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 Discussion Document and the Employment Intermediaries and Tax Relief for Travel and Subsistence Consultation, to which we will also be responding separately. In responding, we have sought to represent the views of our clients, who are also concerned about these issues.
As we are regular commentators on status matters – via our own in-house publications, our Blog (www.abbeytaxblog.co.uk) or in contributing to the publications of others – and not withstanding that our clients expect us to have a view on the Discussion Document, our concern is that this Discussion Document reflects a fundamental policy shift taken with the intention of reducing HMRC’s workload, rather than policing IR35 more effectively, as requested by the Chancellor in the July 2015 Budget and recommended by the House of Lords Select Committee Report published in April 2014.
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.
We believe that HMRC has the tools within the existing legislative framework and its powers of enquiry should allow it to clamp down on transgressions. We recognise the House of Lords Select Committee’s finding that “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” (Summary of Findings and Conclusions 14) as being the reality of the situation. Yet a step-up in enquiry activity together with more efforts to engage with the market would surely start a significant sea change and result in greater compliance.
It seems to us that this Discussion Document cannot be viewed in isolation to that on Employment Intermediaries and Tax Relief for Travel and Subsistence, as the same approach of narrowing employment tests down to one – supervision, direction or control – is being suggested here. Moreover, putting the onus onto Engagers, we believe, is unrealistic. As the Select Committee found: “We acknowledge that businesses would generally resist being made responsible for IR35 assessment, finding the additional administrative pressure and liability as overly burdensome.”
We strongly believe that making these changes will undermine David Gauke’s assertion in the opening paragraph of the Travel & Subsistence Discussion Document that a flexible labour force “plays an important role in the UK economy and in ensuring access to the individuals, skills and services it needs to encourage growth and respond rapidly to new demands”.
As we responded to the Travel & Subsistence Discussion Document, we believe that HMRC has the legislation and powers to properly police IR35 and putting additional burdens on to the taxpayer is not the answer.
Our response generally follows the format of the discussion Document, as well as seeking to respond directly to the points raise under ‘Next Steps’ on pages 9 & 10 of the Discussion Document. We have also taken the opportunity to highlight the key points of this response by attending the IR35 reform: discussion round-table on Tuesday September 15th 2015.
2. Non-compliance with the legislation
We recognise that there has been an increase in the number of PSCs and HMRC’s 265,000 estimate for 2012-13 seemed about right and is no doubt significantly higher in September 2015. Moreover, it comes as no surprise that there is non-compliance, as we also find it hard to believe that less than 5% of PSCs are operating on contracts, which are ‘caught by IR35’; Abbey Tax’s contract review experience tells us that the figure must be higher.
At enquiry levels that equate to a risk for contractors of less than 1 in 1,000, it is also not surprising to find the OTS stating in 2011 that the legislation was little used (albeit enquiry levels were shown to be even lower at that time) and that the Select Committee three years later found that “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.”
Our experience of HMRC’s risk based approach referred to in the Discussion Document on page 5, is that the most high-risk cases do not appear to be selected, nor are they well-argued; with the result that we were not surprised to find that yield from these enquiries had fallen by 60% in 2013/14. In our experience, the officers dealing with IR35 cases have very little commercial understanding of the marketplace; how end clients approach projects and the creation of project teams; how agencies interact with end clients and contractors; indeed what it means to be a contractor.
If there was a better understanding, we wouldn’t for example, have requests for contractors to supply the ‘Upper Contract’ between agency and end client, which they never see; the standard questions would be more tailored to the sector and/or individual engagement under review (and seemingly ignoring information already provided); or placing over-reliance on a generic contact at the end client and not the individual at the end client actually responsible that individual engagement.
In addition to the recent Round-Table discussion on 15th September, colleagues at Abbey Tax have attended round-table discussions with HMRC in 2012 and 2013, where the issue of forcing the low-paid to incorporate was raised by HMRC together with those individuals who are an employee on the Friday and contractor on the following Monday. Yet, from our experience, HMRC still appears to select many PSCs with a turnover in the £75-£150K range where these risks are unlikely to occur. If the ‘incorporation’ of the low-paid is a concern, why isn’t HMRC routinely selecting companies with an annual turnover of, say, £30K or less? Presumably, HMRC could consider some form of transfer of debt to penalise engagers who should be employers?
