Off-Payroll Working (Economic Affairs Committee Report)
Lord Bridges of Headley
That the Grand Committee takes note of the Report from the Economic Affairs Committee Off-payroll working: treating people fairly (1st Report, Session 2019–21, HL Paper 50).
Lord Bridges of Headley (Con)
My Lords, I am delighted to open this debate on the Finance Bill Sub-Committee’s report Off-payroll Working: Treating People Fairly. I will try to be quick because I gather that we are under a bit of time pressure. Before I go any further, I thank my noble friend Lord Forsyth, who was chair of the Sub-Committee when the inquiry took place, our excellent clerk, Tristan Stubbs, and our advisers, Robina Dyall and Sarah Squires, all of whose input was invaluable.
Onlookers might be surprised that we are debating in 2022 a report written in 2020. They may think that its findings have passed their sell-by date but they would be very wrong, for it anticipated many of the problems that might result from extending the IR35 reforms into the private sector. Our committee concluded that the approach to this issue—that is, off-payroll working —should be certain, simple, supportive of growth, administratively straightforward, enforceable and, above all, fair. We found the current approach lacking on all counts.
In light of Covid, the Government wisely delayed extending the rules to the private sector until April 2021, so the committee recommended that the Government use that time to rethink their approach, learn lessons from the public sector’s rollout and address issues that our inquiry unearthed. At the end of last year, we conducted another inquiry into the implementation of the rules, and we wrote to the Financial Secretary with our conclusions, to which she replied. I thank her, her predecessor Jesse Norman, and the Treasury and HMRC officials for all of their co-operation. Therefore, now is a good time to take stock of our report and letter-writing and see where we stand. I will draw on both the report and the letter that we sent to the Financial Secretary.
My first question is on whether businesses and contractors are finding that the new rules are simple, are administratively straightforward and offer certainty. We flagged problems regarding HMRC’s tool for checking employment status for tax, CEST, in 2020. Last year, we were told that it was still “not fit for purpose” and did not provide accurate results. The CBI said that, although businesses had found CEST helpful, where HMRC guidance and case law diverge, businesses are left in a position of being told that they can rely on an outcome that would likely differ from that which would be handed down by a court. CEST cannot and should not be a substitute for law. Although it cannot be expected to cater to every scenario, a 20% undetermined rate means that a significant number of people need additional support to identify their status. This support must be improved.
Furthermore, the continued absence of questions on mutuality of obligation within CEST means that many people affected by the off-payroll rules do not have confidence in the accuracy of the results. Only today, we see the lack of clarity on this point highlighted by another current case between HMRC and Atholl House. This uncertainty has contributed to unfair employment practices, blanket bans and decisions. We heard that 21% of freelancers had reported that their client had simply determined all engagements as inside IR35, a blanket assessment. Although the Financial Secretary said it was legitimate for companies to decide against using contractors working through personal service companies, the committee concluded that it is regrettable if such decisions are driven by tax rather than commercial considerations. Tougher compliance action is needed where engagers are effectively evading their obligations under the rules to make individual determinations.
Then there is the issue of appealing against a state of determination. Research from IPSE showed that more than three-quarters of those who disagreed with their status determination challenged the outcome and, of those, 79% reported no change as a result of the challenge. The National Audit Office has said
“there is not a clear legal route to appeal further. If workers believe they have been taxed incorrectly, their recourse is to use HMRC’s self-assessment and NIC reclaim routes.”
On appeals, HMRC told the Public Accounts Committee:
“If everyone co-operates and there are no challenges, it will take a few months. If it is complex and there are multiple reports, it can take years”—
years, my Lords.
So, in response to my first question, this system is not simple, not easy to administer and does not offer certainty. Let me ask a second question: are these changes supporting growth? Here, I freely admit, it is difficult to disentangle the impact of Covid, Brexit and other macro events. But in the words of one of our witnesses, the UK’s reputation as
“an easy place to start up”
businesses has been replaced by a “huge compliance burden” and a “punitive tax regime”. That is why research into the impact of the measures must consider changes in the UK’s labour market and the broader economy. The committee said that the scope of this research should be more comprehensive and invite input from affected contractors as well as engagers and intermediaries.
Specifically, the actual cost of these changes on business is still unclear. HMRC estimated the one-off administrative cost incurred by business in preparing to operate the off-payroll rules would be £14.4 million, with a negligible ongoing impact. The committee challenged this estimate, as witnesses judged it to be too low. HMRC revisited its estimates and increased that one-off cost to £19.7 million, with an ongoing net saving of £0.3 million. The CBI told us that that £19 million is still an underestimate, and the NAO agreed that HMRC might have underestimated the cost to employers. So, to answer my second question, there is no evidence that this change is supporting growth.
I turn to the question of whether these changes are making the system fairer and whether they are enforceable. For contractors assessed as within the off-payroll rules by an engager, we were told there is likely to be a financial cost, given the difference in employee tax and NIC treatment compared to contractors. We were told that a key issue is employer NICs: how the cost of contributions is allocated between the engager and the contractor.
The CBI and the Federation of Small Businesses explained that people in the more skilled end of the market are more able to ensure costs are paid by the engager. However, for the lower skilled end of the market, it seems many engagers are passing costs on to contractors via reduced rates of pay. It is these lower paid contractors who are falling into the clutches of so-called rogue umbrella companies. In our 2020 report, we warned of the risks presented by umbrella companies and the likelihood that their use would increase when off-payroll rules were extended to the private sector. Look at what has happened: HMRC estimated that 100,000 individuals were working through umbrella companies in 2007-08, but that by 2020-21 this had increased fivefold to at least 500,000. External commentators estimated the figure to be 600,000.
