IR35 Tax Reforms

Ged Killen Excerpts

Thursday 4th April 2019 Westminster Hall

[Ged Killen (Rutherglen and Hamilton West) (Lab/Co-op)]

I beg to move,

That this House has considered IR35 tax reforms.

It is a pleasure to serve under your chairship, Mr Gapes. We are now a year out from the Government’s extension of the IR35 rules to the private sector, and we are halfway through the Treasury’s further technical consultation, which is due to conclude on 28 May. Although the IR35 reforms are a complicated issue, I hope that this debate will provide an opportunity for us to add something to the process, raise the concerns of constituents who will be affected by the changes, and flag up to the Minister our anxieties about the IR35 roll-out into the private sector.

The rules have been a long time in the making. It was in the late 1990s that concerns began to creep across Whitehall that private service companies were becoming a widely utilised tool to disguise worker status, allowing some workers to perform the role of an employee while they and the employer reaped the tax benefits of a business-to-business relationship. We all want to tackle non-compliance and tax avoidance and close any loophole that allows an employee to leave their employment on a Friday and return to the same role in the same office on the Monday as a contractor or consultant through a PSC, paying less tax. The question, however, is how it is being tackled and what impact it will have on legitimate small businesses and the clients who engage them.

The last Labour Government introduced provisions to allow the tax authorities to take a closer look at contractual relationships to identify where an intermediary, such as a PSC, may be being used to avoid tax contributions and associated workers’ rights. That legislation, known as IR35, was introduced in 2000 following the March 1999 Budget statement. It was a controversial measure at the time, and calls to scrap it came from different parties. However, although the initial implementation created problems that still bedevil the modern IR35 rules, the legislation took important steps to avoid a contraction of the tax base as self-employment increased across the UK labour market and to ensure that where individuals acted as employees, they were treated as such.

In many ways, the objectives of the original IR35 rules were significantly ahead of their time. The growth of self-employment in the UK economy has produced several structural problems, with employment status and the gig economy leading to situations in which employers can privatise the reward of lower-cost labour through tax avoidance, but socialise the risk that comes from cutting corners, with the costs borne inevitably by the public purse.

The Select Committee on Scottish Affairs, on which I sit, has looked closely at the impact that unclear worker status can have on the wider economy. Our inquiry considered the findings of the Taylor review and supported its conclusion that there is an “overwhelming case” to tackle the lack of clarity around employment status. We also supported its recommendation that the Government should produce

“a clearer outline of the tests for employment status, setting out the key principles in primary legislation”.

Perhaps at the moment the Government lack the necessary bandwidth and political capital to follow through fully on the review’s recommendations, but that is ultimately where we must end up.

One of the major issues with the IR35 changes is the great difficulty in assessing whether an individual should be caught by the rules. Her Majesty’s Revenue and Customs’ guidance and tools are far from 100% effective, and there is a lot of complex case law. I would therefore be grateful if the Minister said what progress the Government have made on the issue and on the Taylor review’s recommendations.

It is impossible to look at the myriad changes that the labour market is likely to go through in the coming decades and not conclude that legal clarifications will need a serious rethink, particularly to secure the integrity of the tax base that will be all too important in an ageing society. In many ways, the IR35 rules are a stopgap in the journey towards a statute book that supports 21st-century employment practices and the realities of modern workers’ lives. I have no doubt that the objective of the reforms is correct, but their implementation threatens to scupper any associated benefits.

The roll-out of the IR35 rules in the public sector has raised several concerns that need to be ironed out. Independent research has highlighted problems in implementing the reforms, including initial unfamiliarity with the legislation and guidance, which has resulted in compliance problems. Many public authorities were found to be overly cautious or to have judged more contractors to fall within the rules than they should have.

The incentive, of course, is on the fee payer to take a cautious approach rather than leave themselves potentially vulnerable to future tax liabilities. If there are agencies in the contractual chain, it is the agency immediately above the PSC in the chain that becomes the fee payer and is therefore responsible for the liability of an incorrect status decision, so an agency is unlikely to dispute a decision that brings the contractor within IR35 even when it should not be. I know that the Government are exploring options for the consequences for businesses that fail to use reasonable care in making a decision. Will the Minister update us on progress in that area?

