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IR 35 Part 2 – The Insanity Intensifies

In opposition the Conservatives and some Liberal Democrats, not to mention quite a few Labour MPs, were united in highlighting the ridiculous anomalies of the IR35 legislation introduced by Chancellor Gordon Brown way back in April 2000.

The IR35 legislation sought to tax freelance workers providing services via their own limited company as if they were employees. Such companies were called “Personal Service Companies”. The stated aim of the legislation was to prevent employees setting up personal service companies to perform their duties because that led to a reduction in the tax and National Insurance payable to the Treasury.

IR 35 was originally designed to deal with a scenario, particularly common in the IT industry, where employees left their jobs on a Friday and started back on the Monday as “consultants” doing exactly the same job as before. I used to know one IT consultant who claimed to be a freelance working via a limited company. He worked in the same office doing the same job for over 10 years, five as an employee and five as a consultant. He really was an employee in all but name but he paid less tax and NI and – perhaps more importantly - his “employer” also got round a whole raft of employment legislation as well as saving 12% Employers NI contributions, holiday pay, sick pay, redundancy liability, pension rights etc. The “consultant” could also claim a lot of expenses against his income which as an employee he would not be able to claim.

However, the legislation also caught many genuine people working through a limited company for other reasons. As ever the sins of a few were visited on the vast majority of innocent people.

When he introduced the legislation Gordon Brown claimed that it would result in an extra £220 million a year being paid to the Treasury in National Insurance alone. Yet nine years later an application under the Freedom of Information Act (I bet Gordon Brown wishes Tony Blair hadn’t come up with that idea) shows that the total extra income – tax and Nation Insurance - amounted to just £1.5 million. It gets worse because that figure didn’t allow for the legal costs incurred in taking limited companies to court and in fact HMRC actually lost the vast majority of these cases and the suspicion is that it probably cost more than £1.5 million.

There is no doubt that many people – employers rather than “employees” were working the system, but IR35 was too blunt an instrument and that is why Conservative, LibDem and Labour MPs alike were critical.

However, just a few months ago the media, led by The Times, woke up to the fact that there were a whole lot of senior people in the Civil Service who were using personal service companies. Everyone expressed surprise but the only thing that surprised me was that anyone was surprised because I know that the use of personal service companies was, and is, endemic in the civil and public service, not to mention in quangos up and down the country.

Far be it for me to ever defend the dreadful Ken Livingstone but I did have some sympathy – just a little – at the hammering he got in the media when it transpired that he had been using a personal service company for a lot of his public service appointments. However that sympathy evaporated when, after having his bluff called by Boris Johnson during the elections for London Mayor last month, Ken stated that he had accounted for all his due tax. Probably true. The media, led again by The Times, seemed to think that being paid via a company meant that once the company paid its Corporation Tax – at an admittedly lower rated than Income Tax – Ken and others like him could just take the money out without there being no further tax payable. That just isn’t true – taking cash out as dividend would have been taxable on Ken though he might have paid a little bit less than if he had been paid direct. The real savings would in fact be made by the legal avoidance of National Insurance so Ken saying he paid the appropriate tax was a bit disingenuous. But in fact the real savings on National Insurance would have been made, not by Ken, but by the public bodies who paid him. You could easily argue that the main losers in making Ken, and others like him, be paid as employees would be to take money away from the public bodies who employed him and pay that to the Treasury. Then those bodies would probably need bigger grants from the Treasury to be able to pay the extra National Insurance.

So it was that in a typical knee-jerk and ill-thought-out reaction to media attacks George Osborne made an oblique mention, in his 2012 Budget, of introducing a measure to tighten up IR35 (which initially he was going to scrap) in order to stop the practice of civil servants and the like using personal service companies.

The fact is that imperfect as it was, had IR35 been able to be properly applied then steps could have already been taken to stop the practice. But so flawed was the legislation that no-one was willing to tackle it head on.

Faced with the scenario of a poorly drafted piece of legislation which was not fit for purpose any sensible person would scrap it and go back to the drawing board. That’s what the Tories intended to do but instead, driven by The Times, the BBC and others what is now on offer is a “tightening” of the existing IR35 legislation.

So it was that just prior to the Four Day Diamond Jubilee Holiday (getting bad news out while everyone is on a high?) Her Majesty’s Revenue and Customs (HMRC) issued a consultation paper setting out their proposals to tighten IR35 compliance by requiring organisations engaging “controlling persons” through personal services companies to deduct income tax and national insurance from fees paid to their companies and themselves to pay Employers National Insurance.

The consultation document proposes that the new rule will be based around a new definition for “controlling person” that will be set out in the Finance Bill 2013. A controlling person will be defined as someone from the contracting organisation who is able to shape the direction of the engaging organisation during the year. According to the document this would be “someone who has managerial control over a significant proportion of the organisation’s employees and/or control over a significant proportion of the budget of the organisation”. Note that the term used is “managerial” even though accepted definitions would support the contention that both “care and control” and “direction” are the legal responsibilities of directors not of managers.