No doubt some of these umbrella companies perform a useful function, but the committee was told there is
“very clear evidence that it”—
IR35—
“has driven up tax avoidance.”
Here lies the tragedy and irony of this sorry saga. This whole policy was meant to tackle tax avoidance, yet it seems that it is giving birth to a new cottage industry of tax avoidance.
I have not the time to go into the measures that HMRC is taking to tackle rogue umbrella companies, but the sub-committee was obviously concerned and remains concerned about this and that the off-payroll rules are encouraging the insertion of unnecessary intermediaries into the supply chain, increasing the opportunities for rogue operators. A nagging question is whether HMRC is focused too much on non-compliant contractors and not enough on individuals and others who set up these rogue companies, often offshore. That is why the committee has said that the Government should commit to a date for introducing legislation to create the proposed single enforcement body to regulate umbrella companies.
As I am conscious of time, I shall end with a final question: are these changes, and the entire IR35 edifice, achieving their overall aims and objectives? It was said that these changes would protect the tax base. HMRC assessed that the loss of tax from non-compliance with IR35 could cost £1.3 billion. It now states that improved compliance raises much more—£4.1 billion in 2024-25—so it appears that revenue raising, not simply protecting the tax base, has become the main driver of changes.
The second objective is the word in the title of our report—fairness. Everyone doing the same job should pay the same tax. We agreed with this in principle, but the assessment of what is fair cannot be restricted to just tax; it must also apply to rights. It is unfair to tax individuals as employees while denying them the rights of employees. That is why we recommended that the Government take forward proposals set out in the Taylor review, which considered tax, rights and risk together. Failure to address these issues in the round has created the muddle we are in today. Listen to what the Office of Tax Simplification said way back in 2015. It said that
“the tax system is still in many ways stuck in an out-of-date mindset: of categorising workers as either employees, firmly on the payroll, or self-employed … This made sense in the 1950s and 1960s but the huge growth in freelancing as a way of life (and work) doesn’t fit readily into this traditional model.”
The need to properly define employment rights for the purposes of both tax and employment is now ever more urgent. Two years on, nothing has been done about this. We are told that the Government will set out more detail in due course—Whitehall speak for “we don’t know when”. The report’s title was Treating People Fairly. For a Government who want to level up, they are doing the reverse. They are perpetuating a system that is uncompetitive, complex, burdensome and, above all, unfair. Fundamental change is needed. I beg to move.
Baroness Noakes (Con)
My Lords, my noble friend Lord Bridges has given us a masterly summary of the work of the Finance Bill Sub-Committee on off-payroll working, and I pay tribute to his chairmanship of the sub-committee’s latest look at off-payroll working. I agree with everything my noble friend said, in particular on CEST, which is widely regarded outside HMRC as unsatisfactory.
I was a member of the Finance Bill Sub-Committee for its latest update work, though not when the initial off-payroll working report was produced. I did, however, chair the Select Committee of your Lordships’ House on Personal Services Companies, which reported in 2014 and was the first time your Lordships’ House ventured into this difficult territory. When we prepared the 2014 report, we had a very unsatisfactory engagement with the Treasury, which flatly refused to provide either Ministers or officials to give evidence, and the Treasury response to our report was disappointing, to say the least. I concluded the debate on the report in your Lordships’ House by saying that the issues would not go away and that your Lordships’ House would return to them, and I am very grateful that the Finance Bill Sub-Committee has enabled the House to do just that. I am also pleased that the Treasury has engaged with the sub-committee this time—though that engagement does not mean, however, that the Government have fully engaged with the issues.
In principle, I support the Treasury’s efforts to ensure that tax is not avoided on earnings if they are, in truth, disguised employment; there is a genuine fairness issue here. Work which is identical and carried out in substantially the same circumstances should be taxed in the same way. The problem is that the solutions the Government have used do not achieve fairness in an holistic way, as my noble friend Lord Bridges has said. In particular, the latest set of actions that, in effect, outsource IR35 compliance to employers has produced a new form of unfairness—namely, the creation of a class of zero-rights employees. These are contractors who are not technically employees of the engaging employer but are brought on to the payroll for tax purposes. They pay tax as employees but have no rights as employees to such things as maternity pay, and this is most definitely not fair. The Government have allowed this to happen because they focus on tax yield at the expense of seeing the issues in the round.
It was good when the Government commissioned the Taylor report into modern working practices, but very disappointing that, since the report came out in 2017, it has been consigned to the long grass. The Financial Secretary’s latest letter to my noble friend Lord Bridges following the recent Finance Bill Sub-Committee’s work confirms that it remains solidly in the long grass.
The Government’s sole focus on collecting tax has also resulted in employers pushing workers into the use of umbrella companies, as my noble friend said. This avoids them taking those workers on to their own payrolls. As we heard, there has been a fivefold or sixfold increase in the number in the last 15 years, with 500,000 or 600,000 individuals working through umbrella companies. While there are some well-run and responsible umbrella companies, there are also some very bad ones, and there have been egregious cases of tax avoidance associated with them. Many of the workers in this category are low-paid workers, not the higher paid IT contractors; these are relatively low-level manual workers. These people have a relatively dim understanding of their worker entitlements and rights in any event, but they are pushed into this model. The Government’s priorities ought to be to ensure that they have appropriate employment rights and protections, but the Government have been focusing on tax collection and that alone.
