Personal Service Companies (Select Committee Report)

Tuesday 17th June 2014 Lords Chamber

Motion to Take Note

17:42

Moved by

[Baroness Noakes]

That this House takes note of the Report of the Personal Service Companies Committee (Session 2013-14, HL Paper 160).

[Baroness Noakes (Con)]

My Lords, I am delighted to have this opportunity to move that this House takes note of the report of the committee on personal service companies.

The committee was part of last year’s experiment of setting up Select Committees for half a Session in order to tackle discrete topics. Our committee was set up in November 2013, and we finalised our report at the end of March 2014. I am delighted that seven other members of the Select Committee have put their names down to speak in this debate. We had an excellent committee, and I place on record my thanks to them for their hard work and for their insightful contributions to our report. I also record my thanks to our committee clerk, Patrick Milner, who coped magnificently with being thrown in at the deep end for his first assignment on joining the staff of your Lordships’ House. He was very ably supported by other committee staff, and I also record my thanks to the committee’s special adviser, Anita Monteith.

The Government produced their response last week. While I thank them for that response, I cannot say quite as much for its contents. I will quote just one outside view of the Government’s response:

“Lots of words, in fact saying very little … Looks to me as though it was written by a PR agency… what they do say is simply the same old trite clichés”.

I would not express it quite like that, but I know what they mean.

The subject of our report is personal service companies, but much of it is about how the modern flexible workforce interacts with the tax and national insurance system. No discussion of that can exist without delving into something called IR35, which is anti-avoidance legislation that first appeared in the Finance Act 2000. It is called IR35 for the very simple reason that the detail of the proposed legislation was first announced in a press release issued by the then Inland Revenue in its press release No. 35, which supported the March 1999 Budget. The name has stuck despite many changes, both before the legislation was first enacted and subsequently.

Of course, that took our committee into the territory of HMRC, which is responsible for administering the tax system, and HM Treasury, which sets policy. We held two evidence sessions with HMRC officials. As will become clear, we were not uncritical of HMRC, but had no issue with its co-operation with us. I wish that the same could be said of HM Treasury. My noble friend Lord Higgins will be picking up on this, but I will just say that the whole committee was “disappointed” that the Exchequer Secretary refused to give evidence. To rub salt into the wound, he also refused to allow Treasury officials to do so.

There are no precise estimates of scale of the use of personal service companies, but the general view was that there were around 200,000 and that their use continues to grow. Personal service companies are typically used by contractors or freelancers to offer their services, particularly in IT and in the oil and gas industries. However, they are found in all business sectors and, as I shall come to later, in the public sector. Companies using personal service companies told us in evidence that they generally use freelancers and contractors on things such as projects or time-limited activities, which gives them the opportunity to acquire those services without the encumbrance of employment rights.

On the contractor side, we were told that there were many reasons for individuals to use personal service companies. There is no doubt that the opportunity to pay lower amounts in national insurance and tax is among those reasons, but it is not the only one. The flip-side for those individuals is that they forgo employment rights. However, we received evidence that the individuals concerned did not want to be regarded as employees and had no desire for such rights.

Our tax system developed in an era when freelancers and contractors did not feature greatly. In this country we tax sources of income, and there is a sharp distinction between employment income, trading income and other sources of income. The world of work has many shades of grey in it, but they have to be fitted into our tax system. Successive legislation has taken many of those grey areas, which are not employment in a contractual or general law sense, and treated them as deemed employment. IR35 is part of that theme.

One of the things which surprised us is the extent to which a whole industry has grown up around IR35. That indirectly supports the evidence we received of the burdens of compliance. On that basis, we challenged whether that part of the tax code was cost effective. We received evidence from HMRC about the value of IR35. It told us that it amounted to £550 million, but that only £30 million of that was direct Exchequer yield. The remainder was based on calculations of how much tax would be at risk if the IR35 rules did not exist.

We were not convinced by some of these calculations and recommended that a detailed assessment be published, both of the Exchequer protection claimed for IR35—more than half a billion pounds—and of the costs of taxpayer compliance. The material provided in the Government's response provides hardly any more information than was given to the committee in evidence, and I remain sceptical about those figures. I do, however, welcome the commitment from the Government to give an updated administrative impact assessment this autumn, and I hope that HMRC will be open to proper debate on both the costs and benefits of IR35.

We also queried the resources allocated by HMRC to IR35 compliance, which appeared to us to be disproportionately small compared with the size of the personal service company population, and we asked for greater clarity on the costs and related yield. The Government's response does not really answer our points and certainly gives no comfort that HMRC has a firm grip. If I were in the Treasury, I would be distinctly concerned about the approach of HMRC, which can be summarised as, “We are doing a bit more than we used to but we don’t know how much we are spending on it or what we get for it”. We were, however, pleased to see that HMRC will look again at the confusing questions about service companies on the annual tax returns.

The Office of Tax Simplification had looked at IR35 in 2011. It recommended suspending IR35, but also offered an alternative of improving the administration of IR35, and that is what the Government chose to adopt. We spent some time looking at the various components of that—namely, an IR35 forum, some business entity tests, and a contract review service. We were not at all sure that any of these was working in an optimal way and there was particular criticism of the business entity tests which were supposed to help guide taxpayers in complying with the legislation but it was not clear that they did.

The Government’s response to our recommendations merely references an existing review by the IR35 forum. I shall take that review on trust, but I express personal reservations about whether anything much will change.

The freelancers and contractors I have been talking about are generally well paid, which is why there are attractions in corporate structures which offer opportunities to minimise tax and national insurance. The committee also turned its attention to the issues of the lower paid, who are also well represented in the flexible workforce of today, often through agencies. We heard that many lower-paid workers were in the past employed through managed service companies, whose advantages have already been neutralised by anti-avoidance legislation. Umbrella companies are now used instead to employ lower-paid workers who are undertaking temporary work. We heard that there was a very real problem of those workers not understanding the effect of those arrangements and what their rights and obligations were.

We had two basic recommendations. First, the Government should publish a short guide about the basic differences between employment and self-employment, and make that available on multiple platforms. The Government’s response simply stated that HMRC already had something online. The committee emphasised the proactive use of multiple platforms, including paper, for good reason—we were far from sure that the individuals who needed help would in fact be reached by a digital resource and nothing else.

Our second recommendation was that the Low Pay Commission should be asked to look at the use of intermediary companies for the low paid. The Government did not state whether they would do this. I hope that the Minister will clarify that today.

In addition, we heard in evidence that umbrella companies abuse expenses dispensations from HMRC, so we recommended that HMRC took more enforcement action and also ensured that dispensations were granted only where appropriate. I am encouraged to hear from the Government that the Office of Tax Simplification is to look at dispensations, but turning them into exemptions will not do away with the need for effective compliance, and the Government’s response here lacked real conviction.

Lastly, we looked at the use of personal service companies in the public sector. This is not new territory and there have been some causes celebres which had led to a Treasury review and to Cabinet Office guidelines which apply where there are appointments involving salaries of more than £58,200 per annum. We noted that large areas of the public sector—namely, much of the NHS and local government—were outside the scope of this review, as were all those on earnings levels lower than £58,200. We recommended that the Government look at these areas.

We also found that there was inconsistent application of the Cabinet Office guidelines and recommended that the Treasury should take the lead in ensuring compliance and in monitoring guidance.

I cannot pretend that the Government's response to any of our recommendations was encouraging. I do not think that the Treasury has shown any interest in finding out the full extent of the use of intermediaries or indeed in compliance with the Government’s own rules.

I hope that our report has shone a light on a difficult and complex area. The issues that arose during the course of our work have not been resolved by the Government’s reply, so this whole area of personal service companies must be regarded as unfinished business. I urge the Government to look again at their approach both to the higher-paid population and to the lower-paid population. I firmly recommend that the Government get their own public sector house in order.

