Personal Service Companies (Select Committee Report)

Lord Davidson of Glen Clova Excerpts

Tuesday 17th June 2014 Lords Chamber

[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.

--- Later in debate ---

[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.