The call for evidence last year was a belated attempt by the Government to wake up to the problems in this area, but I am not sure that I have confidence that there will be a good outcome from that. In other instances, employers have either declared that they will not hire contractors or have made blanket decisions that they will put all contractors on to the payroll for IR35 purposes. Some contractors have in turn decided that they will not work for those engagers, and we had evidence that some were now working from outside the UK in order to get away from IR35. The one thing that seems highly likely is that the off-payroll rules themselves have distorted the labour market and may well have diminished the prized flexibility of the UK labour market. The Finance Bill Sub-Committee has urged the Government to undertake research into the impact on the labour market, but I do not have high hopes that the research currently being undertaken will provide definitive answers, based on the Treasury’s response to the sub-committee.
The root of the problem is the foundations on which our tax system has been built. The UK taxes income according to its source and we treat income from employment and self-employment differently and, in particular, have made a conscious decision to tax unearned differently again. The tax system positively incentivises people to work on a self-employed basis and to seek to convert earned income into dividend income via service companies. The biggest distortions arise from the choices that have been made in the design of national insurance, including the new health and social care levy. These are taxes in all but name. There is a fairly big difference between the way in which employed versus self-employed people pay national insurance—the gap is three percentage points in the main national insurance rate—but there is a massive difference in employers’ national insurance contributions. It is now just over 15%, for which there is no equivalent for the self-employed. Therefore, employment income can attract a tax rate of 18 percentage points higher than self-employment income, and dividend income attracts no national insurance at all.
Last year, the Institute for Fiscal Studies published a study on taxing work and investment across legal forms. The clear finding was that the distinctions between different forms of income involved unproductive work in policing the boundaries. In particular, in relation to IR35 it said that this approach is failing, and will continue to fail, because it cannot overcome the core problem:
“there is no coherent principle underlying the distinction”
between legal forms.
A fundamental reform of the taxation of income, including national insurance, is now long overdue. It is the root cause of the problems with IR35 and the many types of unfairness that IR35 promulgates. I know that there are no easy solutions and that it will take a brave Chancellor to reorient the basics of our tax system, but equally there is no easy answer to the IR35 problem, as the past 20 years have shown. It is time for the Treasury to be bold.
Lord Desai (Non-Afl)
My Lords, I served on this committee. I was specially drafted to serve on it and it was a great experience, because I found it very difficult to understand the problem. I was aware that various people had suddenly declared themselves to be self-employed which I knew to be completely fraudulent, especially when Ken Livingstone, my socialist friend, decided that he could avoid tax by becoming self-employed. I always regarded this particular thing as a problem of fairness. It is quite clear that if you give people half a chance they will invent themselves all sorts of ways of avoiding paying tax. As far as I am concerned, that is a tax avoidance problem.
Obviously, there are different kinds of income. Some are more uncertain than others. It seems to me that the principle is that you treat more uncertain incomes differently from incomes that are more or less certain. All my life I was a lecturer—or a professor, at LSE. My income was known, I had to pay my PAYE and that was that. However, there are people who are actors, musicians or playwrights or whatever and whose income is uncertain, so to some extent I think what we need here is a preliminary anthropological study by the tax authorities into how different people make their money in different ways. You have to have genuine uncertainty of employment to be able to qualify as self-employed. That seems to me to be absolutely standard.
Actually, while I was doing this work, the Equity trade union contacted me and asked if I could give my learned opinion on this matter. I said that I had absolutely no idea how to tackle this problem, because it is not the size of income but its uncertainty that determines the fairness—or unfairness—of the tax system.
I still consider that we should find a way of distinguishing between different incomes, not so much by size but by variability over a period. We should distinguish people who are not sure of employment, such as actors or musicians, who may make a lot of money while they are employed but whose employment is not guaranteed from month to month, from people who have absolutely no reason to think of themselves as self-employed because they are just contracting themselves differently with an employer and have a perfectly well-known and certain contract between them and their employer. So, to the extent that this is a tax avoidance scheme which helps both the employer and employee, it is a very damaging phenomenon, because it makes people doubt the fairness of the tax system.
All I can say about this matter is that I still find it very hard to get to grips with this problem. As and when HMRC, or whoever else, wants to do a different study, they ought to do an empirical study of different kinds of employment and incomes and genuinely establish the variability of employment prospects and income. They are the two aspects in which employed people differ from the self-employed. If we can establish that distinction in some legal way that is guaranteed not to be evaded, I think we can set up this concession that some people can be treated differently for tax purposes.
There are problems with employment rights and all that that involves as well, but I presume that it is the variability of employment and income likely to be earned when you are employed that are the main things. That cannot be dealt with without a proper anthropological survey of what kinds of employment people have. To that extent, as and when anybody wants to do research again, please let them do it properly. I know that there is the Taylor review, but we need something more than that. We need proper anthropological research into what kinds of employment and incomes there are in this economy.
Lord Balfe (Con)
My Lords, I thank the noble Lord, Lord Bridges, for instigating this debate. I did not serve on the committee, and this is not my area of expertise, but I would like to offer a few thoughts. It seems to me that this is a very classic case of when the market works out a solution to or a way around a problem that has been given to it by the Government.
The key thing here, of course, is the figure in the report that the number of individuals working through umbrella companies has increased from 100,000 to 500,000 in the last 15 years. This has clearly happened because it is of value to work for an umbrella company, although the report also makes the point that
“many contractors had been left in an undesirable ‘halfway house’: they do not enjoy the rights that come with employment, yet they are considered employees for tax purposes. In short, they are ‘zero-rights employees’”.