17:56

[Lord Myners (Non-Afl)]

My Lords, I speak as a member of the Personal Service Companies Select Committee. It was a privilege to sit on the committee, not least because of the excellent leadership provided to the committee by the noble Baroness, Lady Noakes. The noble Baroness’s efficiency is already apparent in her summary today, which has left very little that is new for the rest of us to contribute. I therefore seek simply to underline one or two points made by her.

The work of the committee spoke powerfully of the contribution that your Lordships’ House can make in applying closer scrutiny to a complex and difficult area that is subject to the pressures of social and economic change, the way in which employers seek to employ and the ways in which those who seek employment offer themselves to the labour market.

There has been a substantial growth in the use of personal service companies and umbrella companies for employment. The committee, I believe, has done a first-class job in analysing areas where it was quite clear that from a public policy perspective neither HMT nor HMRC had a clear policy objective. There seemed to be a lack of consistency in the answers that we were given, masked behind a degree of contentment that was ill judged and hardly appropriate in the circumstances as they were revealed by the committee.

The noble Baroness, Lady Noakes, said that she was disappointed that the Exchequer Secretary to the Treasury declined to be interviewed by the committee. I would go further than that. When I served as a Minister in the Treasury, I regarded it as absolutely beyond question that if I were invited to account to Parliament, I should do so. The reasons given by the Exchequer Secretary, Mr Gauke, for not doing so were, quite frankly, not acceptable. The issues that we are looking at were not ones of HMRC implementation; they were a much broader policy issue.

There are prima facie reasons to believe that there is substantial tax leakage at the upper end through personal service companies, while at the lower end of payment there may well be social harm as a result of people forgoing, unknowingly or under duress, some of their employment rights. It was quite frankly unacceptable for the Treasury Minister not to accept either of the invitations from the committee to give evidence—and, moreover, to say that his officials should not give evidence.

Perhaps in that context it is not altogether surprising that we have had a very flimsy response from the Treasury to the work of the Select Committee, one that quite frankly shows a disservice to the hard work that was put in by the members of the committee, our advisers and the clerks. I sincerely hope that when the Minister sums up at the end of this debate, he will be able to give us more substance in his reply than we have received from the Government to date.

It is quite clear to us that IR35 causes many problems. I want to say that it is not working, but it is not entirely clear what it is designed to do. The HMRC officials who gave evidence to us seemed far from clear about how it worked in practice, or were unable to substantiate the figures that they gave us, and they seemed excessively reliant on the IR35 Forum, which seems to be somewhat unbalanced in its constitution, comprising as it does many people who have an interest in the economic activity known as IR35.

I hope that the Minister will go back to the Treasury and say, “We should not be as dismissive as we have been about this report”. Some fundamental and important questions are raised in it about the operation of an area of the labour market that is increasing in its substance and significance. Yet the message that we have from the Treasury is that it really does not want to take this matter seriously at all. I, for one, find it very difficult to understand why the Treasury has adopted that position, so I urge the noble Lord, Lord Newby, to convey to his colleagues in the Treasury that this is a report of substance that raises a number of important questions that deserve close attention from government.

Finally, as a former chairman of the Low Pay Commission, I would like to emphasise the important role that it could play in reviewing the operation of personal service companies and umbrella companies in the employment of the lower paid. There is, again, very strong reason to believe that people are pressurised into accepting employment through one of these arrangements without fully knowing or understanding the implication of their loss of employment rights. Those rights constitute part of a package of reward for work, which is not limited to the hourly rate, although that may be the most important element. Therefore, it falls entirely legitimately within the framework of the Low Pay Commission’s role and within the competence of that commission and its officials.

I very much hope that the Minister in his summing up will give noble Lords a clearer message on whether the Government are going to put this matter in the hands of the Low Pay Commission or whether we have to conclude, regretfully, that HMT just cannot be bothered to get to grips with this issue, regardless of the cost in lost tax revenue or the potential damage to employment rights of the low paid.

18:04

[Lord Palmer of Childs Hill (LD)]

My Lords, I, too, was a member of the committee and I thank my noble friend Lady Noakes for her incredibly able chairmanship of it. We received a very complex set of reports, which were often conflicting and incomplete. I shall not repeat her comments on the Government’s response, which did not really address many of the problems that were raised.

My noble friend Lady Noakes dealt in great detail with the report and the response from the Treasury. Perhaps I may take a more generalised look at this issue. I came to the Select Committee with the experience of 28 years as a local government councillor. With some relief, I stepped down this May. I also have a lifetime behind me as a practising chartered accountant, so IR35s and the whole concept of tax reduction were not new to me. My view before the hearings was that personal service companies were essentially a means of reducing income tax and national insurance. That was my view when I went into the committee. People who were self-employed were able to claim greater expenses against their income and thus reduce their tax. There was a difference in tax law for those who were employed. Any expenses claimed had to be wholly, exclusively and necessarily in the course of one’s employment. If you were self-employed, any expenses claimed had to be only wholly and exclusively; the “necessarily” did not come in and you could claim more expenses, thus reducing your tax.

Being a personal service company is cost effective for what I will for simplicity call the employer—although it is not the employer—paying via such a company. The so-called employer does not have to pay holiday pay, redundancy pay, sick pay or employer’s national insurance, as well as a number of other things. So you might say that it is pretty useful. The employee is able to reduce his tax and national insurance liabilities by using a personal service company. It is good for the employee and employer, if I may call them that, but not so good for tax-gathering, because it essentially reduces the taxes that the state receives.

I was particularly worried by the move to use personal service companies in local government, the BBC, health authorities and the like. There is an acceptable use, as mentioned by my noble friend Lady Noakes, such as in employing IT contractors for a specific task—a contractor who may well have many other clients, be on a short-term contract, and so on. But a test of being self-employed in the old days, when I practised as a chartered accountant, was that you had recurring fees, not necessarily from one but from at least two clients. You could very well be treated as being an employee by the Inland Revenue if you had only one payer of your fees. But is it really acceptable to have people in designated positions of chief executive, director, assistant director or head of a department who are not employees under PAYE? To my mind, this is the big fault of what we have ended up with through personal service companies. However, in the private sector, it has always been sound business practice to trade through a company to take advantage of limited liability. This could apply whether you were the local grocer, running an IT company or whatever. After six months of hearing very complex and often conflicting evidence, I saw the problem as being that a whole industry has been built up on how to trade as a personal service company and avoid the pitfalls of IR35.

It appears that very few personal service companies are investigated by HMRC for non-completion of the IR35. It was shattering to hear what a small number it is. If there is any benefit it is purely that of deterrence. This was addressed by my noble friend Lady Noakes’s comment about the larger sum which the Inland Revenue theoretically maintains has been saved. I reckon that personal service companies simply chance their arm that they will not be caught by the IR35 legislation and do not actually bother too much with it. I will not repeat the comments made by the noble Lord, Lord Myners, and my noble friend Lady Noakes about the Treasury Minister or civil servants not coming to give evidence. I agree entirely with what they said.

After six months on the committee, having gone into the committee with a completely different preconceived view, I came to the conclusion that the report and government response should be noted, which is what we are asked to do, but I am not happy with it. To my mind, having thought about it even after the end of the committee proceedings, I believe that one of the fault-lines is that public bodies should not pay senior employees through personal service companies, or, indeed, umbrella companies. By some form of government directive, enforced by the payment of grant allocation, these bodies should be forced to employ people as proper employees under PAYE. If these are government-style bodies, however one looks at them, then the Government have control in terms of the money that those government bodies receive, and one of the requirements should be that they do not try to circumvent the PAYE system, which most people in this country are caught by.

Other than that—this is my final, rather bold statement—we should abolish IR35s and let all the accountants, lawyers, contractors, organisations and politicians go and get a life, without IR35s. There will be, in my view, no real, noticeable loss to the Exchequer and if there is no noticeable loss to the Exchequer, can other noble Lords and the Minister please tell me why we have entered in this farrago of IR35s? It is a deterrent to do something which is not really deterring. If there were no IR35s, the Exchequer would not lose more than the very modest sums that my noble friend Lady Noakes mentioned. The idea of IR35s is almost a jealousy that some part of our community—our business community—is getting a better deal than anybody else. That may well be the case, but it is not a case to my mind, having come at this from completely the other angle as a practising chartered accountant. There is no benefit in the IR35 and when HMRC and Treasury Ministers deign to come back to your Lordships’ House on this matter, I hope that they will take that point into account.