Furthermore, the Friday/Monday scenario is likely to involve an element of compulsion, where potentially low-paid individuals might require a guiding hand in the background to help them through the accounting and taxation requirements involved. Was it not the intention of the 2007 Managed Service Company legislation to deal with such issues?
Lest any suggestion be made that we make these proposals because it might increase any income that Abbey Tax might earn either in insurance premiums or consultancy, it is unlikely that these types of client would (be able to afford to) insure or indeed look to engage a consultancy for their defence. Nor would they be looking to Abbey Tax (or any other consultancy) for a contract review.
3. Options to increase the effectiveness of the rules
We accept that there is no easy fix, but it feels like HMRC is discounting some options, we suspect, in favour of the model espoused in the Employment Intermediaries and Tax Relief for Travel and Subsistence Discussion Document; namely, basing everything on ‘supervision, direction or control’. How can HMRC wipe out all other status tests at a stroke? Does this not require legislation?
We believe that all the options need to be considered:
3.1 Administrative Changes
We welcomed the change in the IR35 enquiry regime introduced in May 2012. Whilst the Business Entity Tests didn’t quite hit the spot, the fact that the new process introduced clarity and addressed the unnecessary lengthy delays of the previous ‘regime’ (and one accepts not all the blame can be left at HMRC’s door) was extremely positive. The ‘Check of Employer Records’ Letters have been a refreshing change; no more hiding behind PAYE reviews, the matter is now tackled head-on: has the taxpayer considered IR35, and, if so, why do they not think it applies?
This now presents the taxpayer and the adviser with a clear opportunity to state their case. Inevitably, the taxpayer will select the facts that suit their argument and HMRC those that suit theirs – that is the nature of our adversarial legal and parliamentary system. Yet, the fact that in the first year, our ‘opening arguments’ were accepted in about one third of cases, seemed to be about right. Status is a grey area and it is understandable that HMRC would have wanted to pursue matters further in the remainder of the cases.
In the last two years, the picture has changed and almost all cases are being pursued to the next stage: involving lengthy questionnaires – some three times as long as they were in 2012, albeit containing the same set of questions several times over – and contacting the end client. It is hard to understand why: the proportion of cases where IR35 is being successfully made to apply has not changed, so we wonder if HMRC’s less accepting approach is a reaction to the reduction in yield?
If there is a correlation, then the underlying reason must be that HMRC’s risk-based enquiry selection process is not identifying the right cases. As stated earlier, if HMRC has concerns about certain types of contractor, why are these not being targeted?
If IR35 is to remain and HMRC is to police it more effectively, then the only real solution is to increase the number of IR35 enquiries. If they remain at their current low levels, the risk of enquiry is minimal and the deterrence value of the legislation is nil.
3.2 Requiring Engagers to take on the responsibility for the liability
Prima facie, this is the most logical approach and many have argued that this is where the responsibility should always have rested: the client is best placed to describe the requirements of the role; determine the specific project deliverables etc.
However, there are two caveats:
a) This can only work if the status tests remain based on the three key issues of personal service, mutuality and control, as laid down by Justice MacKenna in Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance 1968, as well as in-business and financial risk factors. If the tests are reduced to considering only ‘supervision, direction or control’, is it not likely that engagers will absolve themselves of all responsibility (see next section) and all engagements will be deemed ‘caught’?
b) Engagers are prepared to accept that engagements which are deemed ‘caught by IR35’ may only be filled at a premium; i.e. contractors will want higher fees to offset the higher tax bill. Otherwise, what is the incentive to take the engagement?
3.3 Align the test with that used for agency rules
As referred to in the previous section, the alignment with agency rules means considering whether each engagement involves supervision, direction or control. We have recreated in gold the definitions provided in the Employment Intermediaries and Tax Relief for Travel and Subsistence Discussion Document and then commented on each below:
Supervision is someone overseeing a person doing work, to ensure that person is doing the work they are required to do and it is being done correctly to the required standard. Supervision can also involve helping the person where appropriate in order to develop their skills and knowledge.