This is the problem.
As we come up to a new Queen’s Speech, now would be an ideal time for the Treasury to try to get to grips with the whole problem of how you treat people who are earning money from others. The problem is not just as outlined here; it is endemic in society, and I have come across it many times. I wonder whether other noble Lords have—I would be surprised if they have not come across the tradesman who says, “Cash only, of course”. I do not know of a single cleaner in the city of Cambridge, where I live, who pays tax. My wife had a very interesting conversation with a Polish cleaner whose child had gone into hospital. She said to the cleaner, who was a very nice lady, “Who do you think is paying for this hospital?” The cleaner said, “The Government”, and my wife said, “No, we are, because you are not paying any tax on the money that you get from us”. There is this great gap.
One of the things that not just the Government but the country has got to get to grips with is the way in which people are remunerated. I remember when I was an MEP and we had a nanny, and I was advised very firmly by the Labour Party that I should make sure that I paid tax on what we paid the nanny, because the one thing it did not want was a scandal involving an MEP who was hiring a nanny and not paying tax—so we paid tax. Most of our friends were absolutely astonished; they just could not believe it, until it was explained to them that it was because the Daily Mail might get hold of it and we would be all over the papers.
In this country, we run a system in which the evasion, frankly, of tax is built in and widely accepted. We need to look at this, keep the efficiency of off-payroll payments under review and make sure that the legislation is fair. But we also need to look at the Taylor report, which is what brought me into this, because there are a number of trade union issues that need to be looked at to ensure that workers are being given a fair crack of the whip. This has to be done by legislation: you cannot go around the country saying to individuals, “You must do this”, but you could get them to sign a form saying that any payments they have made have been declared to the Revenue. Alternatively, you could get them to sign a simple form for taking tax.
But my view is that, unless we tackle the very basis of the problem, gradually there will be another way around the situation, and another. It will be rather like our garden hose: every spring, when we turn it on, somehow, without any help from us, it seems to have sprung four or five new leaks, which then need binding up—and, by the next spring, you have four or five more. That is what our tax system seems rather like at the moment.
I ask the Minister, who I realise is strongly constricted in what she can say today, at least to say that she will go back to the department and see whether we can have a root-and-branch look at the ways in which remuneration is paid and rights are given to and taken away from people. It is a matter of basic fairness that, if you live in a society, you should pay your taxes and you should all get the same benefits. It should not be possible for employers to get out of giving benefits, in a fiscal way, because it is good for them financially not to give them to the people who are doing the work.
There is a big challenge ahead, a much bigger one than some would like to admit, but one that has been left to lie dormant for probably the last 20 years. This is not a matter of this Government and this Prime Minister; it has not been faced since the Blair Government came to power. It was resolved to make it easy for people to work and move around, and that laxness has been in the system for a long time. I hope the Minister assures us that she will try to make some reforms.
Baroness Bowles of Berkhamsted (LD)
My Lords, I was a member of the Economic Affairs Committee and the sub-committee at the time of this report and I mainly want to address those principles. I agree with the analysis of what has happened since, which has already been brought forward by other members, referring back to the principles. The problem is that IR35 has not worked from the start and, as the noble Lord, Lord Bridges, explained, it is still not working fairly.
A key issue in the IR35 space, as has already been said, is non-compliant umbrella companies. The Financial Secretary to the Treasury told the committee that HMRC recognised umbrella companies as a strategic risk in its compliance plan. Note that “compliance plan”, its tax-collecting plan. It is clear that HMRC had only a tax-collection perspective, rather than what might be compared to a consumer or worker protection perspective and fair treatment.
We should not forget that non-compliant umbrella companies brought us the loan charge, effectively scamming people. How HMRC handled that is still among the most egregious injustices of recent times. Its treatment was tantamount to, “It doesn’t matter that you were, in effect, swindled; here is your extra tax bill because we cannot find the swindler or the client company, so it is all on you”. HMRC caused ruin and suicide by the intransigence of its perspective. That is unforgivable.
When it comes to IR35, and individuals and small businesses in particular, there is a valid comparison with consumer protections when the biggest financial risk to which individuals are being exposed is around their work, how they are paid for it, and when employment law and its benefits are not applicable. But then, you do not get the same kind of protection that you would, for example, if you put that amount of money at risk in a financial service fund.
Against that background, I would like to know more about what the Government are doing to ensure the quality of umbrella companies. With scamming and fleecing active in this area, amplified by the rules on recovering tax, a step change is required. Many more people are looking to umbrella companies to sort out their compliance and IR35 issues, as others have said. It is easy to find the adverts. This morning, I found an umbrella company promising compliance solutions, keeping the same Ltd status and income, and carrying an ERA certification mark. Can it be trusted? Is it right to rely on a private certification organisation anyway? Do the Government endorse that and should there not be more regulatory protection around umbrella companies? They are clearly responsible for the creation of the leaky hose that the noble Lord, Lord Balfe, described.
HMRC has looked only at tax and NI contributions, not at rights, responsibilities, risks or benefits. It rejected a new kind of body, as suggested in the Taylor review, but then created one by carving out an “employee just for tax purposes” that brings manifest unfairness to the individual and condones undermining employment protections. The HMRC approach also seems to miss the whole picture about risk management and particularly how smaller and new businesses get started and grow. They will be caught before they even have lift-off.