18:13

[Lord Hope of Craighead (CB)]

My Lords, it is a real pleasure to follow the noble Lord, Lord Palmer of Childs Hill, who did so much to enliven our discussions during the six months that he referred to. I very much welcome the opportunity to debate the report of this committee. It was a privilege for me, as a complete beginner who had never heard of personal service companies, or indeed an IR35 before, to sit on the committee and take part in its deliberations. I pay tribute to the skilled leadership of our chairman, the noble Baroness, Lady Noakes, and of course, as she did, to the clerks who supported us, Patrick Milner and Matthew Smith, and our specialist adviser, all of whom played an important part behind the scenes in guiding us through a very complicated situation. I found it an interesting exercise but at times a rather frustrating one, for reasons that have been hinted at already. It was not easy to get hold of the facts; indeed, the facts, when there were any, did not seem very firm or reliable. Some employer groups and, notably, the Treasury were reluctant to give us any firm information at all. That was highly regrettable.

As I understand it, the complex, perhaps outdated, nature of our system of income tax and national insurance contributions lies at the heart of the problem. On one hand there are those skilled, hard-working and well informed people who prefer to trade through the medium of a personal service company, rather than as individuals, for perfectly legitimate tax reasons, because that is the nature of the work they do and because the markets in which they deal prefer to employ companies rather than individuals. It is good for business, it is good for their business, and I see it as a sign of a vibrant and healthy economy. On the other hand, there is real cause for concern, because there are people on very low rates of pay, often with a very poor command of English, who are being forced into a system they simply do not understand. The problem is to identify the steps that can and should be taken to protect the disadvantaged without impeding or, at worst, penalising those who are making proper use of the facility. Across the board, there is the risk of exploitation of the system simply to avoid tax and insurance contributions that ought properly to have been gathered in by the Revenue.

As the noble Baroness said in her introduction, we are considering the effect of an anti-avoidance measure. The main purpose of IR35, as I now understand it, is to deter people from disguising employment income through the use of intermediary arrangements. A personal service company can, indeed, be used for that purpose, but as our evidence showed, in many cases that is not why the arrangement is being used at all. One has only to consult Google—a rather shocking exercise in this field—to see what a huge industry now offers advice, perhaps some of it very proper advice, perhaps some of it not so proper, on how the system can be made use of. Just as the number of people who are becoming self-employed is growing, as we hear daily, so, too, is the use of the personal service company.

I now realise, having been educated by the evidence, that I have come across such a person myself. He maintains the generator which provides electricity for my cottage in Scotland. It is situated in the hills of east Perthshire, north of Dundee, not far from Glen Clova, from which the noble and learned Lord, Lord Davidson, derives his title. It has no mains electricity, so if we want water, light or heat we must have a generator, and it is quite a big one which I cannot possibly look after myself. He is employed by me to look after it. He told me that he was once employed by a generator servicing company, but left to set up in business on his own. He works as a sole trader, providing his services right through Scotland, from the islands in the north to various places in the south and possibly even to Northumberland. He provides me with bills which, to my initial surprise, show that he trades as a company. I suspect that he finds that a useful protection, because these machines are complicated and he is able to limit his liability and not expose his personal assets should something go wrong. No doubt there are other benefits, too, but I would not dream of telling him what to do. His is a classic case of a personal service company being properly used. It is clear from the evidence that there are many others who adopt the same mechanism. I am glad to see in the response, in paragraph 2.16, that the tax system from which these people benefit is recognised by the Government, who recognise the risks that these people take in carrying on business in this way for themselves. It is a proper recognition of the proper use of the facility.

There is, however, a real problem in sorting out those who are in that category and those who are not; it lies at the centre of the inquiry. I have to say that it is not a new problem. It is one that tort lawyers have been grappling with for decades. The position is that it is crucial to a claim for damages for personal injury, if one claims against somebody one thinks of as an employer, to prove that the individual within the organisation whose act caused an accident was indeed an employee. There are various tests used to sort out who is and who is not in that category. Was the individual truly an employee or was he an independent contractor? Was his contract with the company one of service or was it a contract to provide services? If the latter is the case, the respondent is not liable.

The position lawyers adopt is that this will always be a question of fact and each case is different. I suspect that much the same problem confronts the Revenue when it is trying to police this huge and growing industry. As the response says in paragraph 2.11,

“differing engagements can result in differing tax consequences”.

We were urged to recommend that there should be a more precise definition, but I rather think that it is not possible to go much further than the Revenue has already gone subject to the following point, which I think has already been made, that better guidance could be given in language that is easy to understand so that people who are getting trapped in a situation really understand the difference between employment and self-employment and the exposure to the loss of the benefits that go with employment, which we have built up over so many years.

When one crosses the margin and moves into this grey area, the question arises of whether the Revenue is doing enough to help those who are genuinely not trying to use the intermediary to avoid tax. As the noble Baroness pointed out, the Government have responded positively to our question about the information given on the tax return and the guidance notes that accompany it. That positive response in paragraphs 2.24 and 2.28 is very much to be welcomed. That is the voluntary side of the coin, where people are prepared to come forward and provide the information, if they are told what to do. On the other side are those who are seeking to avoid their liabilities. I must confess that I was less impressed by the response to the question of whether sufficient resources are being allocated to policing non-compliance. The evidence that we heard was not convincing, as we said in our report. The response says a little more about this in paragraphs 2.32 to 2.37. The message seems to be that HMRC will continue to keep the situation under review. What we were looking for was a fresh, renewed effort, not just more of the same thing.

A commentator on our inquiry asked whether it would achieve anything. It is true that in paragraph 2.35 it is said that HMRC revised its approach in 2012. However, the point we were trying to put across is that even this is not good enough. The response to our concern about the contract review service, as to which the evidence told us there was a lack of confidence in its independence from HMRC, is also rather muted. It is not clear from the response that the problem of assuring users of its independence and impartiality has been fully appreciated. Solving that problem is crucial if the success of that service is to be achieved.

As the noble Baroness pointed out, we decided to dedicate a separate chapter of our report to the lower-paid and to the real concern we had that people in this category were being dragged into a system that they did not understand and whose consequences they did not appreciate until it was too late. This is evasion by those responsible for bringing them into the system not just of tax but of the whole structure of the employment law that we have built up for their protection. To some extent, the response is encouraging but one wonders whether reliance on the helpline mentioned in paragraph 2.58 is doing enough to address the problem. More attention needs to be given to publicising its existence, to the language problem and, indeed, to helping people who cannot afford the systems that give access to advice online in this way. It would surely be helpful if the Minister could assure the House that the Government support the committee’s recommendation that the Low Pay Commission, to which the noble Lord, Lord Myners, referred, should examine this whole issue. We set out our recommendation in some detail but paragraph 2.68 of the response does not make it clear that the Treasury has fully grasped the point.

Finally, as to whether this short inquiry in which we were engaged has achieved anything, I think it has served a useful purpose. We have drawn attention to the benefits and, even more, to the abuses and the deficiencies. It is now for the Government to support the benefits, as the response indicates that they intend to do, while at the same time curing the abuses and meeting the challenge of avoidance, as to which the response could have been more positive in endorsing our recommendations.

18:24

[Lord Higgins (Con)]

My Lords, I join those who expressed appreciation for the chairman of our committee, my noble friend Lady Noakes, who was an outstanding chairman and succeeded in producing a report in a very short timescale. That report deals with an extremely complex and difficult subject, as the committee discovered from its inquiry, but my noble friend put forward the problems very clearly in her speech this afternoon.