It is almost unheard of for a client to give a contractor a brief and then expect the contractor to return within a specified timescale with the finished article without their being some interaction with the client in the meantime. It is very rare that a contractor will define the scope of the project – it is after all, the client who has determined that they need a resource to meet their need.
Whether a householder is having building work undertaken at home or a commercial organisation launching a new product or service, there is always someone with the role of “Project Manager” (PM) whose role it is “to ensure that person is doing the work they are required to do and it is being done correctly to the required standard.” There is hardly a project being undertaken where there aren’t regular update meetings being chaired by a PM, whose responsibility it is to deliver the project, but that doesn’t mean that the PM has any control or knowledge/expertise about how the work is done. Furthermore, as a customer, would you not want to ensure that the work is being done properly?
The second sentence to the definition offered above, one can accept, but the first sentence effectively means that there are barely a handful of people in the UK not caught by this definition. That surely cannot be the intention of such a test?
The only real test of independence has to be whether the client can determine ‘how’ the work is undertaken. If the engager can, as would be suggested by the definition of ‘control’, then the contractor’s independence is undermined.
Direction is someone making a person do his/her work in a certain way by providing them with instructions, guidance, or advice as to how the work must be done. Someone providing direction will often co-ordinate how the work is done, as it is being undertaken.
This definition is also unclear and the comments made about supervision apply here too. How are “instructions, guidance, or advice” defined? At what point does the scope (the ‘what’) of the project become “instructions, guidance, or advice”? What if the Engager explains that in their sector, products are usually demonstrated using one particular method, or the proprietor states that the website needs to be released in several stages, or explains that the website is part of a wider campaign and therefore these are constraints which need to be followed? Does the scope now involve ‘direction’?
Another example of changes in scope is demonstrated by the Tribunal Case, MBF Design Services Ltd  UKFTT 35 (TC). The contractors were involved in a project, based on integrated engineering such that a change made in the design by one contractor could immediately affect the work of the others, thereby changing the scope of the project. There was never any suggestion that MBF came under the client’s control because the key test is surely ‘how’ the work is undertaken.
Where security or commercial interests are paramount, then it is unlikely that the client will want a contractor logging into secure terminals from offsite. The location may also be determined by other physical and practical issues such as where equipment is or where the people are located who can assist the contractor. If the work has to be undertaken on site, then the same factors may determine the timing, or at least determine how flexible the contractor can be with his or her working patterns. But will HMRC view this as ‘direction’?
Moreover, many organisations with several locations or different business units will have unified reporting methods in order for management to be able to compare like-with-like. This will inevitably constrain how a contractor might report his/her findings and you could argue that it influences ‘how’ the work is undertaken. But in reality, does the fact that there are physical or practical constraints as to where and when work can be undertaken or how it is presented, genuinely amount to direction?
Control is someone dictating what work a person does and how they go about doing that work. Control also includes someone having the power to move the person from one job to another.
This definition seems reasonable and would constitute the test which we believe in reality determines independence – can the client exercise (or have the right to exercise) control? If the answer is ‘yes’, then this is a key indicator of employment.
We struggle to think of an example of an engagement for which at least one of those definitions would not apply. It is unrealistic to expect any client not to monitor progress against deliverables/objectives. A right to check that ‘the work is being done correctly and to the required standard’ surely would not equate to a right of control over the manner in which the service is provided. HMRC accepted at the Round-Table Discussions on the 15th September that more work needs to be done to clarify what is meant by ‘supervision’ and ‘direction’.