Determinations focus on tests, such as the red herring of mutuality of obligation, which is a description—effectively, a definition—that can apply to any contract, whether of employment or not. That is a fact even admitted in HMRC’s Employment Status Manual. What else does the contract do other than define your mutual obligations to one another, whatever it is about? Other tests such as substitution and not relying on the skill of a particular individual fly in the face of how businesses and reputations are established in the professional field, and certainly discriminate against microbusinesses, start-ups and sole traders.
I am not sure how some businesses are supposed to get started with this hanging over them. I founded my own business from scratch and operated it for 30 years, but this would have stopped me in my tracks, because I started as a sole trader and, believe it or not, on day one or day 10, or in month three, you might get your first client—and whoops! Oh dear, you are an employee.
Other tests are equally absurd. I can see many reasons why things that are prohibited will become desirable. Of course you want a timetable of when you will function, because you want to know when you can offer services to other potential clients you might raise or because you have other matters you want to attend to. But if you have a fixed timetable, they say you are dancing to an employer’s tune. In the real world, there can be other reasons for wanting a more generalised contract. How many of your Lordships have wrestled with some of the rather difficult and complex purchase order systems of many large companies, which make it difficult to keep having a new one for every new project, as HMRC now suggests should be the case? It is much easier and less time-wasting to have an overarching contract that, yes, flexes as you need it to.
I am not surprised by the number of 20% that do not get a decision under CEST, but given HMRC’s track record, I have no confidence that an enlightened and sensitive approach will be taken. Indeed, I would not even be surprised if bonuses were paid for allocating a business to employee status and upping returns. In fact, will the Minister find out the true situation on bonuses paid to those who are dealing with allocations and let me know in writing? I recall being given some very wrong answers about this kind of thing and bonuses given by HMRC when we were discussing the loan charge. Given where we are at, as I said, my greatest concerns are for small and developing businesses, which are given new responsibilities to sort out status and yet are the most likely to be in uncertain, developing and changing positions, having fewer resources and where these tests about timing, location and substitution really do not work.
As a final point, will the Minister explain what work has been done on providing exemptions for microbusinesses and start-ups, so as not to apply tests that are inappropriate and clearly discriminatory to the circumstances? For example, could there be a three-year period of consideration before any assessment and determination starts, or exemptions for small turnover that rules out looking at a building-up phase?
Overall, I still consider the Taylor review proposals better, not least as the Government have not avoided the creation of a different body—no matter that it is hybrid and, unfairly, for tax purposes only.
Lord Tunnicliffe (Lab)
My Lords, I first join in the congratulations for the noble Lord, Lord Bridges of Headley, and the rest of the Finance Bill Sub-Committee on their work in this area.
I am surprised at the extent to which I have been impacted by this debate. I knew peripherally that this was a bag of worms; this debate has brought out what an enormous bag of worms it is. The noble Lord, Lord Bridges, criticised CEST and illegal or dodgy umbrella companies. I found myself agreeing with the noble Baroness, Lady Noakes—I get very worried when that happens, but she is absolutely right. She talked about the Taylor report and this conflict between tax and rights, and the word fairness came through. “Fair” is an incredibly complex issue, and the phrase I took from her speech was “no coherent principle”. That is the issue; you just cannot do it from one point of view.
The noble Lord, Lord Desai, brought in this concept of uncertainty and the issue of start-ups. The noble Lord, Lord Balfe, said that the whole point is that this has to be root and branch and that it is a big challenge. The words I come back to are that it needs an holistic approach. I will say very little more about the debate, but I somehow pray that this issue will not be allowed to go away. Until it is tackled on an holistic basis, it will generate its own industries, there will be lots of people from all sides making it more and more complicated and there will be more and more laws to patch up little points here and there. Any Government, whatever their general political persuasions, should really be addressing this issue and getting back to that lovely idea of trying to see a coherent principle.
Through the sub-committee’s 2020 report and the subsequent February 2022 correspondence with the Treasury, it has held the Government’s feet to the fire. It was clearly right to raise the concerns it did. The trends we are seeing with off-payroll working very much reflect the sub-committee’s warnings.
When the so-called IR35 system was established under the last Labour Government, it was with the intention of ensuring greater fairness in the tax system. It could not have failed more, could it? I think that was not a political failure but a failure to grasp the complexity of it. There had been a steady increase in the number of employees managing to become contractors and enjoying significant tax benefits as a result. As others have observed, the system was designed to identify so-called disguised employees. These individuals may have been working under the same conditions as an employee but avoided certain tax liabilities by entering a contract through an intermediary, such as a personal service company.
For many years, the IR35 determination was made by the contractor themselves. Such a determination is based on several factors and can be complicated, inevitably leading to incorrect decisions. The sub-committee flagged in its original report that the Government’s own “check employment status for tax” tool may not be fit for purpose. Listening to the debate, clearly it is not. As we have heard, the burden for determining whether IR35 rules apply has gradually shifted from the contractor to the fee payer. This occurred first in the public sector, and those reforms have since been extended to the private sector.
The Government were right to delay the extension by a year, citing the pandemic. We endorsed that decision, as to delay gave businesses and individuals more time to adjust in an already uncertain world. However, in truth, the extra year was already desirable, or even necessary, before the pandemic struck. As the sub-committee noted, there was early evidence that the 2017 public sector reforms were not working as intended. I believe we have now reached a total of five Whitehall departments that have admitted incorrectly classifying contractors. These departments—Work and Pensions, Home Office, Health, Justice, and Environment, Food and Rural Affairs—have had to compensate HMRC for their oversights to the tune of around £250 million.