The response—indeed, the whole process—has been remarkably fast. As my noble friend pointed out, the committee was set up in November. We are only in June but we have already taken evidence, produced our report, received a reply and now had a debate. That is probably a record for any Select Committee report. However, as was made clear by previous speakers, the problem is that the Government’s response is very inadequate indeed and does not solve the problems to which we drew attention.

We are concerned about the Government’s attitude to this matter, as was said in previous speeches. I regret having to draw the following comments to the attention of the House and, I hope, to the Liaison Committee, which is ultimately responsible for these matters. Our report states:

“We were surprised by the lack of co-operation from the Government. The Exchequer Secretary to the Treasury, who has responsibility for tax matters within Her Majesty’s Treasury (HMT), refused to attend an oral evidence session citing that our enquiry was concerned with HMRC’s application of the legislation. He also refused to allow Treasury officials to appear on the same grounds”.

That is a quite absurd explanation of why he did not attend. We could not conceivably have looked into the way in which the tax collection system operated without also considering the legislation. Although the first of those matters is the responsibility of HMRC, the second is clearly the responsibility of the Treasury.

We investigated and raised a number of Treasury issues with other witnesses but were unable to get a reply from the Treasury itself until this evening. I hope that my noble friend Lord Newby will be able to give us a better explanation of why the Treasury was so unco-operative in this matter, because it is of concern to the House. Having been chairman of the Liaison Committee in the other place, I am more familiar with the problems that one has in getting witnesses there and am less clear what the situation is in this House. However, this example raises serious questions about the way in which the Government respond to Select Committees. Like the noble Lord, Lord Myners, I would have found it inconceivable not to respond to a request to appear in front of a committee, and even more inconceivable to refuse to allow Treasury officials to do so. This is a very unsatisfactory situation.

There is no doubt at all that the IR35 issue, which we looked into in considerable depth, is extremely unpopular. Indeed, as has been pointed out, a whole industry has grown up to deal with the problems that it presents for those who are subject to it. While it is clear that people may incorporate a company for good reasons of limited liability and so on, there are also serious tax and national insurance implications. The Office of Tax Simplification suggested that perhaps IR35 should be abolished or at least put on hold. Contrary to what my noble friend on the Liberal Benches said, the committee did not take the view that it should be abolished and went along with the view that it should continue, but clearly a great deal has to be done to improve the present situation.

The Revenue is concerned that if it were abolished there would be mass migration from PAYE to personal service companies, and estimates a loss of revenue of £550 million. As my noble friend Lady Noakes pointed out, however, we have serious doubts about how valid that estimate is. While the Revenue has produced a slightly more sophisticated version in response to our report, it does not add anything significant to the earlier assurances that we were given on this subject.

The other matter that has been pointed out is that it seems clear that the Revenue is not pursuing individual IR35 cases with enormous enthusiasm. One of the other issues discussed was whether the merger of national insurance and income tax should take place. The response suggests, “We might do that eventually but not now”. I realise the complexities of such an operation; we should not hold our breath and suppose that that is suddenly going to take place.

More important is that implementation of the legislation by the Revenue has not been at all satisfactory. I was astonished to find that we have a self-assessment declaration form with a specific question on personal service companies that, it turns out, many people do not answer at all. Nothing seems to have happened as a result. We raised this question and received a response from the Government; it would seem that they are going to try to tighten this up. However, it is their attitude to the non-completion of the questionnaire that gives cause for concern.

The use of personal service companies is very widespread and produces, for those who operate them, considerable benefit to the economy of the country. That is not in dispute but there are, none the less, a number of issues here. Particular concern was expressed about the use of personal service companies in the BBC, for example, and in the public sector in particular. This needs to be dealt with seriously, and while the Government have taken some action, the committee was not satisfied that this problem had been solved—still less in parts of the public sector in which it appears that no action at all has been taken, even though it is the Government’s policy that personal service companies should not be used to mitigate tax and national insurance charges in the public sector. Something more needs to be done about that.

The area that perhaps gave us most cause for concern was the following: it is clear that many personal service companies are set up not at the instigation of the individuals concerned but at the instigation of their clients. This is particularly so for those on low pay, and it seemed to us that there was most appalling ignorance among those people about what they might be losing as a result of their use of personal service companies. Again, this issue is important. The Government’s response on it was somewhat better in terms of the Low Pay Unit and so on. However, again the matter brings out a real difficulty.

I believe that our report has been useful. It has been produced at very considerable speed and raises some difficult issues. In effect, we have turned over a stone and what is underneath is fairly unpleasant. The question that arises is this: we need some sort of comeback. It is fine having a debate; the Minister will reply and so on. If we are going to set up these ad hoc, high-speed committees, and they produce reports that result in unsatisfactory responses, the case for reconstituting the committee—which is familiar with the issues in the first place—in order for it to look at what has happened as a result of its recommendations, is worth while. I hope that the Liaison Committee will consider whether some form of post-report scrutiny can be carried out by the original body.

18:37

[Baroness Morgan of Huyton (Lab)]

My Lords, I, too, served as a member of this committee, and I confess that this was not an area about which I knew a great deal at the start. So I, too, pay tribute to the able chairmanship of the noble Baroness, Lady Noakes, who focused our attention for a short and concentrated period on the key issues and allowed us to understand the serious concerns that noble Lords have heard about and, I hope, to produce some practical recommendations. As other members of the committee have said, these recommendations have, sadly, not been taken seriously so far by the Government. I hope that we will hear more this evening. I also pay tribute to the team who worked with us.

It became clear during the course of our work that there has been a massive explosion in the number of personal service companies over the past 10 years or so, although there is no definitive number of them or an explanation of why this has happened. There is a somewhat fuzzy definition, because the personal service company is not defined in law: rather, its definition is understood and some of what we were trying to pin down was elusive.

There is a whole new industry, a sort of job creation in action, around servicing IR35 and personal service companies. There are companies and advisers on the details of tax: they produce publications, they do marketing, they run member bodies and campaign bodies seeking reform, and so on. There has been an absolute explosion. Beyond the fact that that presumably provides some jobs to some people, it only underlined our concern about the confusion in this area of taxation.

It was disappointing—in fact, incomprehensible—that evidence from HMRC was inconsistent and that HMT refused even to contribute at either ministerial or official level. Their explanations were unconvincing at best, and I hope that we hear a better reason from the Minister about the failure to appear and contribute. There appeared to be a general lack of rigour and focus by HMRC on the functioning and validity of personal service companies or on the overall functioning of IR35. There seemed to be insufficient resources focusing on compliance, and a lack of clarity about whether HMRC was really trying to enforce compliance or whether it was just trying to do a bit of deterrent work around the edges.

In fact, during the investigation we found a decreasing number of compliance investigations, which we felt sent a signal in itself. Bizarrely, as we have heard, HMRC asked questions, for example on the personal tax return SA100, that are not compulsory. We have been told that there is going to be a review of this in the Government’s response. I hope tonight that we feel it will be a worthwhile review that leads to change rather than just a review. Probably many of us have been part of reviews of that sort in the past.

It is clear that in some industries—we had strong evidence from the oil and gas industry in particular—the use of personal service companies is really extensive and is considered useful and understandable. Contracts in those areas were time-limited and specialist. It served those industries well to encourage the use of personal service companies. In other industries and sectors it is fair to say that it was less clear. We struggled to persuade some businesses to give evidence at all, particularly in the financial services and banking sectors, where I think it is fair to say that people wished to stay somewhat in the shadows and not appear before us. We received a lot of generic evidence, for example from the CBI and the LGA, but when we pursued details they immediately told us that they could not represent those details in detail. All they could do was talk in generalities. Their individual members on the whole chose not to appear before us.

What was apparent in the evidence we received was that highly skilled workers—often highly paid—were capable of seeking, paying for and receiving the necessary advice about the advantages and disadvantages of personal service companies. Whatever the shortage of information, lack of clarity and low-level obscurity of the issues surrounding IR35 and the use of personal service companies, it seemed clear through the evidence we received that those at the top end of the income scale were at least in control of their own destinies and made decisions accordingly. In many cases, it was the individuals rather than those hiring them who were insistent that they wanted to operate via personal service companies.