Concerns have also been raised about the reforms’ impact on the ability of public authorities to recruit contractors in sufficient numbers and with the required range of skills, as a result of which the rates for off-payroll workers have increased in some areas. Some contractors have been put off working in the public sector at all.

Many of those problems in the public sector have been solved, or at least mitigated, but the private sector presents a very different problem, with significantly greater variation, potentially weaker channels of communication and less room for manoeuvre when things go wrong. That has led a number of membership organisations, including the CBI, to call on the Government to extend the trial period in the public sector and offer extra resources to support the initial roll-out when the private sector is eventually included. The CBI was so concerned that it even went as far as to ask the Government to eliminate the prospect of an early roll-out in 2019.

We are in a state of great uncertainty about our future relationship with the European Union and its likely impact on businesses, the economy and private sector recruitment. I wonder whether the Government will consider delaying the roll-out beyond 2020 if it is deemed necessary. I have received representations from constituents who operate as contractors and have enormous reservations about the extension of these rules, and I am sure other hon. Members have received such representations.

One constituent who came to my surgery set out his concerns about the complexity of the system. He has deep reservations about whether it could be implemented successfully and about the costs when things go wrong. He says:

“I have no idea how clients will assess my work when the responsibility transfers to them, and neither do they”.

He believes there will be widespread non-compliance as clients struggle to make assessments and default to playing it safe. He works in IT, and also has deep fears about where ultimate liability will rest. I know the idea is that the fee payer is responsible, but contractors are looking at recent HMRC decisions about various schemes that were deemed legal when they were set up, which are now leaving individuals with massive retrospective tax bills. There is a worry that poor application of the rules now could end up meaning that individuals face bankruptcy later down the line if they are chased for payment.

My constituent sums up his concerns by wondering if there will be any point in continuing as a contractor at all. Among the reasons, he cites potential problems for processing expenses. In the public sector, we have heard about the removal of the 5% allowable deduction from the income of personal service companies for general expenses incurred in running the business. If all engagements are treated as caught by IR35, all the income accounted for is either tax, national insurance contributions or net pay, so there is nothing to set running costs against.

My constituent also says that the situation could lead to him setting up an umbrella company, which would increase costs. He is seriously concerned about that, as he is about the potential for disproportionate costs to be passed on to the contractor by clients. He says:

“Ultimately, if the benefits are removed from me and I am actually paying more tax than a regular employee, with none of the rights, then I have a difficult choice to make. What will my clients do if they cannot source flexible skills in the contract market due to many others doing the same as me? They have two choices: one is to hire an employee, which defeats the ‘flexibility’ argument. If they cannot hire an employee just for the duration of a project, they will most likely go to a large organisation, such as IBM or Capita who will charge them 2-3 times the contractor day rate.”

My constituent makes the important point that those large companies are much more likely to have sophisticated tax and legal expertise at their disposal than small businesses such as his.

What my constituent says about being treated as an employee for tax purposes while not enjoying the same employment rights is crucial. I know that the Government are aware of that point, and I would be grateful if the Minister would update us on their current thinking. I am sure that the Minister will recognise many of the concerns that my constituent has highlighted, as they reflect much of what has been raised by private sector interest groups and in Government consultations.

As I said before, the aims of the IR35 rules are right, but the prospect of their implementation has fostered a very bleak view indeed. The substance of this implementation must therefore be better, as the rules will be wholly self-defeating if, by their very nature and complexity, they force contractors out of the market or encourage more sophisticated forms of tax avoidance. I am sure all of us here would agree that the aim is to allow flexibility where needed, while ensuring that revenue and rights are not lost where a contractor effectively becomes an employee.

I have asked the Minister for quite a lot of things. When he is summing up, I hope he can provide a further update on the use of the IR35 rules in the public sector, particularly around compliance with the rules, uptake and concerns that companies are exiting the public sector market because of those rules. I hope he will summarise the key lessons the Government have learned from the public sector roll-out and how they are being adjusted to suit the different nature of the private sector. Will he clarify whether the Government have any ambitions or plans to further roll out the IR35 rules to small businesses in the private sector? Will he also give an update on how the IR35 rules sit in the Government’s wider consideration of the recommendations of the Taylor review?