We believe that the policy representatives at that meeting understood that the issue is about’ the manner in which the work is undertaken – the ‘how’ – but we know from our own experience that this is widened by HMRC’s IR35 case workers to include the ‘what’, ‘where’ and ‘when’, which would be beyond the control of many independent contractors or the self employed. Neither the plumber coming to fix a faulty radiator nor the decorator coming to paint a room (whether in a domestic or commercial building) are going to have choice over the ‘what’, ‘where’ and ‘when’ – which HMRC seem to be arguing in the Employment Intermediaries and Relief for Travel Subsistence Discussion Document would fall under ‘supervision’ and/or ‘direction’ – but no-one is expecting the client to determine how the tradesman does his/her job. The manner in which the work is undertaken is surely the correct and only test; we were under the impression that this was accepted by HMRC representatives at the Round-Table discussion. As they stand, the definitions would also assume that collaboration – and contractors do work in teams – is tantamount to a right of control. This surely cannot be the intention of the proposals.
Surely, ‘supervision’ and ‘direction’ are a red-herring. If the work is task-based and there are no specific project deliverables, then there is likely to be control.
We believe that HMRC need to change the test to ‘supervision, direction AND control’ or work with ‘control’ only. One must accept that there are constraints by which everyone is bound irrespective of tax status; e.g. health & safety, site rules & security, industry codes, data protection and intellectual property. These cannot be viewed as elements of control. Furthermore, one needs to accept the assumption that the contractor is working towards the common aim of completing the project.
These issues aside, where there are specific project deliverables, which require the contractor’s expertise for a limited time period, and the role is not the replacement for an employed role left unfilled, it should follow that there will be insufficient control being exercised over a truly independent contractor.
3.4 Considering the length of time of an engagement
There isn’t presently such a test; however, HMRC regularly appear to be swayed by engagements with any longevity, assuming that a lengthy engagement is automatically ‘caught’ by IR35.
Projects in different sectors/industries have different time-frames, but the key issue is whether the work is genuinely project-oriented or task-based. In the Tribunal case of JLJ Services Ltd v Revenue & Customs  UKFTT 766 (TC), the initial engagement and the next two extensions related to a specific project; thereafter the engagement was extended for 12-month periods without any specific project deliverables.
The Judge ruled that the annual extensions to the contract did not reflect an engagement for a specific purpose, but a client securing a resource to which work could be assigned. As a result, Mr Spencer (the worker and director/shareholder of JLJ) was deemed to be coming under the end client’s control and ‘part & parcel’ of the end client’s business. With no right of substitution and evidence of mutuality of obligations, the latter years were determined to be ‘caught by IR35’.
Therefore, a specific timing period set in legislation is not relevant or practical; each case needs to be considered on its own merits. We keep returning to the view that for an engagement to be considered ‘outside of IR35’, there must be specific project deliverables, which require the contractor’s expertise for a project specific time period (which may have to be varied if the project over-runs), and the role is not the replacement for an employed role left unfilled.
4. Next Steps
In this section we seek to address the points raised on pages 9 & 10 of the Discussion Document:
~Any evidence on the use of other types of intermediaries, aside from PSCs, to which IR35 may apply.
We are unable to offer any comments, as our only involvement in this market is with PSCs.
~Any evidence on how PSCs currently operate IR35 and the issues the rules create for individuals and businesses across the market.
Please see our comments under Section 2 Non-compliance with the legislation
The government also welcomes views on options for reform, and specifically on:
~Any proposals for how to improve the effectiveness of IR35 that meet the objectives outlined in this document.
Please see the comments at 3.1 and 3.2 above
~Any views on the potential option outlined in this document which would result in the engager taking on a greater role in being responsible for operating IR35, including whether such an approach would be effective in achieving the objectives outlined in this document.
Please see our comments at 3.2 above. If the tests for IR35 remain as they currently stand, it may be possible to put the responsibility upon the Engager and the market will react – in terms of fees – to the difference between engagements that are ‘caught’ or ‘not caught’ by IR35. Reduce the test to ‘supervision, direction and control’ and is it not likely that all engagements will be ‘caught’ and the Engager will avoid any liability or responsibility, as they do now?
~How it could be made as straightforward as possible for engagers to determine whether IR35 should apply as part of their routine hiring conversations.
This will depend upon the status test(s) used.
~Whether there are particular sectors or types of engagers which would face particular challenges.