Part of the problem seems to be the use of blanket declarations, which is a topic covered by the sub-committee, but other forces may have been at play too. For example, it may reflect the simple fact that IR35 has become too complicated. If Whitehall departments cannot correctly apply the rules, what hope is there for others?
Earlier this year, the broadcaster Adrian Chiles won a long-standing legal dispute with HMRC. The authority believed that the IR35 rule should apply to his work for the BBC and ITV between 2012 and 2017, but the tribunal disagreed. What assessment have the Government made of that ruling? Can the Minister comment on how much was spent pursuing the case, given that it ran over several years?
Taken collectively, these events raise the question asked by an increasing number of commentators in the light of the rapidly changing nature of the UK employment market: does the IR35 system continue to serve its original purpose?
Other questions raised by the sub-committee, including how to counter the potential misuse of umbrella companies, are by no means new either. There are genuine fears around the exploitation of workers, particularly those on low incomes, as people seek to avoid tax through rogue umbrella companies and, indeed, former employers seek to avoid tax by forcing low-paid workers into these unsatisfactory conditions. Addressing these questions is therefore increasingly urgent. The sub-committee has pointed to a variety of other possible risks and the Government have at least acknowledged the need to understand them better. In her response to February’s correspondence, Lucy Frazer outlined several workstreams which are under way, as well as committing to ensuring that they are conducted expeditiously.
To be fair to the Government, not all the concerns raised in the report and during this afternoon’s debate could have been addressed during the 12-month delay from April 2020. However, should not some of this work have been under way well before that decision was taken? IR35 rules came into force in 2000. Our economy clearly functions very differently in 2022. While the tax system has seen some changes, it has not kept pace with the developments and trends in the employment market. It seems that there is consensus around the need for modernisation and simplification and the problem appears to be with the political will to deliver.
Of course we must consider this topic in the context of the Government’s continued failure on the Taylor review of modern working practices. As others have noted, employment status for tax purposes and status under employment law have long been separated. The Taylor review made some important recommendations in this area. They include the creation of a special category for those who are neither employees nor genuinely self-employed. These people pay taxes as if they are employees but lack many of the basic employment rights enjoyed by others. It cannot be right for certain workers, often those operating in the gig economy, to remain what the sub-committee labelled zero-rights employees. In some instances the courts have acted to grant new rights to such workers. However, as a rule it should be for the Executive rather than the judiciary to confer adequate protections.
Workers’ rights were prioritised in the Conservative Party manifesto, but the Government seem to have forgotten their promises since the election. Addressing some of the loopholes identified by the sub-committee will improve the situation, but so too would bringing forward the long-promised employment Bill. This question may not directly relate to IR35 but, had the Government legislated to improve employment rights, would we have witnessed the recent P&O ferry situation? We await Her Majesty’s most gracious Speech in a couple of weeks’ time, but if reports are to be believed it will not contain anything on tax reform or employment protections.
The Government want us to believe that everything is under control. However, that is clearly not the case if they are repeatedly unable to deal with pressing issues such as these. We await the findings of HMRC’s research but what we really need is a joined-up approach. We must look at these issues in the round and then, crucially, bring forward that long-awaited legislative package. The sub-committee has called for an off-payroll working regime which is simpler, fairer, more straight- forward, properly enforceable and provides greater certainty to all involved. Which one of these wishes can the Government possibly disagree with and what exactly is the hold-up when it comes to achieving that?
Baroness Penn (Con)
My Lords, I thank my noble friend Lord Bridges for securing this debate. He is right that it remains a timely debate, because of the recent extension of IR35 to the private sector, which was delayed by a year due to Covid, and with the update provided by the Finance Bill Sub-Committee in its letter to the Financial Secretary, and because, as I will touch on and as has been touched on in the debate, there are live issues with regard to the implementation of IR35. The Government are committed to continuing to learn lessons as we press ahead with its implementation. This matter is not closed but one where we want to continue to learn and improve on how we do things.
The Committee has also shown clearly that there are a number of issues for the Government to consider. There has been a remarkable amount of consensus on that from this debate. The noble Lord, Lord Tunnicliffe, should not be so worried about agreeing with my noble friend Lady Noakes. I may not like it, but she can often be right.
Let me also thank the Finance Bill Sub-Committee for the time it has taken in making its careful analysis of this important policy area, both in 2020 and in its more recent follow-up inquiry.
I am grateful to noble Lords in this select group today for their well-considered points. Noble Lords are right that the issues we are debating are key for workers and businesses, and of course to the UK’s financial health. Before I respond to specific points raised in the debate, it is perhaps worth taking a step back to remind noble Lords of the reasoning behind the introduction of the off-payroll working rules.
As I am sure noble Lords are aware, these rules have been in place for over 20 years. Ultimately, they aim to ensure that people working like employees but through their own limited company are taxed like employees. Initially, it was for workers to decide whether they were working like an employee and in scope of the rules. However, it became clear over time that individual workers were often not best placed to properly assess their own employment status; as a result, there was widespread non-compliance. HMRC estimated that only one in 10 people who should have been paying tax under the off-payroll working rules were paying the right amount, prior to the reforms. In fact, non-compliance was forecast to have cost £430 million in 2015-16.
As a result, the Government brought forward legislation to change who made the decision on whether a worker met the rules and should pay tax like an employee. The reform shifts the responsibility for determining employment status and ensuring the right tax is paid to HMRC from the individual’s intermediary to the client, which could be a business or a public sector body. The Government started by implementing these reforms with regard to the public sector in 2017, and then, following significant engagement, extended them last year to medium and large organisations in the private and voluntary sectors, where non-compliance had been forecast to reach £1.3 billion per year by 2023-24 if it had not been addressed.