--- Later in debate ---

[John Glen]

I certainly agree with the hon. Gentleman’s instinct that tax simplification is how all Governments should seek to develop tax reforms. I will make some observations about that later.

As we have heard, the Government have set about extending the reform of the rules that govern off-payroll working. Those rules, known as IR35, were introduced in 2000—in fact, in the previous year’s Budget—to ensure that people working through their own company, who but for the existence of that company would be taxed as employees, pay broadly the same tax and national insurance as other employees. The rules do not affect the genuinely self-employed, and the Government recognise the massive contribution that contractors make to business and public services across the country. Our aim is simply to ensure that contractors who work through their own company pay the right tax.

However, evidence suggests that the rules have frequently been misapplied, meaning that contractors acting as employees were incorrectly paying less tax than if they had been employed in the usual manner. In April 2017, the Government introduced reforms for public sector organisations that take on contractors through their own companies. The reforms mean that public sector organisations are now responsible for deciding whether the contractor is acting as an employee and is therefore within the rules, as well as for ensuring that the right amount of tax is paid.

HMRC estimates that the reform has raised an additional £550 million in income tax and national insurance contributions over the first 12 months.

[Ged Killen]

Does the Minister know—I am not claiming that I do—how much of that £550 million is the result of the public sector incorrectly sweeping up contractors into the IR35 rules?

[John Glen]

I am not aware of any distribution analysis, but I will check with officials, and if I can give clarification on that, I will do so by letter.

Non-compliance in the private sector remains a persistent and growing problem that, if left unchecked, will cost the taxpayer as much as £1.3 billion by 2023-24, according to the Government’s estimates. In last year’s Budget, the Government announced that we will extend the reform of off-payroll working rules to all sectors, including the private and voluntary sectors. That will help to address the issue of non-compliance and to ensure there is a level playing field for the public sector and other sectors when hiring contractors.

The Government have listened to the views of individuals and businesses and have decided that the reform will apply only to medium and large organisations. It will not extend to the smallest 1.5 million businesses. In addition, it will take effect from April 2020, to give businesses and other organisations time to prepare. The Government are consulting on the detailed design of the planned reform, and we are listening carefully to the representations made. Our aim is to provide the individuals and organisations concerned with greater certainty about how the off-payroll working rules will operate from April 2020 in all sectors, including about the actions they can take to prepare for the changes.

Hon. Members talked about HMRC’s check employment status for tax—CEST—tool and raised some questions about its effectiveness. CEST was developed in consultation with stakeholders, including tax specialists and contractors, to assist individuals and public authorities in making the correct determinations. HMRC will stand by the result of CEST, provided the information entered is accurate and in line with HMRC guidance. It gives an answer in 85% of cases, and where it does not, more detailed guidance and support are available through a telephone number for individuals.

To support organisations in applying the rules, HMRC will continue to review and improve CEST. HMRC has already held user research sessions, and will continue to work with stakeholders over the coming months to ensure that the tool and the wider guidance suit the needs of all sectors, and to address specific points raised during the consultation. Enhancements will be tested and rolled out before the reforms are introduced in 2020. I asked officials for greater clarity on what that is likely to mean, and we are talking about improved guidance, better phraseology and improved language that gives greater certainty to individuals who make inquiries.

The hon. Member for Brentford and Isleworth (Ruth Cadbury) mentioned the issue of blanket decisions in the example she gave. Members have expressed concern that businesses might take a blanket approach to applying the off-payroll working rules to contractors without looking at the facts of individual cases. Independent research suggests that has not generally been the case in the public sector, where the reform has been in place since April 2017. I cannot account for every case, but research was done to evaluate the issue because it was a legitimate area of concern. The vast majority of public bodies are making assessments on a case-by-case basis. I have looked into how that research was done— HMRC commissioned an external independent organisation to speak to central Government Departments, the NHS and local government departments to ascertain that.

