Personal Service Companies (Select Committee Report)

Lord Hope of Craighead Excerpts

Tuesday 17th June 2014 Lords Chamber

[Lord Hope of Craighead (CB)]

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

As I understand it, the complex, perhaps outdated, nature of our system of income tax and national insurance contributions lies at the heart of the problem.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

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

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

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

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

“differing engagements can result in differing tax consequences”.

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

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

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

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

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