In very sharp contrast, it seemed to us, were those at the other end of the skill and income level. Collectively we were surprised and shocked by the evidence we received that showed the widespread use of personal service companies across a range of poorly paid jobs, including healthcare workers and cleaners but many others too. This was confirmed by HMRC, which said that personal service companies now exist across all income ranges and all key sectors. The warm words used to explain the widespread use of personal service companies, umbrella companies and agencies emphasised the importance to UK plc of the flexible workforce.

Obviously the specifics vary depending on the vehicle used. For individuals using a personal service company, the drawbacks include lack of holiday pay, sick pay, maternity pay and a package of rights. Workplace pensions would not be offered.

Umbrella companies are obviously different, as there is a contract of employment. There are rights and entitlements, but these are usually less than for a conventional employment arrangement. There are also additional dangers for the individual. For example, they can be encouraged to make inflated tax-deductible expenses, for which they would be personally liable if investigated and found to be in error. Gaps in national insurance records and employers’ national insurance being deducted from gross were also cited, together with charging of fees that were automatically debited from the individual.

We also heard about the working of agencies that offered workers through various routes, including personal service companies. Often the agencies worked alongside umbrella companies as well to deliver flexible workers—or, perhaps more accurately, workers whom the employer wanted to be on flexible contracts. It is clear that workers in this low-paid flexible workforce generally had lower entitlements overall than those in permanent employment.

Crucially, we were concerned about the awareness by individuals of their rights and benefits or reduced packages. We also received evidence that the pressure to conform to the non-traditional form of employment was mainly from employment agencies. The Low Incomes Tax Reform Group talked about the specific targeting of migrant workers at the most exploitative end of the market. Workers were aware of what they had signed up to only when they tried to access benefits or exercise rights to which they thought they were entitled. Put simply, many low-paid workers think they are working for the company that runs their place of work. Why would they not?

There is much heralding of the UK’s flexible labour market, especially when compared to other countries in the EU. We know that much of that is true. There are workers at the lower end of the income scale who are perfectly happy to work in a flexible package because it suits them for a time, particularly when connected to family patterns. However, we should not be proud of people being pressured into flexible working and non-traditional employment contracts without realising what is happening to them. The Government must do more to inform and to expose. The abuse of flexible working damages the overall reputation of this broad policy approach.

The Government can decide to include issues in the annual remit of the Low Pay Commission. They might be reluctant to do so, but it seems essential that this whole issue is looked at calmly and comprehensively. Hotlines and publications will not suffice; I for one felt the Government’s response tended to err towards hotlines and publications. I hope tonight that we will hear a commitment to look seriously at taking this to the Low Pay Commission.

In summary, it seemed to us that there were two worlds. The higher paid tend to choose to use personal service companies, know what they are and why they are doing so, and seek the necessary advice and professional help. There are questions for HMRC and wider government and society about whether enough is done to ensure that there is necessarily tax compliance for these people. The other world tends to be low paid and often relatively poorly educated, not aware of the repercussions of their employment status and indeed may be not even aware of that status. They are pushed into non-traditional employment contracts rather than opting for them. Again, government action is needed but of a very different form. These are people who are working hard but, bluntly, not being treated fairly. They need better protection. I hope that we will hear tonight a more positive reply from the Government than we have heard so far.

18:46

[Baroness Bakewell of Hardington Mandeville (LD)]

My Lords, I welcome the Government’s response to the recommendations of the Select Committee and the opportunity to debate the issue. This was my first Select Committee; I found it a stimulating and interesting experience and one that I more or less understood. I thank my noble friend Lady Noakes for her chairmanship and for making me feel at ease. I welcomed the opportunity to participate and to learn from the more knowledgeable noble Lords on the committee. This has been a privilege. I do not therefore feel it necessary to comment on every aspect of our report and the government response to the recommendations, as there are those here today who are much better qualified to do so. I also thank and pay tribute to Patrick Milner and the others who worked so hard on serving the committee.

With regard to recommendation 2, the merging of income tax and national insurance, I welcome the Government’s acknowledgement that these could be more aligned and accept that employers already have to deal with significant amounts of change in legislation. However, I hope that the Government will return to this in the foreseeable future as a positive step forward.

Recommendations 3 to 6 set out a number of measures that are a mixture of clarification and enforcement surrounding tax returns and IR35. I note that HMRC is planning to undertake a full review of its questions and guidance on personal tax returns and RTI declarations. This move is to be welcomed and we wait eagerly for it to take place in the not too distant future—I hope that we do not have to wait too long. There are a number of recommendations where the Government have indicated that a review will take place, but, as other contributors to this debate have pointed out, the IR35 Forum appears to be either undertaking this review or playing a very significant part in it. As a councillor, I know that whenever a review of a service or an activity is undertaken, it is important that there is a level of independence in that review to maintain public confidence in the outcomes. Like others, I would welcome the Minister’s clarification on this matter, with particular regard to recommendations 8, 9 and 10, on the contract review service, the business entity tests and HMRC.

As others have indicated, the majority of the evidence that the Select Committee received was from those representing or dealing with people who had set up personal service companies and who were very well able to negotiate around the rules and regulations surrounding IR35. However, as has been said, we received evidence of how the legislation affected those on lower incomes. This is the whole thrust of recommendation 11. While the Government feel that HMRC has updated its guidance, and it is the Government’s aim to move us through their digital strategy towards becoming not just a paperless office but a paperless nation, this is not suitable for everyone.

Yesterday I was invited to the launch of the report from St Mungo’s Broadway, an organisation assisting the homeless. One stark fact struck us all: 51% of the homeless cannot read or write. While the subject of this debate is not the homeless, it is patently obvious that those working with the homeless are seeking not only to get them housed but also to get them into work in order for them to be in a financial position to maintain their housing. Many of the lower-paid workers, especially those using umbrella organisations, will have poor literacy and numeracy skills and have no access to the internet. While a digital strategy will suit the majority, it will definitely not suit all. I urge my noble friend the Minister to develop other strategies to reach the poorly paid to ensure that they are aware of the implications for them of a personal service company. I look forward to the publication of the remit of the Low Pay Commission this summer and sincerely hope that the use of personal service and umbrella companies is covered—it will be a wasted opportunity if it is not —and I encourage my noble friend the Minister to give a strong indication that this will be the case.

I was disappointed with the response to recommendation 15. While it is convenient for departments to do their own risk assessments, the response leans towards a certain complacency. Many in this House will have examples of where complacency can lead to poor outcomes. The committee was calling for a review; it is to be regretted that this was not accepted. In order for the outcomes from the committee’s work to be productive, it would be extremely beneficial for such a review to take place.

Finally, with regard to recommendation 16, I am encouraged that there is some movement. However, it is not clear whether this is as a result of the work of the committee or whether it would have taken place anyway. It would be helpful if my noble friend the Minister could clarify this.

While I fear that some of my comments have been negative, I nevertheless welcome the Government’s response to our recommendations. There is much to praise and I am hopeful of moving the issue of IR35 forward in a positive way. However, as with all things, the proof of the pudding will be in the eating.

18:53

[Lord Davidson of Glen Clova (Lab)]

My Lords, we on this side welcome the report as a real contribution to the debate about the UK’s tax system and how the objectives of fairness and encouragement of enterprise can be better achieved. I congratulate the noble Baroness, Lady Noakes—

[Baroness Noakes]

I thank the noble Lord for giving way. I think that my noble friend Lord Stewartby was hoping to speak before the Benches opposite.

[Lord Davidson of Glen Clova]

In that case, I will sit down and oblige. With her usual courtesy and brisk efficiency, the noble Baroness runs this House as well as she runs her committee.

