Personal Service Companies (Select Committee Report)

Baroness Noakes Excerpts

Tuesday 17th June 2014 Lords Chamber

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.

--- Later in debate ---

[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 ---

[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.