If the tests are based on personal service, control and mutuality with business factors also considered at a secondary level as set out in Ready Mixed Concrete, then Engagers will face the same issues as those currently faced by contractors: lack of knowledge and uncertainty because there is no clear guidance from HMRC on how these tests are interpreted. However, assuming that Engagers are prepared to make the decision between engagements, then the initial reaction for PSCs would be the same as if an Engager or agency currently offered the assignment on the basis that it was ‘caught by IR35’. PSCs would only accept the work if paid ‘premium fees’ to set off the additional tax bill.
If HMRC make the test only supervision, direction or control, Engagers will reduce the administrative burden and at the same time negate any liability by declaring all roles as ‘caught’ by supervision, direction or control. Except for those contractors charging the highest fees, where engagers might take the risk about supervision, direction and control not applying, the broad rump of the contractor workforce will be wondering about the value of contracting.
We imagine that some of the specialist sectors such as aerospace, oil & gas, the nuclear industry, banking and financial services and certainly the public sector, which rely on contractors often travelling great distances to undertake necessary and much needed project work, will find it difficult to attract contractors who cannot recover their travel and subsistence costs.
Not all of these sectors will be able to pay the additional fees to allow the contractor to cover the cost of marginal rates of tax being applied to the cost of travel and subsistence payments. We therefore risk the best specialist talent moving overseas where there are not these restrictions.
In broader terms, we also believe that based on the definitions of supervision, direction or control, any engagement with a company that needs to monitor progress against budgetary or wider project requirements will be affected – this will be particularly relevant in the Public Sector, as well as, in our experience, in the banking and financial services sectors.
Moreover, the definitions of supervision, direction or control, will mean that engagements will be ‘caught’ if the work being undertaken involves something which needs to be integrated into a client’s existing system; e.g. a piece of software is being developed; processes are being created that need to meet industry standards or regulations; a piece of equipment is being designed – particularly where the client has certain preferences or requirements which may not be apparent at the outset, e.g. if a new logo or website is being designed (creative industries).
~How such an approach should work where a PSC is engaged by an individual rather than another business, and if there should be different rules which apply in these circumstances.
No, the tests to be applied should be the same. Is this genuinely of real concern?
~Any other views on the impacts of such a change and how they might be addressed to minimise any additional burden on engagers.
Please see comments in Section 3.2 above.
~Any views on the implications of a change in the test which determines whether IR35 applies, both positive and negative, and what stakeholders’ preferred approach would be.
Please see comments in Sections 3.3 and 3.4 above.
As the Lords noted: “Serial contracting is a feature of the modern British workforce and is supported by both businesses and contractors.” If changes need to be made to the PSC market, then HMRC should surely follow the requirement of the July Budget to “engage with stakeholders this year on how to improve the effectiveness of existing intermediaries legislation (‘IR35’) which is designed to protect against disguised employment” and not pursue options which are designed to by-pass the legislation just because HMRC are not willing, or able, to enforce it.
If the option is to shift the burden on to the Engager, then HMRC must engage with End Clients in order to explain how status is determined – in a manner that it never really has with the contractor market.
If the test is reduced to supervision, direction or control, HMRC will create a market where the genuine ‘self employed’ PSC contractor cannot operate and Engagers will lose access to the skills that they need for the short periods that they need them.
Status tests based on time periods are not practical and the market will find ways of getting around any specified engagement period.
We recognise that there are abuses in the PSC market, but HMRC has the Intermediaries and MSC Legislation to tackle these abuses; it just needs to police the market better, as it has been asked to do by the Chancellor, and as was recommended by the House of Lords Select Committee Report.
It would be our view that HMRC improve their administration and their risk selection procedures and police the market properly, so that it will be no longer possible for anyone to claim that “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”.
It is time for HMRC to identify the low-paid workers coerced into incorporation and penalise the employers; root out the Friday/Monday employee/contractor scenarios and determine the liability; as well as improving its investigations techniques. IR35 is not a great piece of legislation, but its effect used to lie in its deterrence value. PSCs are still confused by IR35; just no longer frightened of it.
Author: Paul Mason, National Contractor Manager
Contributors: Jacqui Mann, Nigel Nordone and Rebecca Walker
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