18:54

[Lord Stewartby (Con)]

My Lords, I do not know whether it was my timing that went wrong, but it enables me to take a slightly more detached view about proceedings over the past couple of hours. I have crossed out most of my speech anyway, so that is no problem.

What is left is a whole area of vagueness. There is very little in the way of action taken. You get the feeling that somehow people thought that, if they let things happen, that would be all right. However, a little while ago I checked through the nature of this issue and it raised a question in my mind as to what the people who are running the bodies think they are trying to do. A lady professor from Oxford remarked, “If you don’t know what you’re trying to do, you are not necessarily going to be very successful”. It is that sort of attitude that I felt had spread through a lot of our deliberations.

We all know that the arrangements for the way things work mean that it is quite difficult sometimes to get straightforward answers to straightforward questions, but we took that to some sort of an extreme. Whenever these issues came up, I asked myself what the authorities were trying to achieve. Did they want to have more of these companies or fewer, or did they not mind either way? This is a culture that spreads through a lot of the areas that we have been discussing this evening. I think that the whole show lacks not only direction but any sort of impetus. I do not think that it is possible just from observing what happened in the cases that we looked at to know whether the authorities actually have any objectives of their own. Do they stop and think whether they are doing what a reasonable person might do? I did not get very far ahead with my little investigations on that front, but I do not think that you will get a well organised and efficient body if its objectives are so vague. How would we know whether we had done a good job if we did not know what we were meant to be doing? It sounds rather asinine because it is such a simple issue.

If you take it in the round, covering all the areas that we have been looking at, you would find quite a lot of comments about what people did but not why they did it, or whether they were pleased with having done it, or however you would like to express it. I would ask that my late contribution to this discussion should not merely be filed away in a corner, because big changes are needed in the structure of management in a lot of the areas that we have been talking about. This is the wrong end of the debate to set off with a lot of new ideas—they are certainly not personal to me—but I hope that perhaps I have spent a bit of time trying to judge what would happen in an ideal world. It would not be quite like the world that we have in this area and there is a huge opportunity for improvement. It is necessary because a lot of what we were looking at is almost incomprehensible unless you are a specialist or expert in the field. I leave with the committee the thought that we could be a little less inert when we tackle these areas and I hope that that will come without too much delay.

18:58

[Lord Davidson of Glen Clova]

My Lords, I will try again. I repeat my welcome for the report as a real contribution to the debate. For the second time this evening, I congratulate the noble Baroness, Lady Noakes, on her chairing of the committee, and I congratulate the committee on producing this timely and useful report. Immediately, I should say that on this side we support the committee’s recommendations. Our welcome for the report is tempered by much of the response from the Government. I join the noble Baroness, Lady Noakes, in restraining my enthusiasm for the Government’s response.

Most commentators accepted in 2000 that curtailing the use of personal service companies to disguise employment was a proper target and that IR35 was a reasonable first attempt to deal with the problem. It is plain that the legislation imposed on contractors, as the committee observes, the need to expend a great deal of time and effort, as well as the costs of accounting advice. In a business environment that is much changed since 2000, it is essential to understand the efficacy of IR35. I am glad I stopped and was able to hear the contribution of the noble Lord, Lord Stewartby, because he made it very clear that the question here is about what one is trying to achieve. In 2000, one knew what one was trying to achieve: to prevent disguised employment. But what is the position now? Is it simply about deterring something that is said to be bad but none the less seems to be expanding quite dramatically? It would be very interesting to hear the Minister in due course provide the clarity that the noble Lord, Lord Stewartby, requested.

The core justification for IR35 is recognised, correctly, by the committee as the Exchequer protection resulting from the deterrent effect of the legislation, and one might expect a reasonably articulate view from the Government after some 14 years of operation of this apparent deterrent effect. We are told that the calculated deterrent effect amounts to a figure of some £520 million. The committee’s concern about this issue, and the Government’s response, are instructive. Where the committee seeks “more robust work” on whether the justification for the deterrent is convincing, the response is that the Government are “confident” that their assessment is “robust”—their favourite word—while accepting at the same time that their methodology is based on uncertain assumptions. That is perhaps not reassuring. The government answer that this is “inherently difficult to estimate” is apparently based on “behavioural assumptions”. We are told that these assumptions are,

“consistent with intelligence from operational experts”.

I hear the words and of course understand them, but this is hardly a model of transparency from the Government.

One might also ask what the cost is of the current system to taxpayers—a figure not dependent on “behavioural assumptions”. Does the Minister have any estimate of taxpayer costs: the fees paid to accountants, tax consultants and so on? The size of the IR35 industry, as my noble friend Lady Morgan observes, must be fairly large—that is a cost imposed on taxpayers.

If the Exchequer protection guess is not as robust as asserted, what would the Government do? The Government’s confidence in the figure is not so impressive when one notes that they were not prepared to co-operate with the committee. The plea that “application of legislation” was in issue could not sensibly have prevented a detailed explanation of the core justification for IR35. As the noble Lord, Lord Higgins, observed, the explanation from the Exchequer Secretary is absurd. That answer could, in a sense, be applied by every Minister, who could say, “Oh well, it’s to do with the implications of how one operates legislation”. It would make answering to Parliament perhaps not a very powerful remedy in our democracy.

Presumably the Minister will take a bolder—possibly more robust—stance and explain the Exchequer protection figure with greater clarity than the government response offers. I imagine that the Minister, who is a sensible person, will take on board the observations of the noble Lord, Lord Myners, who describes the Exchequer Secretary’s conduct in this matter as “unacceptable” behaviour. The noble and learned Lord, Lord Hope of Craighead, identified the need for facts in this area. I trust that the Minister will agree. The noble Lord, Lord Higgins, described the Exchequer Secretary’s behaviour as “inconceivable” by his lights. These are quite strong observations. I will not extend the Minister’s pain any further—I am sure he listened to those observations.

When IR35 was introduced, the concern was about the use of personal service companies to disguise—to conceal—what was truly employment and to enable an individual to obtain advantageous, but presumably improper, tax benefits. The aim of IR35 was to produce fairness between employees and contractors. Now it has been seen that the use of personal service companies has expanded considerably, which, on one view, possibly contraindicates the effective deterrence by IR35, although it might be that more behavioural assumptions need to be considered.

More seriously, the committee identifies the use of umbrella companies to employ the lower paid—not through the choice of those workers. As the noble and learned Lord, Lord Hope of Craighead, observed, the potential for the exploitation of such individuals, who often are not fully aware of their rights, is clear. An environment where lower-paid workers are charged fees, confused over their employment rights and encouraged to charge expenses improperly, as my noble friend Lady Morgan pointed out, suggests a need for both strong enforcement and a high level of education. The noble Baroness, Lady Bakewell, draws attention, correctly, to the way in which communication needs to be dealt with sensibly when one seeks to bring information to the lower-paid. I assume the Government will agree with that as a generality, but could the Minister give greater clarity? For example, the government response states at paragraph 2.70 that,

“HMRC is aware that some”—

umbrella companies—“are non-compliant”. Might the House be told what steps have been taken to deal with these companies?

The committee notes the decrease in enforcement: the reduction in the number of investigations by about 70% over a decade. Is this decline a result of the success of the policy, a lack of resources or a change in HMRC priorities? The recent increase in staff, to which the Government allude, may suggest that the answer is not the success of the policy, but an answer would be helpful in understanding the Government’s view of the operation of the legislation.

Part of the thinking behind IR35 back in 2000 was that it might encourage direct employment. Do the Government have a view as to whether this has in fact been a consequence of the legislation? The move to outsourcing and a desire on the part of some employers to avoid the costs of employment legislation may suggest otherwise, but some information on this aspect would be welcome.