Yet the consultation document says “This measure is intended to be targeted only at those who are able to influence the direction of the entity/organisation as controlling persons. We do not intend for this measure to stop genuine commercial arrangements.” Maybe the difference between direction and management needs to be explained to HMRC.

As it stands this consultation document is aimed at private sector organisations but it is clear that the controlling person rule is a direct response to the controversies in Whitehall that followed revelations that more than 2,000 senior civil servants were engaged through personal services companies. These people are to be covered by a similar set of rules that will be brought into force – without any consultation - in September 2012.

According to the Chief Secretary to the Treasury – Danny Alexander (LibDem) the proposed tightening of the rules “will apply to any organisation, be it public or private. It is right that when an individual is in a position to control the major activities of an organisation, they should be on the payroll of that organisation”.

He goes on to say that “the use of personal services companies in Whitehall should be exceptional and unusual, and should apply only in particular cases, such as when there is a short-term shortage.” He also pointed out that 40% of the civil service contracts related to IT services but I wonder how many of these people are in a position to “control the major activities” of the departments in which they work?

Showing an astounding lack of knowledge Mr Alexander also claims that “there is an employee test under the IR35 rules, which I am told is simple and straightforward, and that should be sufficient for determining on which side of the line someone sits.” Do you believe everything you are told Chief Secretary? Frankly if the test were simple and straightforward you wouldn’t be in this mess and pigs would be circling round Big Ben on gossamer wings!

The consultation period closes on 16 August, and asks for feedback on questions including:

1. Is the measure proportionate?

2. Does it raise commercial issues, or can you suggest alternative approaches?

3. What are the consequences of this provision taking precedence over IR35 (Part 2 Chapter 8 ITEPA 2003) Part 2 Chapter 7 ITEPA 2003?

4. Is someone who has managerial control over a significant proportion of the workforce and/or control over a significant proportion of the organisation’s budget the correct definition for a ‘controlling person’?

If you feel you might want to make your views know perhaps you might want to think about the responses I have given to the above four questions:

1. Is the measure proportionate? No - this a direct response to ill-informed media story initially over the Ed Lester issue. It needlessly will penalise the private sector for the public sector's inability to follow the existing IR35 regulation. I neither like nor agree with IR35, but the regulation is there and compliance with it would not have led to this - and other highly publicised breaches - occurring. 

2. Does it raise commercial issues, or can you suggest alternative approaches? Most senior interims operate their own businesses. This proposal seems to imply that they have to go on the payroll and therefore start accruing employment rights. If neither party wants this to happen then what are their options?

3. What are the consequences of this provision taking precedence over IR35 (Part 2 Chapter 8 ITEPA 2003) Part 2 Chapter 7 ITEPA 2003? The definition of a “controlling person” will be too hard to clarify, let alone monitor, and will no doubt lead to businesses using the big consultancy firms to fill their interim requirements rather than the independent “one man bands”.

4. Is someone who has managerial control over a significant proportion of the workforce and/or control over a significant proportion of the organisation’s budget the correct definition for a ‘controlling person’? Absolutely not. If control over a number of people is a guideline you could have an interim manager of a low level department caught by this new legislation even though they would be unlikely to have any significant impact on the strategic direction of the organisation. Also a contracted temporary junior finance resource could easily control a substantial budget.

The only way this might work is if the “controlling person” is someone with the title “director” and who participates in Board meetings at a strategic level. However that would unfairly penalise those individuals who specialise as career interims and run a business providing short term resource to those businesses who need it. They often have a very different skills set to those who will be brought in to run the business on a full time basis.

Links:

The full HMRC consultation document 

What Is IR35? 

What Was The Point of IR35?

You can read more tax related articles at our sister website - Link4Business

Comments   

 
+13 # ThanksMark 2012-09-13 00:51
Interesting post guys. Any thoughts on recent legal decisions?
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+17 # Help PleaseIan 2012-06-19 10:59
I work as a consultant and have no other staff but so far I have managed to avoid being brought into IR35 as I have usually had two or more clients "on the go" at the same time. I've been approached about a 12 month contract starting towards the end of this year which would mean me having no other clients. Is this going to bring me into IR35?
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+18 # RE: Help PleaseSteve Burrows 2012-06-19 11:06
My opinion, without detailed study. A prolonged period of working for one client is going to set you up to fall foul of IR35. A year is neither "temporary" or "short term", you would be de facto an employee unless you could show that you were entirely self-directed, i.e you work when you want, where you want, doing what you want to fulfil the client's needs without them managing or directing you. The situation you envisage is precisely what IR35 is intended to target, HMR&C want you on your client's payroll so they can be assured that PAYE etc. is properly paid with no concealed "benefits.
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+21 # RE: IR 35 Part 2 – The Insanity IntensifiesCarl 2012-06-15 16:23
I had a look at the consultation document which is very long. It seems to me that HMRC don't really want anyone to respond but I reworked your suggestions for the main questions so thanks for that as I woudn't have bothered otherwise.
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