are genuinely given and readily accepted by the department concerned, and are deemed to be correct, but subsequently the online status tool did not agree. Where would the contractor stand at this point?
The Government will need to offer both clarity and reassurances where this could happen, because in essence, we have one example where it already has. We have been instructed to deal with an IR35 review by a contractor who was engaged to provide services at HMRC. Prior to the engagement commencing, HMRC in its role as the engager undertook a review of its own and gave clearance that it fell outside of IR35. Despite that, the HMRC investigating officer, acting in the capacity of ‘regulator’, disagrees and has deemed the engagement ‘caught by IR35’…
Whichever individual may be right or wrong, this just highlights the subjectivity of the IR35 legislation. If HMRC cannot agree internally; what chance is there that agencies will be in a position to determine status correctly? Indeed without full and proper training – which we do not believe has been considered, let alone costed in this consultation – is it reasonable to expect the public sector bodies to determine status?
In summary, the liability remains with the engager (Q.14) and on that basis, it is difficult to understand circumstances where the liability could or should move to either the PSC or the agency (Q.15).
We agree there is a need for a clear, consistent approach across departments; in fact there is a need for consistency across the marketplace as a whole. Whilst the current system for dealing with IR35 is not perfect and has its flaws, we believe that the concepts of personal service, mutuality of obligations and control are understood by informed contractors, agencies and end clients.
This consultation seeks to undermine these status tests by dropping mutuality; it is seeking to make the issue a ‘tick box’ exercise – the withdrawal of the Business Entity Tests should have been a warning that this wouldn’t work; the cost to the public sector of implementing this proposal has not been fully considered; the time frame is too short; we have concerns that the transfer of liability to agencies is both misguided and an abrogation of responsibility; there are accounting issues which have not been fully addressed; and finally, this consultation risks creating two separate systems for status: one for the public sector and one for the private sector.
The measures proposed in this consultation may work for black and white cases, but IR35 status is inherently subjective and it is not clear how departments will address those grey areas in between. However, both public sector and agency staff lack the experience to determine status accurately, and we already know that a ‘tick box’ approach is woefully inadequate – yet, this consultation is returning to the principles of simple tests and an online status tool as the panacea for all ills. We do not believe that the consultation has taken into account the complexities of employment status. If it were straightforward, why would IR35, almost 20 years after its introduction, still lack clarity for its various stakeholders: contractors, agencies and engagers?
The practical ramifications of this complexity have been highlighted in the last few years in the public sector. A large proportion of contractors have been required to provide tax assurances; but even though this applied across the public sector, there was no obvious guidance to departments how they should seek the assurances and certainly no consistency of approach. Why should we believe that the relevant staff in the public sector will be sufficiently trained to determine the status of an engagement by next April?
Is it realistic that the Online Status Tool will be ready and functioning adequately? Not least because the tool being developed needs to be extremely sophisticated to take into account differences between departments, sectors, industries, and all nuances in between, as well as being well-designed so it is easy and quick to use for staff short on time and experience.
The burden on public sector bodies will be enormous, and we believe that the consultation has seriously underestimated the time and expense needed to meet next April’s deadline and to train public sector staff in the technicalities of status.
Transparency and fairness is required to ensure working in the public sector remains an attractive prospect for small businesses. With a sector that is so contractor-heavy, losing such an important pool of skill and experience will be far more costly to the public sector than the tax ‘avoided’ by contractors incorrectly operating outside of IR35. We have already seen surveys suggesting that most contractors will seek to leave the public sector if these proposals are implemented.
Whilst the answers to those surveys and what happens in practice may well differ when decisions actually have to be made, can the public sector afford the contracting sector to become like the teaching profession; i.e. the best graduates only enter teaching when the economic climate is poor?
Even if that scenario does not occur, there must be genuine concern that the contractors with the most valuable skillsets are those naturally more in demand; and they will simply seek engagements in the private sector or increase their fees – both at significant cost to the public sector.
The consultation has not explained how the measures will be implemented in practice, particularly how contractors will draw income from their PSCs without suffering tax twice or it having a negative effect on cash-flow. The question about the 5% allowance looks like the precursor to an attempt to withdraw it, which would remove the last piece of evidence that a contractor is running a small business.
We are also concerned that the transfer of liability is somehow a measure to put the compliance burden on a third party, when it is evident that the only organisation which possesses the full facts to determine the status of an engagement is the engager – in this case the public sector body. There is already evidence from both public and private sector engagements that the contractor does not really understand the requirements of an engagement until he or she has spoken to the engager and often even not until a few days of the engagement have elapsed. How can agency staff be expected to know enough to determine status – particularly, as we are dealing with an IR35 review when even HMRC cannot agree the status? If the experts cannot be consistent in their decision-making; how can one really expect an agency to be liable for something it cannot control?
Whilst the proposals may work in theory, the practicalities and consequences have not been fully thought through. In our opinion, the perceived issues with the intermediaries legislation (IR35) lie more with the lack of compliance activity on the part of HMRC, activity that has considerably reduced over the years than with the understanding of the legislation. The reference in the consultation to an increase in compliance activity (page 39) was somewhat disingenuous, as the activity increased from an all-time low of 23 to c250 in subsequent years. In February 2014, HMRC gave evidence to the House of Lords that the number of PSCs was around 265,000; that number has no doubt increased to 300,000+ since then. With a risk of being selected at about 1 in 1,250, and no evidence that HMRC is targeting the right contractors or indeed is achieving a marked level of success in arguing that IR35 applies in the cases that it does select; why wouldn’t a contractor simply ‘take the risk’?
In summary, this consultation appears to be an attempt to by-pass the legislation rather than enforce it. Any attempts to legislate along these lines will not lead to greater compliance based on a genuine interpretation of status, but will result in the over-compliance referred to in the Background to the consultation and a fear raised in last summer’s discussion paper. It is really difficult to see how the approach outlined in the consultation can work practically and without compromising fairness.
15th August 2016