I stress that these changes simply ensure that the rules that have been in place for the last 20 years are actually followed—and that two people who are doing similar jobs, but through different structures, are not paying very different amounts of tax. It is about ensuring fairness and protecting the tax base. It is not about revenue raising, as has been implied at points in this debate. This is not to ignore the wider points—which I will come on to—about the status of employment with regard to tax and rights, which are two different systems, as all noble Lords have noted. This question has been considered by the Government over some years.
The Government have not changed the way in which the genuinely self-employed are taxed. If someone is running their own business through their own company, these rules will not apply to them. The reform does not create a new tax on contractors or change the principles of tax status in any way. It simply moves responsibility for determining employment status to the party in the labour supply chain that is best placed to take it on: employers who already make these assessments for their regular staff on a routine basis.
So far, the evidence suggests that the reform is successfully achieving its primary objective: to ensure fairness and improve compliance with existing rules. As a consequence, it has resulted in additional tax revenue of £250 million in 2017-18 and £275 million in 2018-19—money that has helped to fund vital public services, as noted by my noble friend Lord Balfe. It is therefore heartening that the Finance Bill Sub-Committee acknowledges that these reforms are helping to reduce non-compliance.
However, I recognise that the sub-committee raised further issues. As noble Lords will be aware, last month the Government set out a comprehensive response to the sub-committee’s conclusions and recommendations in its follow-up inquiry into the off-payroll working rules. In that response, we first set out how our engagement work with taxpayers, businesses, agencies and other organisations has been at the heart of our approach to this reform. Indeed, before extending the reform to the private and voluntary sectors, the Government carried out two consultations in 2018 and 2019. We listened closely to stakeholders’ feedback on how the legislation was working and introduced changes that provided more certainty to parties in the supply chain. To answer the point from the noble Baroness, Lady Bowles, about an exemption for micro-businesses or start-ups, we decided not to include 1.5 million small businesses in the reform’s scope. The Government also carried out a further review of the off-payroll working rules in 2020 and have acted on stakeholder feedback by expanding the consequences for those who provide fraudulent information and introducing anti-avoidance provisions.
The sub-committee welcomed the fact that HMRC has learned some lessons from the public sector reform when rolling it out into the private sector. This additional insight has led to a range of important improvements, including adapting HMRC’s education and support to better suit the needs of specific stakeholders and customers. When the rollout of the reform to the private sector was delayed by a year due to Covid-19, we put this extra time to good use by expanding the support offered to taxpayers, businesses and other organisations to help them prepare, and this has continued since the reform’s implementation last year.
The noble Lord, Lord Tunnicliffe, made several points about the implementation in the public sector. He talked about the use of blanket declarations being the most significant reason why the public sector got its determinations wrong. The most common error that HMRC identified through its compliance work with public bodies was the understanding of the impacts of substitution clauses in their contracts. HMRC has worked with the Tax Centre of Excellence to improve understanding in this area. HMRC has not seen any evidence of the widespread use of blanket determinations, which is supported by its internal data and external research. In fact, HMRC compliance activity has found that many public bodies did take reasonable care when implementing the rules. None the less, many lessons have been learned from the 2017 reforms, as I have noted, feeding into the approach that we took in the expansion in 2021.
Another issue raised was the Check Employment Status for Tax tool, CEST. HMRC has spent £1.1 million enhancing that tool to help employers, workers and agencies determine their tax status, following feedback. On the point raised by my noble friend Lord Bridges about a tension between case law and the CEST tool, the tool was rigorously tested against known case law and settled cases and is the only status determination tool for which HMRC will stand by the result produced, provided the information inputted is accurate and the tool is used in accordance with the published guidance. However, while we believe we have responded to some of these points, as I said to noble Lords, monitoring the impact of the reforms is still very much a priority for the Government. We have commissioned external research into the 2021 reform that will gather further information on the effects of the reform on the way contractors are engaged, rates of pay for contractors, challenges with implementing the rules and the effectiveness of HMRC’s support and guidance.
Noble Lords asked whether this research would take into account the changing post-Covid labour market. Indeed, it does ask for information on the reasons for any changes in the use of contractors since March 2021, including Covid. In addition, insights from our evaluation of the 2017 reforms show that the impact is broadly in line with HMRC’s expectations so far.
Almost all noble Lords in the debate raised the issue of umbrella companies. We have seen some evidence since 2017 of some contractors changing the way they provide services, moving to the use of other structures. As noble Lords noted, some clients and contractors will reasonably take the view that direct employment on the payroll of the client, an employment agency or an umbrella company is preferable to having contractors work through their own limited companies. This is expected and perfectly acceptable. None the less, we recognise the concerns about the scope for non-compliance in the umbrella company sector. As my noble friend noted, there is no problem where an individual is working with an umbrella company that is compliant with the rules; it simply means that the right tax is being paid and that the individual may be receiving the benefits that come with employment. But we have published guidance for those working for and with umbrella companies and have also recently completed a call for evidence on the umbrella company market. We are analysing the responses to that call for evidence and, at risk of aggravating my noble friend, the Government will respond publicly in due course.
At the same time, the Government are focused on tackling the promotors of tax avoidance schemes. Indeed, we introduced a tough new package of measures at the Autumn Budget which came into force in February this year. These included new powers for HMRC to freeze promoters’ assets, so they pay what they owe; steps to deter offshore promoters; and legislation allowing HMRC to shut companies and partnerships that promote these dubious schemes.