Having listened to people’s concerns, we included proposals in our recently published consultation to help to ensure that processes are put in place for individuals to resolve disputes with their engagers directly and in real time. The proposals would put a legal requirement on engagers to have a status disagreement process in place, and would require them to consider evidence provided by an individual contractor and review their status determinations accordingly. HMRC is committed to working with organisations to ensure they make the correct status determinations, and will publish detailed support and guidance to help organisations prepare well ahead of April 2020.

--- Later in debate ---

[Ged Killen]

I thank the Minister for his response and hon. Members for attending the debate. This is a very complicated issue, and it is not necessarily one that sets pulses racing. However, for the people affected, their livelihoods are at stake, so I am pleased that Members have had the opportunity to raise their constituents’ concerns.

My hon. Friend the Member for Brentford and Isleworth (Ruth Cadbury) spoke about what is going on in the NHS, and the hon. Member for Inverness, Nairn, Badenoch and Strathspey (Drew Hendry) pointed out how many public services in rural communities are dealt with in this manner. We have not yet got this right in the public sector. That is the crucial point: if we cannot get it right in the public sector, these issues will only be amplified in the private sector. We have to consider that carefully.

As my hon. Friend the Member for Clwyd South (Susan Elan Jones) said, people’s livelihoods and incomes are at risk because, for example, expenses will be treated as earnings. For a lot of small businesses, having expenses treated differently could be the difference between success and failure. Small decisions in this respect may have major impacts.

My hon. Friend the Member for Glasgow North East (Mr Sweeney) mentioned the CEST tool, which I touched on in my opening remarks. I am not comforted by what the Minister said about that tool, purely because I have experience of it in a previous life and I know just how inconclusive it can be.

[John Glen]

I am happy to meet the hon. Gentleman to engage further on that and discuss his concerns in detail. I am not paying lip service to the consultation; I want it to be effective, and I want the tool to be as effective as possible.

[Ged Killen]

I thank the Minister for that. I appreciate that we can have a constructive approach. I do not think any of us disagrees about the principles; this is about getting it right.

HMRC’s idea of working with people to assist them is different across the board. I point out gently to the Minister that it can be daunting for people to have HMRC assisting them, because it provides guidance but it is also the enforcer. People are therefore keen to get things right on their own, so we need a fair and transparent system that everyone can understand and use fairly. If we can get a tool that works, that is great, but let us make sure we have one before we come down too hard on people.

I did not hear the Minister confirm whether the changes will eventually be rolled out to small businesses in the private sector. I appreciate that he might not be in a position to answer that today. If the Government are considering that, I urge real caution. They have not suggested that yet, but, having come from a small business background, I can say that that would be a very difficult prospect.

[Mr Sweeney]

My hon. Friend makes an important point about the roll-out being restricted to larger businesses, which the Minister referred to. The changes will inevitably also impact small businesses, which are contractors with areas of expertise. For example, a large bank such as Barclays might commission a software expert to come in and build a product or tool, and that expert might in turn employ staff to support that project. If we classify the person who runs that small business as an employee of the bank, how are they meant to pay their staff?

That is the fankle that this reform will result in. It will draw us into situations where thriving, dynamic businesses that are responsive to the needs of large businesses—small businesses that can, for example, plug into a large financial institution to deliver a bespoke project and detach again —are not able to function in that way because their people will be pulled in as payroll staff members. Does my hon. Friend agree that those will be some of the inevitable negative impacts for small businesses if the Government do not get their act together with these changes?

[Ged Killen]

I absolutely agree. Small businesses will be affected by these changes anyway. People will be operating in a two-tier system, because many will work for small businesses as well as for large businesses in the private sector, and different rules will apply in those situations. I am not saying that is an argument for equalisation, because I still think it would be difficult for small businesses to act as the judge of whether someone falls under the scheme.

I am not in any way opposed to the principle of preventing tax avoidance. We all want to ensure that we boost tax revenues as much as possible, but that must be done fairly and transparently, and we must not destroy flexible working in the economy or self-employed people and small businesses in the process.

Question put and agreed to.

Resolved,

That this House has considered IR35 tax reforms.