From another angle, IR35 was intended to catch the limited number of disguised-employment personal service companies but not to place obstacles in the way of genuine start-up companies. However, an emerging concern has been that start-up companies, perhaps with only one or two clients, without physical premises and without employees, can present as a disguised-employment company—whereas the reality is that it is a genuine start-up that may in fact develop into a business success. In due course, inevitably, some start-up companies will fail and some will succeed, but in the precarious initial stages of these companies, HMRC’s investigations into possible disguised employment can be immensely disruptive—a disruption that their larger, more established, competitors would not face. Is it possible for the Government to say whether there is evidence to bear out this concern and, if the concern is sound, whether any steps have been taken to reduce such a burden on these entrepreneurial enterprises?

Of course, greater and more visible legal clarity would reduce the confusion that sometimes exists on this subject. The risk criteria that HMRC uses in guiding its activities in this area could do with being made rather clearer so that taxpayers might understand where their activities need to be properly vouched. In the past, one understands that doctors, teachers and health professionals all appear to have featured as being within the risk sectors. In the interests of promoting greater clarity, is it possible for the Minister to inform the House of how these risk sectors are identified?

On what is perhaps a more parochial point, at a time when the prospect of different income tax regimes between Scotland and the rest of the United Kingdom is becoming a nearer reality thanks to the Scotland Act 2012, have the Government considered how personal service companies may be used to arbitrage tax rates within the UK? For example, have the current Scottish Government sought to discuss this potentially difficult area with Her Majesty’s Government?

Finally, I turn to the use of personal service companies in the public sector. We share the concerns expressed by the noble Lord, Lord Palmer of Childs Hill. The Government response to one view in this area raises more questions than it answers. As I read it, the Government are committed not only to tackling tax evasion, as all Governments must be, they also recognise the inappropriateness of public sector appointees using personal service companies. The Treasury review of these persons’ tax arrangements issued a recommendation that such persons should normally be on the payroll. Is it possible to state what the effect of the recommendation has been on such appointees’ tax arrangements? Broad-brush answers will do. Further, at paragraph 2.86 of the response, we note that so-called satisfactory assurances were received from 1,940 contractors within departments. Can the Minister indicate the broad nature of those assurances and why they were regarded as satisfactory?

This has been a useful debate in shining a spotlight on this area, which, as all speakers have said, is both difficult and important. The balance between encouraging enterprise and defending the Exchequer’s revenue should properly be kept under continuing review. As the noble Baroness, Lady Noakes, observed, this is unfinished business, and we agree.

19:12

[Lord Newby (LD)]

My Lords, I thank all noble Lords who have taken part in the debate. It is correct to say that, with the exception of the noble and learned Lord on the Opposition Front Bench, all noble Lords who have spoken served on the committee, and therefore I can doubly thank them for the work they undertook on a very short timescale. As the noble Lord, Lord Myners, pointed out, this is an extremely complicated area, while my noble friend Lord Higgins made observations on the procedure in terms of the pace of the committee’s work. The Government response, however inadequate some noble Lords feel it to be, and the speed with which we have been able to hold this debate are a good example of your Lordships’ House scrutinising how we attempt to implement public policy, and I hope that it will be followed more frequently in the future.

I hope that I am able to reassure the House that the Treasury and HMRC take this report and the issues it raises extremely seriously. There is one area where I am not going to be able to satisfy noble Lords, which is their understandable irritation at the non-attendance of a Treasury Minister. The experience of your Lordships’ House of Treasury involvement in the work of its Select Committees over a number of years has been variable. When I served on the Joint Committee on the draft Financial Services Bill, not only did the Chancellor of the Exchequer of the day refuse to turn up, he refused to allow his officials to turn up and he refused to allow them to send a written response to our questions on the administrative workings of tax on the basis that it would undermine the sovereignty of the Commons in that area. We thought that that was very unsatisfactory at the time. I can assure the House that I drew this committee’s views to the attention of colleagues in the Treasury before the debate and that I will do so again.

However, I think that both the Treasury and HMRC take the work of the committee very seriously and they are acting in response to that work. In some cases the committee has looked at and made recommendations in areas where work was already under way, but some of the recommendations made by the committee are being taken forward where work was not under way, specifically in relation to the questions around personal service companies’ self-assessment returns and employers’ returns. As a result of the work of the committee, these are now being reviewed with stakeholders with a view to making any necessary changes as soon as practicable. That is a concrete example of the influence of the committee in getting real change.

The committee did not confine itself just to the use of personal service companies, but looked more widely into the engagement of workers in today’s labour market, and that was reflected in a number of speeches in the debate. The UK has one of the most flexible labour markets in the world and we recognise that that is one of the reasons why our economy has been more resilient and has recovered faster than many other western economies. We recognise that personal service companies are a key feature of this flexible and dynamic labour market and will continue to contribute to its growth. Regrettably, however, as noble Lords have made clear, there are those who see such arrangements as an opportunity to avoid paying their fair share and there is abuse of the system, not least among those on low pay who are often unaware of the situation in which they find themselves. Clearly, that is not right. The Government have provided a clear mandate to HMRC to ensure that everyone pays the right amount of tax. One of our biggest challenges is effectively to tackle avoidance while encouraging genuine enterprise. We have introduced a plethora of measures to encourage enterprise, but at the same time we have legislated to stop avoidance and help HMRC bring money in more quickly. Since 2010, we have introduced 42 changes to tax law in order to close loopholes and we have invested an extra £1 billion in the area of preventing and deterring tax avoidance, thus bringing in billions of pounds for the Exchequer.

IR35 is the central theme of the committee’s report. It is one of the best known, least popular and least well understood pieces of anti-avoidance legislation. HMRC has been working hard to change this, and I shall come on to it later. However, the real starting point of the debate is the analysis carried out by HMRC on the estimates, which showed that more than half a billion pounds of Exchequer receipts would be at risk were IR35 to be abolished. The noble Baroness, Lady Noakes, said that she was sceptical about the figure, as undoubtedly was the noble and learned Lord, Lord Davidson of Glen Clova. I am not sure whether my noble friend Lord Palmer dismisses the figure altogether, because he is not normally a man who likes to throw away 550 million quid. The assessment made by HMRC is robust—to use the word of the noble and learned Lord, Lord Davidson—but inevitably there are challenges around estimating the deterrent effects of anything. While we can quibble over whether it should be £550 million or slightly more or slightly less, the bald point is that I do not think anyone who looks at this would doubt the broad conclusion that hundreds of millions of pounds of revenue depends on keeping IR35 in place, and that is why we are going to do so. All our past experience has shown a number of UK incorporations to be very sensitive to available tax incentives. Therefore, we believe that there continues to be a compelling need for this legislation.

In 2011, the Office of Tax Simplification recommended that HMRC improve the administration of IR35. Since then, HMRC has been working with stakeholders, including the IR35 forum, to help people understand the legislation, to reduce the burden on compliant businesses and to address many of the concerns that were subsequently raised by the committee. The committee concluded that the guidance issued on how the system works was “far from satisfactory”. A comprehensive review of the guidance has been undertaken and new guidance was published one week ago following widespread consultation. We are confident that it will be an improvement.

One area in which HMRC has been making substantial changes is how it conducts IR35 inquiries. Many noble Lords touched on this area. I think there has been a certain amount of confusion about the numbers. When it was first introduced, the number of IR35 reviews was extremely high: more than 1,000 in 2002. It then fell dramatically so that in the final year of the previous Government there were 12. That number has now increased to 256, which shows a considerable increase in effort and commitment to ensure that this is not a voluntary area of activity. As we pointed out in our response to the committee, three new compliance teams were created in April 2012, and a fourth team has been put in place over the past year to further enhance HMRC’s ability to respond to IR35 risk.

Is this enough? How do you decide on the very many competing claims for the use of HMRC compliance staff? The answer is that HMRC has to do a risk assessment across the whole range of its activities, which attempts to work out how best to deploy the resources at its disposal. In this area HMRC has looked afresh at the way in which it assesses risk to enable it better to target those who deliberately flout the rules. The number of people involved and the number of cases that have been taken reflect the fact that it has decided to give a greater priority to this issue.

