The Lords’ damning verdict on IR35
“Riddled with problems, unfairness and unintended consequences” was The Lords’ verdict in a Report published on Monday on the ‘off –payroll rules’ (the “Rules”) which the Government had proposed introducing on 6 April 2020. The Report is a good read and echoes what many of us have been saying for some time about the introduction of the Rules in the private sector.
The Government has confirmed that it will delay introduction of the Rules to April 2021 as a result of the impact of COVID-19 on the economy generally, but whether the Lords’ damning commentary on the Rules (and IR35 generally) will lead to a proper consideration of viable alternatives remains to be seen. The Lords recommend that businesses will need considerably longer than a year (April 2021) to recover from the COVID-19 disruption and says it is not right to impose unnecessary burdens on businesses at such a difficult time. Further, it recommends the Government takes its time to consider the matter properly, given our current circumstances.
In considering matters, the Report accepts that revenue generation, a key reason for the introduction of the Rules, is an important consideration. Indeed the Government will need to recover the costs of its COVID-19 expenditure somewhere. The Government will see this as a good place to start and will be reluctant to give up this possible source of revenue which HMRC suggests may net as much as £4.1 bn by 2024/25, (although those predictions are somewhat controversial!). However, the Report emphasises the need to balance revenue generation with fairness, making it very clear that in many cases the Rules will not create a fair system for contractors who may then be taxed as if they are employees but not enjoy any of the legal rights that an employee would have. The Report goes as far as describing these contractors as “zero rights employees“, i.e. taxed as employees but with no employment rights. Today, 15% of the workforce is self-employed. However, with the introduction of the gig-economy, many of these individuals are relatively low earners, so fairness in any new system is a key issue, as is the recognition that working through a PSC will often be a requirement of the business they are working for, rather than a lifestyle choice. The Report criticises the whole premise of IR35 in trying to treat independent contractors as employees when they clearly need to be in their own distinct category.
The Report reflects that the proposed introduction has already led to hardship for contractors. Many companies had said that they would no longer work with PSCs after 6 April 2020 given the proposed introduction of the new Rules, so the reprieve in the introduction of the Rules has come too late for some. This has also denied businesses the significant benefits of working with PSCs, providing flexibility in workforce requirements (matching demand with supply), and reducing overall fixed costs. It seems unwise to deny businesses such opportunities in the current environment when they need to be given every incentive to regenerate in as profitable a way as possible. The Report felt the Rules effectively privatised the costs of tax compliance in shifting the burden of compliance onto businesses. The estimate of costs to businesses of this was significant, and the Report did not feel this had been properly evaluated by the Government. The Report identified that the proposed introduction had led to companies introducing blanket assessments for types of PSCs, many of which are inaccurate. Again this leads to a reduction in work for contractors. It has also led to unscrupulous and unlegislated umbrella PSC arrangements coming into play who try to extract high fees from those working under them. The Report emphasises the unfairness of these impacts on contractors.
The Report did not pull its punches on its assessment of CEST – the tool introduced by HMRC to assess employee status. Its conclusion was that CEST was inaccurate in a number of cases and simply did not reflect current case law on employee status, largely because it ignored mutuality of obligation. It also found (unsurprisingly) that CEST tended to favour a finding of employee status.
So what now?
The Report recommended that Government needs to indicate by October 2020 whether it still planned to introduce the Rules in April 2021. It emphasised the need for businesses to be able to plan going forward and criticised the delayed provision of guidance until six weeks before the implementation date this year, which had impacted on the ability of businesses to prepare and was likely to have led to some of the hardships described above.
Importantly, the Lords were scathing of IR35 generally and urged HMRC and the Treasury to consider alternatives properly, and in a measured way, feeling that HMRC had failed to appreciate or listen to the adverse impacts of the introduction of IR35 in the public sector. It set out some alternatives which had been suggested and should be considered including:
- a flat rate deduction rate for companies using PSCs;
- the introduction of a new ‘Freelancer’ limited company with its own tax treatment;
- introducing ‘Engagers tax ‘ to balance the lack of employers NIC;
- addressing the difference in NIC rates for the employed and self-employed;
- introducing a statutory employment test leading to certainty for contractors and businesses alike. In this regard it urged the Government to consider the recommendations in the Taylor Review (which it had committed to doing in 2018 but which appeared to have fallen by the wayside). One of the recommendations of the Taylor Review was the concept of a ‘Dependent Contractor’ – someone who would have identified, but more limited, employment rights to address the unfairness of the “zero rights employee“ concept.
Looking forward, the Report identified six key tenets to be adopted for any alternatives: certainty, simplicity, fairness, supportive of growth, administratively straightforward, and enforceable with limited resources.
It will be interesting to see how the Treasury and HMRC react to such a report. Watch this space!