I am conscious of time. I think the main point of substance that all noble Lords touched on is the difference between employment status for rights and employment status for tax. Noble Lords are correct: those systems are separate. However, officials across HMRC, the Treasury and BEIS work closely to ensure joined-up thinking on common issues. It is worth emphasising that the current employment status frameworks for both tax and rights work for the majority of individuals and businesses. However, we recognise concerns about employment status, and we are considering options to improve clarity, making it easier for individuals and businesses to understand which rights apply to them. We are working externally and across government on how best to address this in a post-Covid scenario.
The work of the Taylor review is an example of the Government considering this question, and while we are progressing on a number of aspects of that review, it is important not to forget that we have already implemented a wide range of its recommendations. We have delivered non-legislative commitments such as launching a holiday pay awareness campaign. We have passed a raft of secondary legislation to boost workers’ rights and deliver the Taylor review recommendations, including by extending the right to a written statement of core terms of employment to all workers and introducing a right for agency workers to receive a key information document when signing with an employment business. I would say that it is right that we do not change the employment law framework until we are sure that any changes will address the needs of businesses and workers in the post-Covid economy. In the meantime, we will continue to take the necessary action to support businesses and protect jobs.
The noble Lord, Lord Tunnicliffe, asked me a specific question about the ruling in the case of Adrian Chiles. While I cannot provide information on specific cases because of taxpayer confidentiality, I should answer his broader point. HMRC has disputed a number of cases regarding television and radio presenters in the courts. Just yesterday, it won two cases in the Court of Appeal, setting down useful principles in such cases. Since April 2019, HMRC has won more than 80% of cases in litigation. Where no other route to resolving issues is possible, it is right that some cases are decided in the courts. In terms of the wider approach, I hope that would be the last place that we want to end up, even though it is necessary in some cases. The noble Baroness, Lady Bowles, asked me a question about bonuses, which I am happy to write to her on—and, indeed, if there any other points that I have not managed to cover.
I reiterate my thanks to all those who have contributed to this debate. I end by emphasising that our changes to the off-payroll working rules have been made with the aim of improving compliance with existing rules and increasing fairness in the tax system. As a consequence, these changes have brought in additional revenue to fund vital public services. However, I reassure noble Lords that we are not complacent. Our approach to these reforms is a collaborative one. Therefore, we look forward to very much continuing the conversation with those affected by these changes, so that we can work together to build a tax system in which everyone pays their fair share.
Lord Bridges of Headley (Con)
My Lords, I thank my noble friend for that response. Indeed, I thank everyone—this little band of us—who has debated this topic. It is rather appropriate that we are meeting in the Moses Room, because I somehow feel that IR35 has become a tablet of stone for the Treasury and HMRC. I fully accept what my noble friend says: there are some sort of scratchings or graffiti on the tablet of stone that have made alterations here and there, but it essentially says that we must not change IR35 in a profound way.
The problem that my noble friend grappled with—I was not expecting her to announce grand changes in tonight’s debate—is that, as all of us have outlined, the underlying unfairness of this system remains. Let me remind everyone of what the committee concluded:
“It is unfair that contractors within the rules are treated as employees for tax purposes but do not qualify for employment rights, thus creating a class of ‘zero-rights employees’. The Government is replacing one unfairness with another.”
That is the fundamental truth that we have to confront and why we have to see change. I fully accept that aspects of the Taylor review are being implemented but that is not enough, and we have to grip this. Indeed, it is even more important that we grip this post Covid because of the need to have a flexible workforce.
I do not want to delay everyone with lots of changes but to make just two points. The noble Lord, Lord Tunnicliffe—he is my noble friend tonight, because we agree on this—said that this policy could not have failed more. I was really struck by that; it is a very interesting point. I accept that the Government made changes to IR35 before implementing it in the private sector, in light of what we saw in the public sector, but let us just understand what has happened in the public sector.
The noble Lord, Lord Tunnicliffe, mentioned the figure of £263 million. That is the amount owed or expected to be owed by government departments for failing to administer the reforms correctly. That is an eye-watering amount of money. What do we already know? HMRC told the Public Accounts Committee in the other place that key personnel in those departments did not understand the contractual framework they were operating in and how they were engaged as the contractor in the labour market. The NAO found that half of all respondents found the reforms difficult to comply with. It also found that
“public bodies have reported incurring additional costs … and challenges in recruiting or retaining contractors … Public bodies we interviewed explained that they had dedicated a lot of ongoing resource to employment status determinations, such as full-time staff, supporting teams and review panels.”
This is a problem we are already seeing in the public sector, and we are now beginning to see what it is meaning for the private sector. I am delighted that my noble friend says there will be research on this, because it is well overdue. I make just one point. Computer Weekly showed that the number of self-employed is falling fast. It has gone from 130,000, or thereabouts, in 2016-17 to 97,000 in 2020-2021. The impact on the nature and shape of our workforce is quite profound, so we need that research and we need it fast.
As my noble friend Lady Noakes and others pointed out, this is having a real impact not just on professions at the high end of the workforce, the more skilled, but on those who are on low pay, the people who are being hit really hard right now by the cost of living. I very much hope that we will learn those lessons and that the Government will publish that research very quickly. Most of all, I live in hope that something might come along soon—if not in the Queen’s Speech, soon thereafter—that will address this fundamental unfairness that must be gripped quickly. I thank noble Lords for taking part in the debate.