However, HMRC recognises that there is more to be done. In partnership with the forum, it is currently reviewing how it administers IR35 in the round, including the compliance strategy. HMRC and the forum will publish a joint report, with recommendations, in the autumn. A number of noble Lords referred to the forum. Its role has developed since its inception so that its external members now feel that they are driving forward its agenda. It is looking at the contract review service, about which there have been a number of complaints, and the business entity tests, which are being reviewed and changed, very much with the full participation of the forum.

As noble Lords have said, when it was introduced IR35 legislation was looking at people on relatively high salaries and in the professions. Clearly, there has been a big change over the past 15 years in that a very large number of low-paid workers have been brought within the net of personal service companies. Some of these low-paid workers are being forced or enticed into structures, including personal service companies or umbrella companies, and they are clearly in many cases unaware of the full implications of those arrangements.

In this year’s Finance Bill, we tackled a particular model that was being used to engage workers as self-employed when in reality they should have been employees. I hope that demonstrates that we take this area extremely seriously. As part of our concern about how low-paid workers are treated, we are also committed to increasing compliance with the national minimum wage. HMRC actively targets employers who flout their responsibilities and investigates complaints against them. Just last month, a number of those who failed to pay the national minimum wage were named by HMRC for their failure to comply. We have quadrupled the maximum penalty payable by employers who break the law in respect of the minimum wage to £20,000 and we will be legislating in this Session to increase the maximum penalty per underpaid worker to £20,000. So we are doing quite a lot in that area.

However, we recognise that there are a number of problems in ensuring that low-paid workers are aware of what is happening to them and of their rights. At one level, this is a question of joined-up government. Obviously, HMRC is not the only arm of government dealing with people in this situation. HMRC is working with the Gangmasters Licensing Authority, the Home Office and BIS to address the issue of low-paid workers’ rights, in particular in relation to their employment status, how they are engaged and how they are paid. HMRC has a pay and work rights helpline, which provides individuals with a confidential route to discuss these issues. We have updated the guidance on employment status and HMRC’s employment status indicator tool, both of which are accessible online, along with two explanatory factsheets. HMRC is now working more closely with BIS on how to improve the dissemination of the relevant guidance.

I was very taken by the comments of my noble friend Lady Bakewell about people who are really at the bottom end of the income and opportunity ladder, who are often illiterate. Clearly, how one reaches people in that situation is extremely complex and difficult—they are certainly not going to use the employment status indicator tool, whatever they do. We recognise the need to put further effort into dealing with that issue.

A number of noble Lords expressed concern that the Government were not taking enough action in respect of the public sector and off-payroll workers. I think that is rather unfair. The Chief Secretary made it clear to all departments that they needed to limit the length of time any off-payroll worker was employed to six months or less. There has been a review of how this has operated, which has led to action being taken against two departments, the Department for Transport and Defra, which failed to bring senior executives on to the payroll. Defra was fined £102,000 and the Department for Transport £398,000. Real action is being taken and I suspect that the Permanent Secretaries of those departments, as accounting officers, do not like the fact that they are being fined by the Treasury for not doing what they are supposed to be doing, and that this will prove to be a good corrective.

Questions were asked about local government and the devolved Administrations. With regard to local government, the Secretary of State for Communities and Local Government wrote to the LGA to highlight the issue and has published guidance on it while the Chief Secretary to the Treasury has written to the devolved Administrations in similar terms, so we are taking serious action to ensure that the public sector acts to stop some of the abuses at the top end. With regard to what happens further down the scale, should the public sector have a very strong presumption against using personal service companies for people who earn less than the current reviewable amount of £220 a day?

[Lord Higgins]

Where is the money to pay the fine coming from? Is this simply a transfer from one part of the Government to another? Is it an appropriate sanction? Should someone not be fired?

[Lord Newby]

Well, it is a transfer of money from one part of the Government to another, but this is hardly surprising since it is one part of the Government that has transgressed a rule set by another part of the Government. As for firing senior civil servants for not having kept this properly under review, I am rather tempted by the suggestion—but if it were a principle, we would rapidly find that there was a depletion of civil servants, not specifically in this area but from a whole raft of other areas where there may have been the odd transgression that was not stamped down on quickly enough.

The noble Lord, Lord Davidson, asked an extremely interesting question about the Scottish situation and the relationship between the UK and Scotland, and asked whether there had been discussions with the Scottish Administration on this issue. I am not absolutely sure but I am almost sure; I suspect that there have not been.

This debate has confirmed that personal service companies play a vital role in the UK economy. However, there are those who seek to exploit such arrangements to gain a tax advantage. Because of this, in our view there is still a clear need for IR35. However, there is still more to be done in improving its administration, and HMRC, in partnership with the IR35 Forum, is working very hard on this. We welcome the committee’s recommendations, which will help with this very important work.

[Lord Palmer of Childs Hill]

Before the Minister sits down, I wish to take up the point about the £500 million saving, which the Minister said I had little regard for. My regard is that it is mythical—there is no proof of it. If HMRC has proof of this, will it bring it forward? The problem with a deterrent is that it is hard to tell what you have deterred and how much you have gained. If there are people who should have been in IR35 and were then brought into it, specific details would be available of the money that had been recovered. I say to my noble friend the Minister that I have no confidence in the figure of £500 million; if I had, I would not have raised the matter.

[Lord Newby]

My Lords, I think the point is: what would happen if the restraint were lifted? Would individuals pay more or less tax? HMRC has looked at the behaviour of individuals in a whole raft of other areas where it has a lot of experience, and has drawn what it believes to be reasonable conclusions—which I have looked at and which seem reasonable to me. By definition, though, you cannot absolutely pinpoint how much evasion of tax you have deterred; that is impossible to do with any degree of certainty.

19:33

[Baroness Noakes]

My Lords, I thank all noble Lords who have taken part in this debate today, including the two noble Lords on the respective Front Benches who did not have the privilege of taking part in the committee. My committee members did not disappoint me today; I expected the debate to be of high quality, and indeed it was. I repeat my thanks to them for their work.

I would like to pick up two points in response to what has been said today. The first is in relation to the Treasury’s co-operation with the committee. If this practice were allowed to become more widespread, it would be a “get out of jail card” for all Ministers whenever they did not fancy appearing before a Select Committee because they did not much like the subject matter. The Minister referred to the Economic Affairs Sub-Committee on the Finance Bill in the era of Mr Gordon Brown. It is not the practice of Treasury officials to shun the committee now, and we would have been happy had Treasury officials come to us. This remains an egregious example of discourtesy to the House in general, and I feel it necessary to record that again.

My second point is about the lower paid. I had not expected the personal service committee to get into the area of the lower paid; I thought that this was about IT contractors and people who could look after themselves, and was just about tax avoidance. I think that we were all shocked by the evidence we heard about the way in which corporate vehicles were being used for lower-paid workers, many of whom did not have language skills, possibly had other kinds of learning problems, and did not understand what they were getting involved in. I do not think that the Government have really understood the nature of the concerns here. Their response is a very reactive one: “We’ll have it online”, or, “We’ll have a telephone helpline and you can come and get it”. That response does not address those needs and I do not think that they recognised them, although the Minister himself appeared to understand them more. I would like to think that this area would be examined again.

I also note that our recommendation was to get the Low Pay Commission to look at this area. We took the advice of the noble Lord, Lord Myners, who I am glad to see in his place again. He is a former chairman of that commission and he assured us that this was exactly the kind of work that could be done under its auspices. The Minister gave us no response to that today, so we just have the very unsatisfactory answer that lies in the Government’s official response.

Personal service companies seem to be here to stay. So, therefore, are many of the issues that were raised in our report, from the big questions raised by my noble friend Lord Stewartby such as, “What is it all for?”, to, “Does this calculation of £500 million or more really stack up today?”, and, “Is all that worth the burdens that we are putting on what are effectively small businesses in our society?”. These issues will not go away. I am not sure that the suggestion that we reconstitute the committee would find favour with all my fellow committee members, but I am sure that some mechanism will be found in future to return to these issues.

Motion agreed.